I need someone to help me understand leverage!

[Carl Flint]

BP!

I need some help.

Today my girlfriend and I were having a debate on buying a property using leverage through a loan or buying a property outright in cash. I know that leverage is can be a good thing for investors if the numbers work.

I need help understanding so that I can explain the pros of using leverage to someone who has no knowledge of the real estate world.

Basically, I need an elevator speech on leverage and why to use it.

[Bill B.]

All numbers rounded off and made up, and ignores expenses other than interest but the idea is....

You have $100k.

You can buy 1 x 100k property that rents for $1,000/mo and you make  $1,000/mo

You can buy 2 x $100k properties with 50% down $2,000/mo minus $225 x 2 (3.5% 30 year) $50k mortgage payments ($450) = $1550/mo cashflow but $160/mo is going towards loan paydown so your income per month is $1,710.

You can buy 4 x 100k properties with 25% down: $4,000/mo minus $337 x 4 (3.5% 30 year) $75k mortgage payments ($1350) = $2650/mo cash flow but $472/mo is going towards paying down loan so your income is $3122/mo.

Leverage: Cons: 

(1) Numbers aren't really this rosey as you're quadrupling your insurance and property taxes.

Pros: 

(1) If you only own 1 property it WILL occasionally be 100% vacant. if you own 4 houses they SHOULDNT all be vacant at the same time, and you actually make $650+$236 or $886/mo with only two occupied. Almost as good as the solo one.

(2) with some VERY mediocre appreciation, say Fed's inflation target of 2%. You make $8k/year versus $2k, that's an extra $500/mo. No imagine if you pick a decent place to invest and its 4 or 6%, that alone could be $1,000-$1,500/mo.

(3) year 1 is the worst comparison for leverage, each year after that you get rent increases times 4 instead of 1, and the interest portion of the payment goes down. (I used the worst month (#1) for comparisons, so even month 2 is better.)

If your plan is to only ever own one and you want super safe paying 100% cash is bad but not horrible. But, if you plan to buy 4 eventually anyway. Then unless you truly believe houses in your market will be cheaper in the future (in which case, don't buy there.) You'll miss out on historically all time low interest rates and rent today so that you can pay more for the property in the future.