Snowballing Real Estate Strategy

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Snowballing Real Estate Strategy

Michael Lopez
Realtor · Delray Beach, FL · Member since 2017 · 102 posts · 20 votes

I have heard of a snowball strategy of paying off rental properties that can speed up the number of doors you can acquire over time. Can this strategy work with partners in which 2 - 4 people put in enough to purchase the first rental then implement the strategy moving forward utilizing the rental income and equity? Can something like this work and has anyone ever heard of such a thing?

For example: 4 people put in equal amounts to purchase a $200000 property in which $2000-$2200/mn rent can be collected. How can we make this strategy work moving forward now that we have a $200k property paid off and collecting monthly rent. We obviously have to take into account monthly fees for the property such as maintenance, CAPX and so on. Can this work? Thoughts?

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Chris SeveneyBusiness Member
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Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
5y

@Michael Lopez

While it’s not a bad idea - having leverage on properties is not a bad thing in a low interest rate environment. If you put 25- 40% down and financed 60-75% on $200k properties you would be able to acquire more properties. If you can earn more than the rate you are paying then it’s worth it to take on some leverage but always be careful not to over leverage

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  • Michael Lopez
    OP
    Realtor · Delray Beach, FL · Member since 2017 · 102 posts · 20 votes
    5y

    What do you think may be some of the pitfalls of going this route?

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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    5y

    @Michael Lopez

    While it’s not a bad idea - having leverage on properties is not a bad thing in a low interest rate environment. If you put 25- 40% down and financed 60-75% on $200k properties you would be able to acquire more properties. If you can earn more than the rate you are paying then it’s worth it to take on some leverage but always be careful not to over leverage

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  • Michael Lopez
    OP
    Realtor · Delray Beach, FL · Member since 2017 · 102 posts · 20 votes
    5y

    @Chris Seveney thank you for the reply. Let me throw age and time into the equation. If there was between 10 to 15 years before “retirement age”, would paying off the first property up front make sense while still having enough to do what you recommended for the 2nd property? Then using the rent from the first property to help pay down the second property as fast as possible to pick up the 3rd property.

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  • Colin Dingfelder
    Investor · Minneapolis, MN · Member since 2021 · 14 posts · 8 votes
    5y

    I guess to fully answer your question, you would need to know exactly how many years before retirement. Or maybe a better way to word the question is how long until the rent payments are no longer going towards paying off additional properties? If you are planning on retiring in 10 years and would like to then start living off of the rent you are receiving, that will obviously play a factor in the best way for you to accumulate properties now.

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  • Cory CarlsonBusiness Member
    Real Estate Broker · OR · Member since 2018 · 311 posts · 226 votes
    5y

    Accelerated paydown is not an advisable strategy, even nearing retirement age. Buy/hold return metrics are generally based on this basic formula: Income $ / Invested equity. Let me give you a couple examples.... 

    We need to know these facts first: 

    1. Income + other income (laundry, RUBS, parking, etc) - vacancy = Effective Gross Income

    2. Effective Gross income - debt = Pre-tax cashflow (ie. whats left over after expenses and debt service)

    By accelerating your paydown on a property you're raising the denominator in the calculation faster than the numerator. Essentially you're returns based on how much money you have invested is getting lower. People get so fixated on the dollar amount they are getting in return but overlook the fact that its how much is that dollar you're making to your investment. To take this a step further would be to incorporate taxes - After-tax cashflow is based on the investors effective/marginal tax rate, depreciation (this is strategy specific) and interest expense. 

    This is just the gist of the illustration. Here is a PDF that serves as a great illustration on leverage and the 4 major return metrics: 

    1. Pre-tax cashflow

    2. After-tax cashflow

    3. After-tax cashflow + Principle paydown

    4. After-tax cashflow + Principle paydown + Appreciation (the only subjective component in the 4 metrics) 

    *The first 3 are just arithmetic, the 4th has some objectivity to it.

    You could analyze an accelerated paydown scenario on a buy/hold property and you would see your returns drop faster based on your invested equity. Simply put, your money isn't working as hard. 

    EDIT: The PDF is on my profile, couldn't figure how to attach. 

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