Need advice on investment property

[Hans Cooke]

Just starting out here...

Have $50,000 to invest in real estate.

Would you:

A) Buy one Condo / Apartment outright (paid in full) and rent it out

or

B) Mortgage two Condo / Apartment's (either 15 or 30 year) and put $25,000 as a down for each


I am leaning towards the first option.

Help me understand the pro's / con's of these choices.

Thanks

[JT Spangler]

Apologies for being far from an expert on this, but the conventional wisdom is that, all else being equal, more properties is the better play. In general, cash is king, and you want to use as little of it as possible to generate a positive cash flow return.

Let's look at your example, and make some assumptions, and then tack some numbers on there. We have two identical 2/1 condos, each with a 50k purchase price, where each rents for $750/month. For simplicity's sake let's ignore the soft costs like closing, title, and inspection.

Scenario 1: You spend your 50k on buying one of them outright, and your gross income is $9000/yr (750*12). Cashflow is $375/month or $4500/yr (50% rule says that half of your gross income can be expected to go towards your non-mortgage expenses, such as maintenance/vacancies/management/capex/utilities/etc). Your cash on cash return (the money you get back vs. what you put in) is $4500/$50000, or 9%. Fair, I suppose, but let's look at scenario 2.

Scenario 2: You spend 50k to put 25k down on both condos, meaning you're financing the other 50%. Your expenses are doubled (two units), but so is the rental income. The added variable is debt servicing. Again, with numbers. Gross Income is 18k/yr (2*750*12). Expenses are $9000/yr (50% rule). Leftover is profit of 9k, but you still have to pay the mortgage. I plugged financing 50k at 5.25% over 30 years into a mortgage calculator and got payments of 275/mo, which is the total debt servicing on both units. So 9k - (275*12) = $5700 yearly cashflow. Better! And your cash on cash return is 5700/50000, or 11.4%. Better there are well.

The thing to understand is that your best cashflow is going to be on a property that's paid off, but it's artificial, because you have to put more cash into it to force that return. Cash that's tied up in rentals is cash that can't be used to buy more rentals.

Suppose we take it even further (why not?!) with scenario 3: 4 condos, each listed for 50k and with that same 750/mo rent. You put 25% down on each (for a total cash outlay of that same 50k), and finance the remainder. Gross income is 36k/yr (4*750*12), and expenses are 18k/yr (50% rule). Leftover profit (called Net Operating Income) of 18k/yr. Now subtract the debt servicing (financing 150k @5.25%: $830/mo*12months= $9960/yr) and you're left with a yearly cashflow of $8040. Best yet! And your cash on cash goes to 8040/50000, or 16%!

Now, there's no question that, from a mathematical standpoint, the less you spend on a property that cash flows the better your return on investment is. But there are other expenses involved in buying multiple properties all at once, most notably the soft costs I ignored earlier (closing costs, inspections, etc). This is why people love multifamily rentals, because you get the benefit of the improved return with only one transaction.

Hope that helps!