Using Money to Buy/Rent Out or Lend out as Private Lender

[THU NGUYEN]

Hi BP members,

I need help analyzing the follow:

In Houston Rental market (suburban), most will follow the 1%...so here is my calculation for getting a rental house that can rent out for $1500/month, at $150K

	Monthly
Rent	1,500	18,000
50% rule (tax, insurance, HOA, Maint 10%, Vacancy 8%)	(750)	(9,000)
Mortgage	(539)	(6,468)
Cash Flow	211	2,532
Price	150,000
20% downpayment	30,000
Closing Cost	4,000
Total Cash out	34,000
Cash on Cash Return	7.4%
Cap Rate	2%

If I get COC return at 7.4%, why should I or any other investors do it? If you lend your money out to as private lender or even on Realtyshare.com; RealtyMogul.com you see that the return can be as high as 13% or as low as 9%.

Am I thinking straight?  Why should I buy and hold a rental property for 7% vs lending out cash at higher rate?

Thank you in advance for your help.

[Jered Sturm]

I would have to respectfully disagree with @Kami S.

Hardmoney lending:

$34k lent out for 1 year at 12% interest will give you a gain of $4,080k. Lets assume you are in a 35% tax bracket. You will cut a check to the IRS for $1,428k, leaving you with $2,652k or a after tax cash on cash of 7.8%

Rental property investment:

$34k down payment on a $150k building. At an 6% capitalization rate (very achievable) you are left with $9k net operating income. lets assume when you borrowed the $120k from the bank they lent it to you at 3.5% interest over a 30 year term. This means your monthly mortgage payment is $539(given by you) leaving you with $2,532 in annual cash flow or a pre tax cash on cash return of 7.4%. This does not beat your 12% from above but we haven't even started on all the other benefits of investing in real estate.

So you cash flowed $2,532k do you pay tax on $2,532k?? NO! another beauty of real estate and leverage is the depreciation tax benefit. Even though you only put 20% of the $150k in to the property you get ALL of the depreciation. residential real estate is depreciated over 27.5 years which means you get to depreciate $150k/27.5=$5,454. What does this mean? It means you don't pay any tax on that $2,532k you made on the building. You actually have a paper loss of $2,922. This loss can off set other income. Again assuming a 35% tax bracket the paper loss of $2,922 would result in an additional $1,022 in tax savings. This means your after tax return is 10.4% substantially more than after tax return from hard money lending.

Thats all great and will make you a lot of money, but where wealth is built is in the amortization of the debt you put on the property. The $120k in debt you put on the building will have a tenant paying down your mortgage month after month. In our example after 10 years you will only owe $92,644 on the building IF the property never appreciated one cent and it was still worth $150k in 10 years you would have $57,356 in equity. You could then sell it or refinance it (again tax free).

Now lets wrap the amortization into our example. using the loan terms I mentioned the first years of the loan will result in a $2,499k reduction in principle or if the value stays the same that would be seen as a $2,499K increase in equity. If we add that $2,499k into the cashflow and tax benefits we are left with a all inclusive after tax return of 17.8%. How much tax do you pay on that??? NONE.

This is just the basics. You can accelerate depreciation benefits through cost segregation, Structure loans for quicker amortization depending on your goals and many other tricks.

I obviously enjoy talking about this stuff. Feel free to reach out to me whenever and we can talk more.