BiggerPockets

Hi, I'm wondering which is better? Below are 2 examples of leverage asset VS solid asset. Please help me by contributing your most valuable comments. This topic has been running around in my head all day long. Thanks.

LEVERGE ASSET

Cost Of Property: $40,000
Downpayment: $8,000
Monthly Rental Revenues: $750
Monthly Debt Services & Other Expenses: $550
Monthly Cashflow: $200
Cash On Cash Return: 30%

Pros: Use only $8,000 and the monthly debt service will be paid with money collected from tenants. After debt is fully paid, the property cost me only $8,000 instead of $40,000.

Cons: If mortage rate goes up drastically, in the event tenant moves out, etc.. this could become a liability instead of an asset.
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SOLID ASSET

Cost Of Property: $40,000
Monthly Rental Revenues: $750
Other Expenses: $100
Monthly Cashflow: $650
Cash On Cash Return: 19.50%

Pros: No fear of tenants moving out, no foreclosure risk as I do not need the money collected from tenants to pay the bank.

Cons: $40,000 can be put into many leverage properties that are able to generate even more cashflow and owning more properties. Upon all debts fully paid by tenants, I own even more properties.
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If you're a savvy investor, which would you choose? Leverage or Solid?

In my own opinion, which I could be wrong, I'd prefer leverage assets as they generates more cashflow and I'm able to own more properties with just a fraction of the total cost of the property.

Of course there are downsides to consider as well. If cashflow every month from each property is positive but pathetically small, runs the risk of bankruptcy if mortgage rate turns against you when you own alot of pathetically small cashflow generating assets.

Without taking the specific examples into account (I agree with Charles they may not be realistic), but to answer this question...

There are savvy investors who would choose Option 1 (leverage) and there are savvy investors who would choose Option 2 (all-cash). There is no right or wrong decision for everyone, but there are two important questions you should ask yourself to figure out the correct answer for YOU:

1. What are your goals and which option best allows you to achieve them?

2. What is your risk tolerance?

Also remember that you can use less leverage that reduces your risk but still provides some benefits of leverage? And your scenario implies that you are using adjustable rate financing, which in my opinion certainly detracts from the leveraged scenario given the likelihood of rates rising over the next several years.

Leverage cuts both ways. With loan constants as low as they are currently you can likely get positive cash flow at 60-70% leveraged IF you locate good deals. Note that this is based on ARV and not the purchase price. You have to buy in the right locations.

A lot depends on knowing how to do the analysis correctly. Read through the rental property forums and learn about real-world cash flows. That would be a good place to start.

For any "savvy investor" to properly analize an investment, he/she must be working with accuarte and realistic numbers first.

From your solid asset scenario, this is not the case. With gross rents at $750, your monthly expenses will certainly be higher than $100 which is only 13.33% of the gross.
After you factor in vacancies (which you will have over time), eviction costs, repairs, taxes, insurance, utilities, capital expenses, etc. you can certainly expect more than 13% of the gorss rents.

One of the most important reasons that makes real estate a great investment vehicle is the ability to leverage your investment. You can't do that with any other investment. I will personally look to eventually use leverage as much as possible to increase my rate of return and maximize number of investment properties.

Bryan, you are correct. I should have added that caveat, but I was simply speaking for an average beginner investor.