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Numbers Don’t Lie — Theory Isn’t Strategy

Jeff Brown
2 min read

Wrote a post a couple weeks ago saying that buying all cash isn’t always the be all end all. It needs context. I easily demonstrated that two investors, each with half a million bucks, would generate wildly different results (Consequences?) if one bought six duplexes with 1/3 down payments while the other simply bought a couple, all cash. The difference was not only in ultimate cash flow, but capital growth as well. Without any appreciation whatsoever the cash buyer ended up with his original half a mil, while the other guy ended up with $1.5 Million in equity. The process took less than 13 years — 12 years, eight months to be precise.

A commenter wanted to know if it woulda been better if the cash buyer had used his annual cash flow to buy more duplexes. I promised I’d get back to him, so here we are.

Before gettin’ started, here’s a poser for ya.

What’s the ginormous, black widow flaw, in the form of an unspoken assumption, in today’s analysis? I’ll provide the answer later.

The cost of puttin’ 1/3 down on these duplexes is about $89,200, including all lender and closing costs. Loan terms are the same as in the original post.

I’ll shorten this by beginning with the fact that it’ll take 8 years to acquire the 4 duplexes required to equal the 6 bought on Day 1 by our non-cash buyer.

That leaves our cash buyer with 6 duplexes — the 2 for which he paid cash, and 4 he bought with cash flow, over time. At that point his total cash flow is $64,800 annually.

25 months later he’s paid off the first leveraged duplex. 20 months for the next one. Then 17, then 15.

To be clear, it took 8 years to systematically apply accumulated cash flow toward the acquisition of the 4 additional duplexes. Then it took an additional 6 years and 5 months to pay them off — again, using the cash flow from all 6 duplexes.

14 years 5 months from Day 1 to owning 6 debt free duplexes. That’s  a year and 9 months slower than the investor who just bought all six from the get-go.

Now, to some, that’s not a big deal. To each their own. Many just feel better with a mixture of debt free property, and are willing to pay the price for that luxury. Sometimes the price is nominal, or nonexistent. However, this particular plan has a built-in potential for monster delays, if not a complete train wreck.

Black Widow Flaw

In the 8 years it’s gonna take to systematically use cash flow to obtain the additional 4 duplexes, do ya think there’s maybe just an itty bitty chance interest rates might go up? Maybe go up significantly?

Do ya think there’s a chance they’ll rise to the point there’s no cash flow, even with 1/3 down? I dunno, my crystal ball’s been in the shop since 1980. 🙂

How ’bout yours?

Once interest rates rise, and common sense says they surely will in the next 8 years, the cash flow approach to adding more property hits an ugly roadblock. An increase of just 1% decreases yearly cash flow from that duplex by nearly 18%. Wonder if that’ll slow his plan down just a tad?

Ya think?

Meanwhile, the investor in the original post secured the lowest real estate investment interest rate in my entire 41 year career — on all 6 properties. He’s not frettin’ a bit about what rates do. His main concern is how he’s gonna spend the $108,000 he’s gonna be bankin’ every year once his plan is fully executed.

Remember too, that his plan included the assumption that neither the properties’ NOIs or value would ever increase.

What approach do you prefer? It’s up to your comfort level — and your gamblin’ spirit, isn’t it?

BawldGuy Axiom: Using theory without analysis as strategy is gambling. Gambling as a strategy to fund your retirement is strongly discouraged here. 🙂

Feelin’ lucky?

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.