No-, Little-, or Lots of Leverage?
Here is a theoretical question about leverage for you. Below you will find some information and 4 alternatives. I would really like for you to give it some thought and write why you think your alternative you chose is right for you.
First the "parameters" in the example. To make it simple, all houses are the same.
- Purchase Price $55.000.
- Income is $775 per month.
- Expenses (excluding mortgage and maintenance) is $290 per month.
- Repair budget is $110 per month.
- Mortgage size 1: $30.000 @ 5% interest. $115 monthly principal. $125 monthly interest.
- Mortgage size 2: $35.000 @ 5% interest. $117 monthly principal. $128 monthly interest.
- You start with $135.000 in Cash.
Alternative 1: No Leverage
Cash on hand: $25.000
Property 1 – Value $55.000 – $55.000 Equity – $0 Liability
Property 2 – Value $55.000 – $55.000 Equity – $0 Liability
Combined Asset Value: $110.000
Money Down: $110.000
Mortgages: $0
Annual Rental income: $18.600
Annual Estimated Expenses minus mortgage and repairs: $7.000
Repair Budget: $2.600
Annual Cashflow: $9.000
Annual debt reduction: $0
NOI: $9.000
Assets ROI: 8.18%
Alternative 2: Leverage 2 properties to buy a 3rd
Cash on hand: $30.000
Property 1 – Value $55.000 – $25.000 Equity – $30.000 Liability
Property 2 – Value $55.000 – $25.000 Equity – $30.000 Liability
Property 3 – Value $55.000 – $55.000 Equity – $0 Liability
Property 3 – 100% Equity – 0% Liability
Combined Asset Value: $165.000
Money Down: $105.000
Mortgages: $60.000
Annual Rental income: $27.900
Annual Estimated Expenses minus mortgage and repairs: $10.400
Repair Budget: $4.000
Annual Mortgage P&I: Principal $2.800 – Interest $3.000
Annual Cashflow: $7.700
NOI: $10.500
Assets ROI: 9.55%
Alternative 3: Leverage 3 properties to buy a 4th
Cash on hand: $20.000
Property 1 – Value $55.000 – $20.000 Equity – $35.000 Liability
Property 2 – Value $55.000 – $20.000 Equity – $35.000 Liability
Property 3 – Value $55.000 – $20.000 Equity – $35.000 Liability
Property 4 – $55.000 Equity – $0 Liability
Combined Asset Value: $220.000
Money Down: $115.000
Mortgages: $105.000
Annual Rental income: $37.200
Annual Estimated Expenses minus mortgage and repairs: $13.900
Repair budget: $5.300
Annual Mortgage P&I: Principal $4.200 – Interest $4.600
Annual Cashflow: $9200
NOI: $13.400
Assets ROI: 11.65%
Alternative 4: Leverage 4 properties to buy a 5th
Cash on hand: $0
Property 1 – Value $55.000 – $20.000 Equity – $35.000 Liability
Property 2 – Value $55.000 – $20.000 Equity – $35.000 Liability
Property 3 – Value $55.000 – $20.000 Equity – $35.000 Liability
Property 4 – Value $55.000 – $20.000 Equity – $35.000 Liability
Property 5– $55.000 Equity – $0 Liability
Combined Asset Value: $220.000
Money Down: $135.000
Mortgages: $140.000
Annual Rental income: $46.200
Annual Estimated Expenses minus mortgage and repairs: $17.400
Repair budget: $6.600
Annual Mortgage P&I: Principal $5.600 – Interest $6.200
Annual Cashflow: $10.400
NOI: $16.000
Assets ROI: 11.85%
As you take on more properties, you increase your NOI and the rate you are growing your wealth. But you also take on more risk of having big expenses. And as you take on more properties, your savings to handle these expenses decrease. I am really interested in hearing your thoughts on this. So please write your answer below.
Comments (1)
I'd say it very much depends on your goals, your approach, and your ability to tolerate risk.
The more you leverage, the faster you can grow, and the faster you can (potentially!) arrive at a larger portfolio with a larger income stream. After all, leverage is one of the great advantages with real estate. One the other hand, little or no cash left on hand leaves you much more exposed to random events and throw backs.
If you purchase the houses at market value and cash flow is the only way you make money, then perhaps there is no immediate reason to rush too much. If, on the other hand, part of your strategy is to purchase below market value (to flip or simply to get some extra equity in the property), then you make a big chunk of your money (maybe even all of it) when you buy. In that case, you'd need to buy as frequently as possible to maximize your gains.
Lastly, what about pulling out equity out of the homes once they have seasoned? I mean, what is the reason to have them paid off completely, to buy them in cash? Is that per se a goal for you? Something to arrive at as fast as possible? Or do you want to build up a nice cash flow as fast as possible, in which case leveraging will probably get you there much faster (provided you try to minimize your risk and/or are lucky).
Severin Sadjina, about 7 years ago