How to determine how many investment properties to buy

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

First of all, I really do appreciate all the helpful guides and discussions on here to help educate a new REI such as myself.

We can all invision the statement "It is better to purchase 5 properties at 20% down, and finance the rest, than purchase 1 similar property cash."

I realize there are many variables such as long term goals and market, but I am trying to get your opinion on this. This is for BUY and HOLD type investing. If you had the cash, would you start with putting 20-30% down on a single property, and look for several more in the coming months?

For the most part, buy and hold investing is tricky in Hawaii when demand is high and rental income is not great compared to purchase prices in a currently seller's market.

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Raj Gandhi

Real Estate Investor · Saint Paul, MN · Member since 2014 · 145 posts · 60 votes

12y

I'm new here but why not jump in, eh? Disclaimer, I'm an engineer, not a finance person so sometimes I don't know the jargon. This thread might be dead already but it feels like there isn't consensus.

Regarding the suggestions for soul-searching for the OP (what's your risk tolerance, goals, profit target, etc.), try this: (my) #1 rule of business is don't lose money. Also, my guidelines are: if the (annual) return on investment is >20% then it is "a business", if the ROI is <10% then it is "a hobby". Between 20% and 10% is a struggle. Try using those buckets when you research investments and see if it works for you.

Here are three examples of investing $100,000 in real estate trying to illustrate buying (1) without using leverage, (2) with leverage and (3) with (evil) negative leverage. I'd never heard the term "negative leverage" but it makes sense.

Assume property cost is $100k, annual rent income is $18k, annual non-mortgage expenses are $10k. In scenario 1, buy with all cash. In scenarios 2 & 3, buy with $25k cash down payment and borrow $75k. Note, in scenarios 2 & 3, you only had to pay 1/4 of your cash to acquire the property. So, you're going to buy three more just like it (because it is a new complex of buildings, or whatever). In scenario 2, the 30-year mortgage interest rate is 4%. In scenario 3 the interest rate is 12%.

1 2 3 Scenario

$100k $25k $25k per unit cash outlay

$18k $18k $18k per unit annual rent income

-$10k -$10k -$10k per unit annual expense

$0 -$4.3k -$9.3k per unit annual mortgage cost

=======================

$8k $3.7k -$1.25k per unit annual profit

8.0% 14.8% -5.0% per unit annual profit

$8k $14.8k -$5k annual profit per $100k invested

The point of scenario #3 is that, by borrowing money at a bad rate, one is losing money. Replicating that over and over multiplies the losses. Don't do it once and don't do it four times. This is how businesses fail.

The benefit of scenario #1 is that it is simple and you don't have to answer to a bank. However, scenario #2 is (the simple version of) what investors want to do. It makes more money so that you can buy more properties.

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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
Originally posted by @Andrey Y.:

For the most part, buy and hold investing is tricky in Hawaii when demand is high and rental income is not great compared to purchase prices in a currently seller's market.
You'll always make more profit by using leverage. Just don't overleverage.
For Hawaii don't look at rent to market value. Look at rent growth. With appreciation running 9% and rents increasing at 6% rents will never match some flyover ratio. THANK GOD!
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Jeff Rabinowitz
Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
12y
You will only make more money using leverage if the value of your property increases and you sell when it is higher than the price you paid. Markets, including real estate markets, are cyclical. They do go down, sometimes very quickly. Many areas are just beginning to recover from the last crash.
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Andrey Y.
OP
Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
12y
Could you briefly expand on what you mean by, 'don't overleverage'. Much thanks!

Originally posted by @Account Closed:

Originally posted by @Andrey Y.:
For the most part, buy and hold investing is tricky in Hawaii when demand is high and rental income is not great compared to purchase prices in a currently seller's market.
You'll always make more profit by using leverage. Just don't overleverage.
For Hawaii don't look at rent to market value. Look at rent growth. With appreciation running 9% and rents increasing at 6% rents will never match some flyover ratio. THANK GOD!
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J ScottPro Member
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Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
12y
Originally posted by @Account Closed:
You'll always make more profit by using leverage. Just don't overleverage.
Actually, that's not true. If your cost of capital is higher than your unleveraged return, you'll have negative leverage, and your leveraged return will be lower than your unleveraged return.
Negative leverage is different than overleverage, btw...
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
Originally posted by @Jeff Rabinowitz:

You will only make more money using leverage if the value of your property increases and you sell when it is higher than the price you paid. Markets, including real estate markets, are cyclical. They do go down, sometimes very quickly. Many areas are just beginning to recover from the last crash.
Exactly how would it be different if you didn't use leverage?
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
Originally posted by @J Scott:

Originally posted by @Account Closed:
You'll always make more profit by using leverage. Just don't overleverage.
Actually, that's not true. If your cost of capital is higher than your unleveraged return, you'll have negative leverage, and your leveraged return will be lower than your unleveraged return.
Negative leverage is different than overleverage, btw...
WHAT?
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Elizabeth Colegrove
Hanford, CA · Member since 2013 · 5k+ posts · 1k+ votes
12y
We are buy and hold investors and try to put as little down as possible. Our goal is to have at least a $200 margin (typically is $300+). As I discuss on my blog, We are happy with that because it is on a fully leverage property In a class A neighborhood. My goal is 11 because that will max out our 30 year loan capabilities.
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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
12y
Originally posted by @Account Closed:
Originally posted by @J Scott:

Originally posted by @Account Closed:
You'll always make more profit by using leverage. Just don't overleverage.
Actually, that's not true. If your cost of capital is higher than your unleveraged return, you'll have negative leverage, and your leveraged return will be lower than your unleveraged return.
Negative leverage is different than overleverage, btw...
WHAT?
Not sure how to say it more simply (it's a pretty basic financial concept), but in the case where the cost of your debt is higher than your all-cash ROI, your leveraged ROI will be LOWER than your all-cash ROI. This is called negative leverage -- the leverage causes your returns to decrease.
Here's a reasonable discussion of the subject with some good examples:
http://www.propertymetrics.com/blog/2013/11/21/negative-leverage/
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Laura Williams
Kansas City MO · Member since 2014 · 357 posts · 349 votes
12y
@Andrey Y.
I believe if you can buy quality cash flowing properties it's better to use financing and have leverage. Sometimes you can find much better deals paying all cash or buying a fixer upper and then renovating it. Might be a possible strategy to buy cash (discount) from a motivated seller and then refinance out afterwards with a higher appraisal value.
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Andrey Y.
OP
Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
12y
Now that I am thoroughly confused...
In all seriousness though, what J Scott mentioned regarding 'cost of capital', isn't it
just what I outlined above, ie. paying cash vs. paying 20% and financing the rest? Just just assume here that no appreciation or depreciation for simplicity.
I guess a better question, for those that have been at this a while, and I would especially like to hear from Hawaii-based investors, would you go the put down 20% and finance the rest, and try to get several properties for the purposes of getting feet wet quicker, or meticulously plan 1 or 2 deal, paying 50-100% cash upfront?
Much thanks for the feedback!
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Roy N.Pro Member
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
12y
Originally posted by @Jeff Rabinowitz:

You will only make more money using leverage if the value of your property increases and you sell when it is higher than the price you paid. Markets, including real estate markets, are cyclical. They do go down, sometimes very quickly. Many areas are just beginning to recover from the last crash.
Jeff:
I must be misunderstanding you. You can use leverage without relying on appreciation.
viz.
I could pay cash and buy a 250K property which, for arguments sake, has an NOI of 25K.
Alternatively, I could leverage at 80% LTV and purchase five same properties for 250K and would have an NOI of 125K. Even if my debt service were 50% of my NOI, I still come out ahead.
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J ScottPro Member
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Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
12y
Originally posted by @Andrey Y.:
In all seriousness though, what J Scott mentioned regarding 'cost of capital', isn't it just what I outlined above, ie. paying cash vs. paying 20% and financing the rest? Just just assume here that no appreciation or depreciation for simplicity.
Cost of capital *generally* just refers to the interest rate you're paying on the loan.
Here are two examples of what I was saying above:
1. Let's say you buy a property all-cash and the cash-on-cash return of the property is 10%. Now let's say that you can leverage that investment (get a loan on the property) at 5% interest and still cash flow. Your cash-on-cash return will generally INCREASE because your cost of capital (5%) is lower than your unleveraged return (10%). This is called positive leverage.
2. Let's say you buy that same property all-cash with a cash-on-cash return of 10%. Now let's say you get a loan at 15% interest. Your cash-on-cash return will generally DECREASE because your cost of capital (15%) is higher than your unleveraged return (10%). This is called negative leverage.
Now, my examples above are very simplified, and there are more details that matter (discount rate versus interest rate, type of ROI we're talking about, etc), but in general, the principals above hold.
See the article I linked above for good examples...
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Eric Taylor
Investor · Mission, TX · Member since 2014 · 117 posts · 40 votes
12y
The operative question is whether you can put down 20% and get cash flow on properties in Hawaii? If so, then I agree with Roy. Sometimes in high demand area it is difficult to find cash flow properties with only 20% down.
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Roy N.Pro Member
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
12y
Originally posted by @Eric Taylor:

The operative question is whether you can put down 20% and get cash flow on properties in Hawaii? If so, then I agree with Roy. Sometimes in high demand area it is difficult to find cash flow properties with only 20% down.
Eric:
I live in one of those areas ... these days the entire country is pretty that way ...
Not only must a property cash flow at 80%LTV, it must produce a sufficient free cash flow to meet our expectations of return ;-)
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
Originally posted by @J Scott:

Originally posted by @Andrey Y.:

In all seriousness though, what J Scott mentioned regarding 'cost of capital', isn't it just what I outlined above, ie. paying cash vs. paying 20% and financing the rest? Just just assume here that no appreciation or depreciation for simplicity.
Cost of capital *generally* just refers to the interest rate you're paying on the loan.
Here are two examples of what I was saying above:
1. Let's say you buy a property all-cash and the cash-on-cash return of the property is 10%. Now let's say that you can leverage that investment (get a loan on the property) at 5% interest and still cash flow. Your cash-on-cash return will generally INCREASE because your cost of capital (5%) is lower than your unleveraged return (10%). This is called positive leverage.
2. Let's say you buy that same property all-cash with a cash-on-cash return of 10%. Now let's say you get a loan at 15% interest. Your cash-on-cash return will generally DECREASE because your cost of capital (15%) is higher than your unleveraged return (10%). This is called negative leverage.
Now, my examples above are very simplified, and there are more details that matter (discount rate versus interest rate, type of ROI we're talking about, etc), but in general, the principals above hold.
See the article I linked above for good examples...
um, @J Scott. You left out what your unused money was doing in BOTH your examples!!! Geez.
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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
12y
Originally posted by @Account Closed:
um, @J Scott. You left out what your unused money was doing in BOTH your examples!!! Geez.
I have no idea what you're talking about...but it's clear you're just trying obfuscate the discussion.
It's simple. You stated above: "You always make more profit by using leverage."
Wrong. You are incorrect and are disseminating bad information. That statement is flat-out ludicrous. There is nothing you can say to make that statement correct. There is nothing you can say to change the basic financial concept of negative leverage (the fact that some leverage will REDUCE your profits).
Period.
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
Originally posted by @J Scott:

Originally posted by @Account Closed:
um, @J Scott. You left out what your unused money was doing in BOTH your examples!!! Geez.
I have no idea what you're talking about...but it's clear you're just trying obfuscate the discussion.
It's simple. You stated above: "You always make more profit by using leverage."
Wrong. You are incorrect and are disseminating bad information. That statement is flat-out ludicrous. There is nothing you can say to make that statement correct. There is nothing you can say to change the basic financial concept of negative leverage (the fact that some leverage will REDUCE your profits).
Period.
Then why are you being so EVASIVE about what is happening with 80% of the money that is FREE to invest when using leverage?? Ya gotta stick it somewhere. And unless you're sticking it..... well you can imagine better than me based on your preposterous examples then you're gonna be making some coin on that.
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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
12y
Originally posted by @Account Closed:
Then why are you being so EVASIVE about what is happening with 80% of the money that is FREE to invest when using leverage?? Ya gotta stick it somewhere.
Presumably, the other 80% is being put into investments that are yielding the same as or less than the original asset where you invested the 20%. Which means the entire return is going to be reduced by the negative leverage employed on the 20%.
Now, if you're going to tell me that you have a better investment for the 80% than the 20%, then I would ask you why you aren't putting the 20% in that better investment as well.
Any way you look at it, negative leverage on any part of a portfolio will reduce the overall return of the portfolio. By definition, your return on a portfolio using negative leverage would be higher if you purchased all-cash without any leverage.
I'm happy to continue answering questions on the topic, but any basic finance textbook can probably explain it to you...
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
@J Scott. You haven't answered any question except that YOU as an investor would go all in no matter what. You control a $1, 000, 000 using ALL your money. I control a $1, 000, 000 property using only $200, 000. Maybe both of us should not want this property but I am the only one that has $800, 000 to make up any losses. Shoot, 15% money. I can buy $800, 000 in 10% CD's and blow your $1 000, 000 investment away.
You don't seem to have the experience to determine how real investors work. The only way your scenario works is if the investor is bound to your artifical "rules". You basically want me to put all my money in the same deal as you and i am saying using leverage will make me more profit. I stand by my statement when applied to the real world.
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James Syed
Real Estate Broker · Mount Olive, IL · Member since 2013 · 1k+ posts · 310 votes
12y
Great job @J Scott .
It's true if you will be borrowing at 15% and your cash on cash return is 10%, that is negative leverage.
Always have at least a 2% cushion when you borrow money vs your cash on cash return. For instance, if you are borrowing at 5.25%, your cash on cash return better be 7.25% or higher, otherwise there is no point of going thru leverage.
Hope it helps.
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
Originally posted by @James Syed:

Great job @J Scott .
It's true if you will be borrowing at 15% and your cash on cash return is 10%, that is negative leverage.
Always have at least a 2% cushion when you borrow money vs your cash on cash return. For instance, if you are borrowing at 5.25%, your cash on cash return better be 7.25% or higher, otherwise there is no point of going thru leverage.
Hope it helps.
You both are ignoring the $800, 000. Geez.
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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
12y
Originally posted by @Account Closed:

@J Scott. You haven't answered any question except that YOU as an investor would go all in no matter what. You control a $1, 000, 000 using ALL your money. I control a $1, 000, 000 property using only $200, 000. Maybe both of us should not want this property but I am the only one that has $800, 000 to make up any losses. Shoot, 15% money. I can buy $800, 000 in 10% CD's and blow your $1 000, 000 investment away.
You don't seem to have the experience to determine how real investors work. The only way your scenario works is if the investor is bound to your artifical "rules". You basically want me to put all my money in the same deal as you and i am saying using leverage will make me more profit. I stand by my statement when applied to the real world.
Bob -
You're clearly missing some very basic concepts about leverage here. And the more you keep writing, the more confused you seem to be.
Let's keep it simple -- in your first post you said, "You'll always make more money by using leverage."
Any freshman finance major knows that this is a ridiculous statement, but you seem to still believe it. If this were the case, the concept of negative leverage wouldn't exist. But it does. Go pick up a textbook, and start reading.
I can't help you if you don't choose to help yourself.
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
Originally posted by @J Scott:
Originally posted by @Account Closed:

@J Scott. You haven't answered any question except that YOU as an investor would go all in no matter what. You control a $1, 000, 000 using ALL your money. I control a $1, 000, 000 property using only $200, 000. Maybe both of us should not want this property but I am the only one that has $800, 000 to make up any losses. Shoot, 15% money. I can buy $800, 000 in 10% CD's and blow your $1 000, 000 investment away.
You don't seem to have the experience to determine how real investors work. The only way your scenario works is if the investor is bound to your artifical "rules". You basically want me to put all my money in the same deal as you and i am saying using leverage will make me more profit. I stand by my statement when applied to the real world.
Bob -
You're clearly missing some very basic concepts about leverage here. And the more you keep writing, the more confused you seem to be.
Let's keep it simple -- in your first post you said, "You'll always make more money by using leverage."
Any freshman finance major knows that this is a ridiculous statement, but you seem to still believe it. If this were the case, the concept of negative leverage wouldn't exist. But it does. Go pick up a textbook, and start reading.
I can't help you if you don't choose to help yourself.
Is this a book you're hawking? Um, no thanks! You are the one confusing the major benefit of leverage. That's not tying all your money up in ONE investment. Savy investors will take all your negative leverage because they can control the property AND have 80% of their money to make other/better investments. Why don't you show some real life math to show how much more you're making with your unleveraged investment. You can be the expert on negative leverage if you want. I'll stick with being an expert on investing for profit! LOL
Anxiously waiting for your side by side comparison of leverage vs. non leveraging and the impact of negative leveraging.
Maybe you and @Jeff Rabinowitz can make this project a learning experience for both of you. Way better than a dry book.
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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
12y
Originally posted by @Account Closed:
Anxiously waiting for your side by side comparison of leverage vs. non leveraging and the impact of negative leveraging.
Here you go...side by side comparison of positive leverage, negative leverage and non-leverage on an equivalent investment:
http://www.propertymetrics.com/blog/2013/11/21/negative-leverage/
As you'll see, the positive leverage scenario generates the highest IRR, the unleveraged scenario generates the next highest IRR and the negative leverage scenario generates the lowest IRR.
Negative leverage generates lower returns than not using leverage. In other words, your statement about leverage always increasing profit is WRONG.
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Joshua Berube
Contractor · victoria, bc · Member since 2014 · 74 posts · 21 votes
12y
newbie here. is that the sticking point of this argument? the fact that Bob said leverage always increases profits? seems to me that nothing in this world is always one way or the other. leverage works, sure. but not if you use it improperly. seems pretty obvious... but im no investing genuis
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