Leverage

6 Replies

i know its good to use leverage when buying multifamily, why does the cash flow increase when debts is used. I am trying to wrap my mind around how an extra expense (debt) increases cash flow. Please leave comments below thank you 

Your Cash flow will DECREASE with more leverage because as you say now you have a larger mortgage payment to spend the cashflow on. Probably what you're think of is Cash-on cash (COC) return. It increases the more leverage you use because there is less of your own money invested.

Ex. You buy a $100k house for cash and you make a $5000 cash return in a year. That's a 5% COC return.

If instead you put $20,000 down and get an $80k mortgage and spend $3000 on mortgage payments, your cashflow falls to $2000. But your COC return is now $2000/$20000 or 10%.

Also notice you have $80k more to invest in other properties.

The trick is to use the use the leverage to increase your COC returns but not use so much that you have cashflow problems.

Also, there are several articles here on the site that explain this in a lot more detail:

http://www.biggerpockets.com/renewsblog/2015/04/18/leverage-vs-pay-cash-rental-properties-debate/

Leverage wouldn't increase your cashflow, however when used properly it could increase your return on investment compared to an all cash buyer.

Also the less money you have tied up in a deal allows you to do more deals, which could in theory decrease your overall risk.

Hope that helps!

@Vidal LeClair I've read many posts on CoC ,however it never made since until just now.

Thanks @Opal Raza for explaining it so simply.  Now leverage makes since. I'm a  newbie so forgive me.

Originally posted by @Jeff Kehl :

Your Cash flow will DECREASE with more leverage because as you say now you have a larger mortgage payment to spend the cashflow on. Probably what you're think of is Cash-on cash (COC) return. It increases the more leverage you use because there is less of your own money invested.

Ex. You buy a $100k house for cash and you make a $5000 cash return in a year. That's a 5% COC return.

If instead you put $20,000 down and get an $80k mortgage and spend $3000 on mortgage payments, your cashflow falls to $2000. But your COC return is now $2000/$20000 or 10%.

Also notice you have $80k more to invest in other properties.

The trick is to use the use the leverage to increase your COC returns but not use so much that you have cashflow problems.

Also, there are several articles here on the site that explain this in a lot more detail:

http://www.biggerpockets.com/renewsblog/2015/04/18/leverage-vs-pay-cash-rental-properties-debate/

 That's puts it into the light a lot more thanx. I did mean cash on cash your right...

Simple - cash flow does not increase only % return on investment if the cost of debt is less than the cost of equity (positive leverage). If not then you have negative leverage.

Hope this example helps;

If you want a 10% return then your investment on an all cash basis might look like this:

cash invested        - $100,000

return %                 X       0.10

______________________________

Cash Flow                $  10,000

With 80% Debt:

Cost of Debt at 5% -  $  4,000  ( $80,000 x .05)

Cash Flow before Debt $10,000

Net cash flow -           $6,000  ($10,000-$4,000)

Cash Invested             $20,000

Return %                     30%

Google "Band of Investment" analysis for a better understanding of leverage and capitalization rates.

Nicolas Paez

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