Why do more people not use principal reduction???
I have a $150,000 equity line that I can borrow from. I have two properties that I am currently looking at. Property A is a 13 unit apartment complex and Property B is a 5 unit apartment complex.
Property A is for sale for $560,000. It has a $49,547.13 NOI equating to an 8.85 cap rate. The owner would hold the remaining note.
Property B is for sale for $150,000. It has an NOI of $16,593. Its cap rate is 11.06%. I would pay cash (from the equity line) for this property.
If we strictly looked at Cap Rate and COC return, property B would win hands down. But, if I am looking for a long term investment property A would probably win. Here is why;
(I am going to self-manage, like many people on BP Forums and will thus be counting the management fee towards my "Total Equitable Profit" annually.)
Property A Analysis:
CBT - $2995.08
Mgmt Fee - $5384.87
Principal Reduction - $15444.37
TOTAL EQUITABLE PROFIT YEAR 1 - $23824.32
Property B Analysis:
CBT - $5373.08
Mgmt Fee - $2332.00
Principal Reduction - $4016
TOTAL EQUITABLE PROFIT YEAR 1 - $11721.09
Property A affords me the ability to completely leverage the $150,000 I have to spend AND doubles the equity/cash flow I create annually compared to property B. I understand that this is not perfect (and the fact that purchasing a property at a lower cap rate compared to a higher cap rate property means that the purchasor paid a higher price for a similar investment and thus has a higher principal balance compared to the other investment) and that leaving Cash Flow on the table to take a lower cash flowing property is not typical. BUT, I see a lot of merit in evaluating the deal this way. Opinons?
Analysis Assumptions:
5.66% Equity Line borrowing Rate
20 year loans
10% Vacancy Loss
6% Mgmt Fee