Making 100% Leveraged Deals Cash Flow & the 2% Rule

Real Estate Deal Analysis & Advice
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Making 100% Leveraged Deals Cash Flow & the 2% Rule

Carrie Giordano
Investor · Marina Del Rey, CA · Member since 2015 · 297 posts · 87 votes

Since Finding BP I have a new love for analyzing deals. Before BP, I found deals that might hit the 2% rule and seemed to have good cash flow. However, now I am looking with much more scrutiny. For example, now I am adding 10% versus 5% of the yearly income to my expenses for vacancy, cap ex and repairs. Boy, has this changed my returns!!! While I haven't found these numbers to actually be that high I think it is a good way to evaluate future properties. I know many of the rules of thumb are just that, a quick way to look at numbers I find it interesting that I can find a deal that is 2% and it still might not be a clear winner. I love leveraging deals 100% using a line of credit as the down payment or as a full cash deal and BRRR. But now with the added cushion of expenses I'm finding them harder to cash flow on paper. So my question is really more of a discussion of what is a winner? How good does a deal have to be to cash flow with 100% leverage and is this possible in B neighborhoods? Is it asking too much to make it work on a 15 year loan?

Here's a recent breakdown I did with rounded numbers for the sake of ease...

Purchase Price: $50k

Closing:$2k

Repairs: $5k

_________

All In: $57k

EXPENSES

PM:1200year

Cap Ex: 1200 year

Repairs: $1200 year

Vacancy $1200 year

Taxes $1500

Insurance $450

TOTAL:$6750

INCOME

Rental Income: $1000 month/ 12,000 year

$5250 ($437 month) Cash Flow = 9.21% cap rate

Now lets say it was 100% financed at 5% for 15 years (yes I know I could put 30 in to make it work) = Payments at $450

=  (negative) -23 month cash flow

I would love to hear what others have to say about this!

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Frank Jiang
Investor · San Diego, CA · Member since 2014 · 592 posts · 765 votes
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If you're doing a 15-year mortgage, you're no longer playing the cash flow game, you're playing the equity game.

Assuming you exit on the 15th year, let's compare the cashflow of this property unleveraged and with 100% leverage.

Since the IRR of your property without cashflow is higher than your rate of borrowing 8.79% > 5%, it makes sense to lever up as much as humanly possible AS LONG AS you are comfortable with taking on the risk of lower liquidity.

This assumes all of your assumptions are right and doesn't get into nitpicky stuff like the fact that you don't have PMI on a 100% leveraged property.

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  • Frank Jiang
    Investor · San Diego, CA · Member since 2014 · 592 posts · 765 votes
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    If you're doing a 15-year mortgage, you're no longer playing the cash flow game, you're playing the equity game.

    Assuming you exit on the 15th year, let's compare the cashflow of this property unleveraged and with 100% leverage.

    Since the IRR of your property without cashflow is higher than your rate of borrowing 8.79% > 5%, it makes sense to lever up as much as humanly possible AS LONG AS you are comfortable with taking on the risk of lower liquidity.

    This assumes all of your assumptions are right and doesn't get into nitpicky stuff like the fact that you don't have PMI on a 100% leveraged property.

    4Reply
  • Joshua D.
    Investor · Columbus, MT · Member since 2013 · 1k+ posts · 1k+ votes
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    How do you get $450 a year in insurance?  how much coverage do you have with that?

    do you have umbrella policy over that for liability? 

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  • Frank Jiang
    Investor · San Diego, CA · Member since 2014 · 592 posts · 765 votes
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    Also,

    Here's the same cashflow schedule with 30-yr mortgage included.

    Note how it's risk free (no negative cashflow) but makes less overall cash than the 15 yr note.

    2Reply
  • Mehran K.
    Investor · Wichita Falls, TX · Member since 2010 · 3k+ posts · 603 votes
    11y

    Agree with @Frank Jiang. A 100% financed deal along with a 15 year amortization makes for a VERY difficult positive cash flow situation. 

    I use 8.3% for vacancy (1 month), and 10-15% for CAPEX+Repairs combined. It can't hurt to be more conservative like you're being, just throwing out what I've used to evaluate deals. Time will tell about how accurate those assumptions are though!

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  • Carrie Giordano
    OP
    Investor · Marina Del Rey, CA · Member since 2015 · 297 posts · 87 votes
    11y

    @Frank Jiang thanks for those breakdowns!   It really helps to look at it over the 15 year period. And I guess you're right the 15 year mortgage is more of an equity game which is currently what I'm in trying to achieve. To avoid the pmi and still be 100% leveraged I will use a Heloc from a rental for the down payment. 

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  • Carrie Giordano
    OP
    Investor · Marina Del Rey, CA · Member since 2015 · 297 posts · 87 votes
    11y

    @Mehran K. those numbers would currently be more accurate for me and help with the cashflow. But like you said only time will tell! I've only been investing a couple of years so while I like a highly leveraged deal I'm trying to play it safe on the analysis. 

    1Reply
  • Carrie Giordano
    OP
    Investor · Marina Del Rey, CA · Member since 2015 · 297 posts · 87 votes
    11y

    @Joshua D. I have a State Farm policy with full replacement value plus 20%. Liability is at 300/600.

    In addition, I do have an umbrella policy for 1 million. It's an additional, $300 a year which I would have to breakdown and add into the $450 for this to be more thorough.

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  • Joshua D.
    Investor · Columbus, MT · Member since 2013 · 1k+ posts · 1k+ votes
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    @Carrie Giordano  Thanks! I need to shop insurance.  My premiums are twice that a year with about the same coverage. Umbrella is about the same but not much different. 

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  • Carrie Giordano
    OP
    Investor · Marina Del Rey, CA · Member since 2015 · 297 posts · 87 votes
    11y

    @Joshua D. It's possible that your replacement cost is higher or deductible lower. My most recent policy has those same coverages and the total replacement cost with the 20% is $128,400, my deductible is $1070 and the premium is $407.

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  • Joshua D.
    Investor · Columbus, MT · Member since 2013 · 1k+ posts · 1k+ votes
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    @Carrie Giordano  my deductible is for $2500 and the coverage is for 130,000k,  It costs $975 a year 

    0Reply
  • Carrie Giordano
    OP
    Investor · Marina Del Rey, CA · Member since 2015 · 297 posts · 87 votes
    11y

    @Joshua D. well in that case definitely start shopping around! :)

    0Reply
  • Brendan M.
    New to Real Estate · Colorado Springs, CO · Member since 2015 · 125 posts · 86 votes
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    What's your end goal? If you're looking to cash flow on a 100% levered deal, you're probably best going for the 30 year mortgage. The reason many investors choose 30 year mortgages is because of the cash flow advantage associated with it. Adding a 15 year mortgage into the mix only increases your risk by decreasing your monthly cash flow. Sure, a lot of that difference will go towards your equity, but you're reducing the liquidity of your cash until you decide to sell or refi your home. What you're talking about doing is starting out fully levered, then rapidly unlevering yourself by paying so much down in equity at the expense of your cash flow.

    Think of it this way, if you do a 30 year vs a 15, you'll have that much more monthly cash flow to use as a contingency for if you have a bad few months. Alternatively, you could take that cash flow and use it as a down payment on a second property after a few months to a year and never have to worry about the refi. 

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