I am trying to buy as many rental properties as I can because of low-interest rates and the incredible returns I am seeing on my current rentals. You cannot get the incredible returns I get, or buy nearly as many properties if you do not leverage your money. I am making over 20 percent cash on cash return on all 16 of my properties. I explain how I do this in my complete guide to purchasing long-term rental properties. Leverage basically means you are using a loan to buy rentals, instead of cash.
Why do your returns increase on rental properties when you leverage your money?
Leverage is when you use a loan to pay for part of the rental property. I get loans from my portfolio lender that are 80 percent of the value of the home. When you pay cash for a rental property, you may make more total cash from one property, but you are not making very much money compared to the cash investment you made. To buy a $100,000 rental property actually takes more money than $100,000 after closing costs and repairs are made when you pay cash. If I were to finance the property, I would only have to spend $30,000 for the down payment, repairs and closing costs. The cash on cash return on my money is much great when I use leverage then when I pay cash.
How much more money can you make with leverage than cash on rental properties?
If you buy a $100,000 house with cash, and make $500 a month in cash flow, you are making about 6 percent cash on cash return from your cash flow. If you buy a $100,000 house and put 20 percent down, you will have a mortgage payment, but the returns on your cash invested increase. If you are paying a 4 percent interest rate, your principal and interest payment will be about $382. You are only making $118 a month cash flow after subtracting the mortgage payment, but you are making 7 percent cash on cash return due to the lower initial investment.
You are actually making much more than a 7 percent return in the above scenario because you are also paying down the principle on the loan by an average of $118 each month. That $118 equals another 7 percent return on your money that you would not have on a cash purchase! You’ve more than doubled your return, by getting a mortgage instead of paying cash. The really exciting part about using leverage is when you get higher cash flows, the returns increase even more. If you can make $800 a month cash flow without a mortgage, you will be making 9.6 percent cash on cash return. With 20 percent down on the same property, you would cash flow $418 a month after mortgage payments and make over 25 percent cash on cash return just from cash flow! The way to make big money in rental properties is finding properties that will give you big cash flows, and buying as many as possible, while leveraging your money. I currently make over $500 a month cash flow on all my properties, and you can too if you leverage your money.
You can buy more rental properties when you get loans instead of pay cash
The best part about leveraging your money is it allows you to buy more properties. You can buy three or four homes with $100,000 instead of just one home paid for with all cash. Using the cash flow figures from above, and buying three properties instead of one, you are now making $1,254 a month cash flow instead of $800 a month. Not only does your cash flow increase by purchasing more properties, but the equity pay down increases, the tax benefits increase and the appreciation increases. If you are able to purchase homes below market, every time you purchase a home, your net worth increases as well!
Advantages of rental properties are multiplied when you use leverage
Rental properties have many tax benefits including depreciation. The IRS lets you depreciate a percentage of your rental properties every year and write that off as an expense. If you have three houses instead of just one, you can get triple the tax deductions.
If you have three properties instead of one and your market appreciates, then you also have the benefit of triple the appreciation. It is the same situation if rents go up. The more properties you have, the more money you will make.
With multiple rental properties you are also paying down the loans on three properties. When you think of the tax savings, possibly appreciation and equity pay down, the returns shoot through roof.
Downside to buying more rental properties
There is a downside to more properties. You will have to shell out more money for repairs and improvements since each property will need repairs, not just one. You will also have three rental properties to manage instead of one. However, if you are able to cash flow $400 or more with a mortgage, you will still be way ahead of the game by leveraging your money. You will also have more total cash flow coming in which is very important in my system.
Waterfall effect of paying off mortgages on rental properties
In my system all your extra cash flow is spent paying down one mortgage at a time. The more cash flow coming in, the faster you can pay off a property. With one property cash flowing $800 a month you could pay off a 30 year mortgage in 6.5 years. With three properties cash flowing $1,254 a month you can pay off a 30 year mortgage in 4.5 years. Once you pay off that first mortgage the water fall effect begins. The extra cash flow from paying off the mortgage goes into paying off the next mortgage even faster.
The principle and interest on the mortgage that was paid off above equals $382. When that mortgage is paid off, that $382 a month equals $4,584 a year, which will go toward paying off the next mortgage. If you can keep buying properties, their cash flow will pay down the mortgages even faster. Pretty soon you will be paying off mortgages in a year or less, with all the cash flow coming in. That is when the fun really starts! Note: I have changed my strategy quite a bit over the years and now I do not pay off my loans early.
For more information on how to finance multiple rental properties please check out my eBook: How to Get Financing on Multiple Investment Properties.
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.