Real estate investing is like a three course meal (TM).
It has three profit centers: cash-flow (or the appetizer), mortgage paydown (the main course) and equity appreciation through asset improvements and inflationary rental upside (the dessert). One key question in real estate investing is: how much cash to put down and how much leverage to apply via a mortgage.
The more cash down, the higher the cash-flow in real estate investing.
Is this better though?
REITs typically use 50% or less leverage and can be good investments for retired income seekers. Or should one be higher levered with more equity upside, but little or no cash-flow?
Look at these three examples … Then you decide.
Real Estate Investing – Scenario 1:
$1M invested, $4M asset, 6% CAP (yield), 75% loan-to-value (LTV) mortgage for $3M at 4%
$240,000 net operating income minus
$180,000 mortgage payment (of which $60,000 is principal and $120,000 interest)
$60,000 “cash-flow” in theory .. Some of which will be asset management fees, annual accounting, tax filing costs, overhead and rest upgrades .. Thus NO CASH FLOW
25% value growth in 5 year to $5M (which is normal in a healthy market with 2-3% rent growth/year and 2-3% due to property upgrades and higher rents on renovated units)
Equity in 5 years: $1M gain plus $300,000 mortgage paydown = $1.3M = 130% return on investment in 5 years .. But no cash-flow !!
Real Estate Investing – Scenario 2:
$1M invested, $2M asset, 6% CAP (yield), 50% LTV mortgage for $1M at 4%
$120,000 NOI minus
$60,000 mortgage payment (of which $20,000 is principal and $40,000 interest)
$60,000 “cash-flow” in theory .. Let’s assume some of which will be asset management fees, annual accounting, tax filing costs, overhead and rest upgrades .. Say $30,000 .. So $30,000 cash flow (3% on the $1M invested)
25% value growth in 5 year to $2.5M Equity in 5 years: $500,000 gain plus $100,000 mortgage paydown plus $150,000 in cash flow = $750,000 = 75% ROI in 5 years .. With some cash-flow !!
Real Estate Investing – Scenario 3:
$1M invested, $1M asset, 6% CAP (yield), no mortgage
$60,000 NOI or “cash-flow” in theory .. Let’s assume some of which will be asset management fees, annual accounting, tax filing costs, overhead and rest upgrades .. Say $20,000 .. So $40,000 cash flow (4% on the $1M invested)
25% value growth in 5 year to $1.25M
Equity in 5 years: $250,000 gain plus $200,000 in cash flow = $450,000 = 45% ROI in 5 years .. With some decent cash-flow !!
What is a better scenario in real estate investing: Scenario 1 .. or Scenario 2 .. or Scenario 3 ?
You decide, depending on your risk tolerance, other income in life, cash needs or stage of life.
We have built a successful business model for real estate investing along scenario 1, for well over a decade.
President, Prestigious Properties Group
T: 403-678-3330 Toll Free: 877-434-4345
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