Investing with Leverage
Investing with Leverage
Have you ever heard Real Estate investors mention "LEVERAGE"? If your a Dave Ramsey fan, you will not hear the word leverage, instead you will hear the word "DEBT". Now, I love Dave Ramsey, I think his "debt is dumb, cash is king" slogan is great.... for most people.... but not for me. At least not at this point in my life. Let me explain.
When I was in graduate school, my last class before I could graduate was one where we built a fictional company and used all the skills we had learned in school to run the company and compete against our classmates. Who knew, 5 years later, I would be in real estate and that an MBA would actually apply more here that it did when I was in the corporate world, but I digress! Not to brag (ok maybe a little) but my company smoked everyone in my class of 36. My revenue was 1st, my profits were 1st, and so were most all other metrics they used to rate our companies (and grade our work). When my professor was handing out grades, I was certain I would have an A+ with a smiley face on it in bright red sharpie ink, but instead, it was an A-. WHAT!!?? "Yo Professor, what gives"? After about a 5 minute ramble all I took away from the conversation was I got that grade because my company was "debt free" (he must have not been a Dave Ramsey fan I thought). Whatever, I was just happy I was done with school so I took my A-, graduated and moved on. It wasn't until I bought my first real estate investment 5 years later that I finally understood why I got that A-. So let me break it down for you kind-e-garden style. WARNING - there are a good deal of numbers but if your not a numbers person, just look at the 2 bolded and underlined numbers and you will get the picture.
So for my first real estate investment, I bought a house in North Charleston SC for $72,000 cash money. The monthly rent was $1200 (sounds great right, it wasnt, but that's for another blog post). For simplicity sake, i'm going to say my monthly expenses were $300 so that gives me a net income each month of $900. Do the math and that's $10,800 a year in income on $72,000 invested. So my Cash on Cash return is 15% annually when paying cash.
Ok now let me introduce the power of real estate "Leverage". Had I bought that house using a conventional loan (20% down) my cash out of pocket would have been $14,400 and I would have had a loan for $57,600. The mortgage on that would be $309. Lets add that mortgage to my $300 a month expenses and now my monthly expenses are $609. Monthly rent is still $1200 so my monthly net income is now $591 and annual income is $7,092. You may be thinking, well dang, that's $3,708 less than if I had paid cash, id rather have more cash. This is exactly my thought process 5 years prior during my MBA school project. Why would you want less cash per month and at the same time have more "debt"?? Well lets look at the Cash on Cash return. Remember I only have $14,400 invested in this house and Im making $7,092 per year. A little simple math tells you that my Cash on Cash return is 49% annually with leverage.
So, would you rather make 15% return on your real estate investment, or 49% and still have $57,600 cash in the bank to buy more real estate???
And that, my blog reading friends, is why real estate investors prefer buying real estate using "leverage".Thanks for reading everyone, hopefully the numbers didnt bore you to sleep (I love this stuff). If you are interested in investing in real estate or just learning more, please give me a call. I could talk about this stuff all day!
