September 23rd, 2021 by igniite

The second lesson for how to become a millionaire.

I remember when I was a child, my folks, and their friends, where dead-set on buying a home after marriage, and paying it off after 30 years or sooner. That was the plan for retirement and it worked…….back then.

Well, a lot has changed since then.

For one thing, most of us are starting on the property ladder later, due to later marriages, later career starts or house prices. Fast forward 30 years and our folks model for retirement, just does not work for us , anymore. In fact, sticking with this model could actually be a very bad decision, as a retirement plan. We are starting later to buy property and have less time. (See my blog two weeks ago, on compounding interest) We need to leverage our positions.

Leveraging into property is what most of us will do when we buy our first home. But do we understand how great it is? Think of leveraging like ‘INVESTING ON STERIODS.’

What is leveraging?,

When you leverage, you’re borrowing money from a bank, to help finance a property.

There are two main benefits to leveraging, that you need to know . . .

Benefit 1: Return on Investment (ROI)

This is a huge benefit, but requires some explaining and some fancy pics.

Strap yourself in.

Here’s an example:

You buy a rental property for $100,000 and you rent it out at $1,000 per month.

Scenario 1: All-Cash Purchase

Let’s say you have a spare $100,000 and pay for it with cash. (Like never, but stay with me.)

After paying expenses each month, let’s say you take home $700 every month of that $1,000. $700 is your monthly cash flow.

Scenario 2: Leveraged Purchase

You finance the property with a conventional mortgage, putting 20% down. That’s $20,000.

You pay the same expenses every month, as you would with the all-cash purchase, but now you also have a mortgage to pay off.

If you’re paying each month with a 5% interest rate, you’re making a mortgage payment of $430 per month. Instead of taking home $700 per month as with the all-cash purchase, you’re taking home $270 per month.

Now you are taking home $270 per month instead of just $700. Big bummer, right?

Wrong.

What matters most is the money you are making on the money you invest. How much cash are you making, on the cash you put in. This is called the Cash-on-Cash equation.

Benefit 2: Cash on Cash Return

Let’s look at those scenarios again with this equation in mind.

Scenario 1: All-Cash Purchase

Your net monthly income is $700 after expenses. To get your annual net income, multiply by 12. Then divide it by your initial investment of $100,000.

The equation looks like this:

($700 x 12)/$100,000 = 0.084 = 8.4%

That’s 8.4% cash-on-cash return.

Scenario 2: Leveraged Purchase

Your net monthly income is $270 after expenses and mortgage payments. Again, multiply this by the 12 months in the year for your annual net income. Then divide it by your down payment of $20,000.

It should look like this:

($270 x 12)/$20,000 = 0.162 = 16.2%

With a leveraged purchase, you’re making 16.2% cash-on-cash return.

The leveraged purchase provides nearly double the return on the money you invested. While your monthly cash flow may be lower, you’re getting double the return on your investment.

A leveraged property won’t always offer double the return on your investment.

What matters is that you’re able to run the numbers on your investment.

Benefit 3: Magnified Capital Gains to Create Wealth Faster

There’s another benefit to leveraging.

In the all-cash scenario, you spent $100,000 of your own money. In the leveraging scenario, you only had to spend $20,000 of your investable money.

Let’s assume you have that $100,000 to invest in both scenarios. There are 5 sums of $20,000 in $100,000. This means that instead of buying one property for $100,000, you could potentially leverage 5 properties.

So, if a $100,000 real estate investment appreciates $30,000, you make $30,000.

But if you own five properties and they all gain the same $30,000 in appreciation? You have a bonus of $150,000 in your pocket (5x $30,000.).

The key is to run the numbers on the properties you buy.

At the end of the day, you need to feel comfortable with the investments you make with your money. No matter how great the numbers are.

Leveraging might be the best real estate decision you ever make, if you can afford the cashflow.

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