The relationship between leverage and appreciation in real estate is very important. Leveraging can affect your returns over time, so it’s important to know and understand what a comfortable leverage is for you to achieve your investment goals.
ROI and Cash Flow on Your Property
You want the ideal loan value on your property, so your returns are maximized. At the same time, you need to make sure you are meeting your cash flow needs. Those are the two sides of the leverage coin. For example, let’s say you purchase a property for $150,000, and you put $40,000 down on it. You are earning a nice five percent cash on cash return, but when your asset appreciates, seven years later your property may be worth $210,000. Your equity and your property are now twice as much, but the cash flow has not changed. Your return was five percent on the $40,000 down, but on the $100,000 equity you now have, the return is only two percent. You may start thinking you can get more mileage out of your money elsewhere.
Do the Math and Evaluate your Strategy
What would be the selling cost if the property was worth the exchange of your investment into a higher value asset, or a more expensive property? Or, you could even invest in two other smaller properties. You need to run the numbers on your investments periodically. This will help determine how your money is performing.
Consider a Few Different Scenarios
Let’s take a look at a few scenarios.
You can buy a property outright for $300,000, and have no debt service. You would keep all the cash flow and have only the maintenances and taxes and insurance as expenses. You have an investment that is $300,000 appreciating at three percent annually or $9,000 per year. You would also have tax depreciation right off the bat and save approximately $3,000 on your tax return. In this example, that’s a three percent return on your investment.
In another scenario, you might purchase three properties, each worth $300,000, and you might put $100,000 down. You are still investing the same $300,000, but with three separate properties. Now you have $900,000 in real estate assets appreciating at three percent annually. That’s $27,000, and the direct tax savings is also three times the amount at $9,000 per year. Your return on just those two income streams are nine percent on your $300,000 investment verses the three percent in the previous scenario.
Analyzing Your Data
In scenario number one, you were keeping more of the rent, and that needs to be considered as well. The amount of that will depend on the property. Run your own numbers in a similar fashion to arrive at a very exact calculation on the best place for your initial investment. Then, you’ll know when it’s a good time to switch up your current property to a bigger one or, perhaps, multiple ones.
There are tables and spreadsheets to help figure out all these possible scenarios quickly and efficiently. We are always happy to sit down with you and go over any of them to help you maximize your investments.
For some professional help, please contact us at Service Star Realty.