Can you sell me on the 25% x 4 property option? Would the cash flow not wash out because of the mortgage payments on the four versus the one paid for? thanks
Sure! Without making it overly complicated, let's use some round numbers and a simple example.
100k purchase prices of homes. You have 100k (and let's say some change for emergencies, etc.. a cash cushion above that, which you'd want if purchasing a rental). You can put 25% down on 4 houses (25k each x 4 = 100k) vs. 100% down on one house (100k x 1 = 100k). Houses rent for $1200.
Let's compare the two scenarios.
We'll use the 50% rule, which was discussed in an MMM blog before, which I can go into more detail if necessary, but basically it says that of your gross rent, about 50% will go towards vacancy, repairs, long term capital maintenance, property management, property taxes, insurance, etc. The rest is profit or for paying down a mortgage.
Scenario 1: 100% down, no mortgage payment. You cashflow is $600/month, or $7,200/yr.
Total for scenario 1: $7,200
Scenario 2: 25% down, 30 year mortgage.
At current rates of 5% (current owner occupied is about 3.75%, investor is 5%), your mortgage payment will be $402.62 principal and interest. 1200 rent - 600 to 50% rule - 402.62 to mortgage = 197.38/mo cashflow per house, or $2368.56/yr. Times 4 houses = 9474.24
Already you're making an extra 2 grand per year.
But wait, we are also paying down that mortgage. Year 1, your tenants pay down $1,012.19 per house of mortgage, or an extra $4048.76 that you gain in equity.
Total for scenario 2: $13,523
So you make
almost double in terms of equity gain + cashflow by having mortgages.
That's assuming no appreciation. If the house appreciates, you gain 4X as much appreciation. If it drops, GREAT, buy more houses! If you aren't buying places where the rents more than cover the expenses + mortgages, don't buy them. Who cares what the "value" is if you're holding long term. Even if you lose your job, you can cover the payments because the renters themselves more than cover the payments!
So great, you get more appreciation. I personally don't think we'll see any appreciation in years. But if you're holding them for 10-20 years, you sure will see some appreciation. I guarantee housing prices won't stay at 2012 levels for 20 years.
But that's also counting having someone managing all those properties for you (that's counted in the 50% rule). If you want a side-gig as a landlord, you can save yourself an extra $120/mo on scenario one, or $1440/yr. But if you landlord in scenario 2, you'll gain an extra $5,760/year. Yes, you'll have 4x the work (managing 4 houses vs one), but you have that choice - let them be managed and pay for that, or manage yourself and pick up a few extra bucks than you can in scenario 1.
On top of that, you ALSO get
mortgage interest write-off. So on top of
2 grand more cashflow,
4 grand principal paydown,
4x appreciation potential, you can write off some of that cashflow. PLUS you'll have
4X the depreciation, sheltering all that cashflow and perhaps protecting some of your W2 income from your normal job.
Still think paying cash is better? It might be. Like I said above:
"Paying cash for a rental instead of 25% down for 4 rentals will just slow down your path to FI. But if it lets you sleep at night, then you should pay cash."Note 1: my numbers are more conservative, not just to make my case. Many, including MMM, think they can beat the 50% rule on expenses. And many investors won't buy a house for 100k that only rents for 1200, or 1.2%/mo., they want higher, like 2%. Using actual numbers investors get, the case is even better for leverage.
Oh, I also didn't mention the fact that the principal payoff grows each month, as the amount towards principal vs interest increases. By year 10, you're getting $7259.56 in principal payoff (as opposed to the $4,048.76 in year 1). Oh, and I also didn't mention the fact that rents rise. 4 rents rising is much better than 1 rent rising, especially because your mortgage payment won't rise. There's two more reasons why leverage is better.
Note 2: I did mention, not sure if it was in this thread or another one, that over leverage is bad. Negative leverage, putting you in a cashflow negative situation, can ruin you. Purchase smart, count on no appreciation or rising rents ever, and make sure the numbers still work. Then be happy when you do get rising rents and appreciation, as a bonus.