Tuesday, April 10, 2012

Rich People get Richer, But SMART, rich people get FILTHY rich

Why do investors finance rental properties instead of paying cash?   The simple answer is that LEVERAGE increases ROI (return on investment).  Let’s start with a simple example:

Mrs. Johnson buys one rental property with $100,000 Cash.
Net rent after taxes, maintenance/vacancy set aside, taxes/insurance, etc. is $500/month
ROI is 6% /year not counting any tax benefits and property appreciation.

Mrs. Johnson buys five rental properties with $100,000 down and finances $80,000 each.
Her payment is $400 per month, so her net rent is approximately $100/month each.
ROI is 6%/ year not counting any tax benefits and property appreciation.

But, now let’s factor annual appreciation at 3% and annual rental increases of 3%.

One Property (Cash)

Net Rent without Rental Increases = $60,000
3% appreciation on one property of $100,000 for ten years = $34,391
3% rent increase on one property = $17,566
Total ROI $111,957 = 11.2% /year

Five Properties (Financed)

Net Rent without Rental Increases = $60,000
3% appreciation on five properties of $500,000 for ten years = $152,386
3% rent increase on five properties = 17,566
Total ROI $229,952 = 23%/ year

This is why rich people get richer and smart rich people get filthy rich. 

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