Welcome to part 2 of this 4-part series on building wealth through real estate. One of the key strategies in real estate investing is leveraging debt to increase your returns. In simple terms, leveraging means borrowing money (a mortgage) to fund the purchase of a property. This give you the benefits of owing a more expensive asset than you could otherwise afford without having to pay for the entire amount up front. Unlike typical consumer debt used for things that go down in value over time, prudent use of debt when buying investment real estate can drastically amplify your returns. The best part is the debt paydown is paid by the tenants, with no money out of your pocket.
Examples
- Scenario 1: All Cash Purchase – You purchase a $325,000 property without a mortgage. After expenses, your rental income is $2,600 per month. Not paying a mortgage will maximize the monthly cash flow, but it will seriously limit how fast you can save up to buy more rental properties.
- Scenario 2: Conventional Financing (25% Down Payment) – You purchase the same $325,000 property, but this time with a 25% down payment, which is $81,250. You finance the rest using a mortgage. This allows you to earn rental income and appreciation from the full value of the property, without paying the full $325,000 up front. The increased purchasing power allows you to either buy your first rental much sooner, or buy multiple properties instead of just one.
- Scenario 3: FHA Financing (3.5% Down Payment) – With an FHA loan, you only need to put down 3.5%, which is $9,750. The catch is: you have to live in the property yourself. This is how I first got started in real estate. I bought a duplex, lived in one side and rented out the other. The FHA loan works with duplexes, triplexes, or fourplexes (more than 4 units require a commercial loan with a larger down payment). The much smaller initial investment allows you to buy a rental property much sooner than saving up the full 20-25%.
The beauty of debt paydown is that with each mortgage payment, a portion goes toward paying down the loan balance, thus increasing your equity in the property over time. As the loan balance decreases, your ownership stake grows, while the property itself (hopefully) continues to appreciate.
The Takeaway
Debt is a powerful tool in real estate investing. It allows you to scale your portfolio and increase your potential returns, all while someone else (the tenant) helps pay down your mortgage.
In our next article, The 4 Pillars of Real Estate Wealth: Appreciation, we will discuss how quality real estate generally goes up in value over time.
Curious if investing in real estate is right for you? I’d love to review your options with you. Call anytime!
Justin Rollheiser – REALTOR®
Keller Williams Realty | Diamond Partners Inc
13671 S Mur-Len Rd | Olathe, KS 66062
Direct 913-800-7653
Office 913-322-5878
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