We, at Bodie Interests, are passionate in our belief that creating a passive income for your family through investment properties is a wise decision. There are generally two ways to go about this, but in our opinion, those two ways are not created equal.
Most investors either pay cash for or leverage a property. When you leverage, you are using a loan of some sort, be it a mortgage or, a term you’ll hear often, OPM (Other People’s Money). You may be surprised to know that paying cash for investment properties is not the best move, and here’s why:
The best investors use OPM. If you have another option, it’s not smart to put your own capital at risk. The concept of “time value of money” asserts that the dollar you hold today will be worth less in the future, so every year that your own money is tied up in the property, it actually buys you less of a different asset that might pay you interest. This also gives you a great opportunity to build a relationship with a mortgage lender.
You can buy more properties if you leverage. One lump sum investment could equate to multiple down payments. Having more than one investment property means not putting all of your eggs in one basket.
The more properties you have, the more sources of income. If you have multiple properties and one goes vacant, you still have others bringing in money.
The returns are higher when you leverage. This is generally due to cash flow, equity and taxes. The cash-on-cash-return is the annual return you’ll make in relation to the down payment. The cash-on-cash-return on a property will be the same if you pay cash, but the return of a leveraged property will usually be significantly higher. If you pay cash for an investment property, you probably won’t be able to afford more than one. When it comes to equity, simply multiply the equity you earn by the number of properties you were able to invest in, thanks to leveraging, versus just one with a lump sum. Do the same with thing with taxes. The IRS allows you to depreciate a percentage of your properties yearly and write that off as an expense. Multiply the depreciation write-off you get by the number of properties you have. (Feel free to call us with any questions about this.)
The risk is lower when you leverage. Your credit score may be the only thing at risk, and that’s in the most extreme circumstance (foreclosure). If you pay cash and something bad happens, you’re out the full amount. If you finance, you are out your down payment, but the bank loses more than you do. (This assumes the buyer has done her homework before purchasing the property, and has the funds to cover unexpected emergencies.)
Leveraging makes the pathway to passive income more accessible to beginners and young investors, and also means the renters will be paying off the mortgage for the investor. It’s more advantageous all around to avoid paying cash for investment properties. Contact Bodie Interests today to start investing in Houston, the smart way.