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The table below demonstrates why real estate investors should buy income producing properties with the lowest possible down-payment. For our example here, we use a typical two-family duplex available in most American neighborhoods for about $50,000 per unit.
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Assumptions |
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Purchase Price of 2-unit building |
$ 100,000 |
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Land Value for tax purposes |
$ 10,000 |
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Value of Building and Improvements |
$ 90,000 |
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Net Operating Income (NOI) |
$ 9,000 |
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NOI = Rent Income minus Operating Expenses |
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Rates of Return With Various Financing |
Paid cash |
25% down |
10% down |
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Cash Down Payment (Initial Equity) |
$ 100,000 |
$ 25,000 |
$ 10,000 |
Net Operating Income (NOI) |
$ 9,000 |
$ 9,000 |
$ 9,000 |
Annual Loan Payment (25 yrs.- 8%) |
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$ 6,947 |
$ 8,336 |
Annual Net Spendable Cash -- Before-Tax |
$ 9,000
9.0% |
$ 2,053
8.2% |
$ 664
6.6% |
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Less Annual Interest (8%) |
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($6,000) |
($7,200) |
Principal Repay = Equity Build-Up |
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$ 947
3.8% |
$ 1,136
11.4% |
Annual Return before Appreciation -- Before-Tax
(Cash + Principal Repay) |
$9,000
9.0% |
$3,000
12.0% |
$1,800
18.0% |
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Depreciation ( 27.5 yrs.) |
$ 3,273 |
$ 3,273 |
$ 3,273 |
Taxable Income (or Loss) |
$ 5,727 |
($273) |
($1,473) |
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Appreciation @ 3% per annum |
$ 3,000 |
$ 3,000 |
$ 3,000 |
Total Annual Rate of Return -- Before-Tax
(Cash + Principal Repay + Appreciation) |
$12,000
12.0% |
$6,000
24.0% |
$4,800
48.0% |
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Fed/State/Local Inc.Tax - Marginal Rate = 50% |
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Tax Payable (negative = tax savings on other income) |
$2,864 |
($ 137) |
($737) |
Annual Spendable Cash -- After-Tax
(includes tax saving on other income) |
$6,136
6.1% |
$ 2,190
8.8% |
$1,401
14.0% |
Total Annual Rate of Return -- After-Tax
(Cash + Principal Repay + Appreciation) |
$9,136
9.1% |
$ 6,137
24.6% |
$ 5,537
55.4% |
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Fed/State/Local Inc.Tax - Marginal Rate = 25% |
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Tax Payable (negative = tax savings on other income) |
$1,432 |
($ 69) |
($ 369) |
Annual Spendable Cash -- After-Tax
(includes tax saving on other income) |
$7,568
7.6% |
$2,122
8.5% |
$1,033
10.3% |
Total Annual Rate of Return -- After-Tax
(Cash + Principal Repay + Appreciation) |
$10,568
10.6% |
$6,069
24.3% |
$5,169
51.7% |
Note: The above numbers are for the initial year of ownership only. The following factors will increase rates of return for subsequent years assuming that other factors remain the same:
1. Principal repayments increase in each of subsequent years
2. Due to compounding, the appreciation amount increases each year assuming the same percentage rate
3. Assuming that income increases at the same rate as expense increases, net operating income will increase
CREATING LEVERAGE is the key to wealth in real estate investing. Using a little of your own money to move a lot of someone else's money allows you to enjoy the benefits of deprecation for tax purposes and the real appreciation that occurs on the value of the entire investment.
Between 1975 and 1995, all forms of real property (including houses, land, buildings and other structures) in the U.S. appreciated by 8% per year. Single-family homes gained about 6% a year. 1996 through 1998 inflation has been almost flat, but in most areas, well located property continued to appreciate nicely.
You will note that in our example above we used a very conservative 3%, which is the average world-wide inflation rate over the past 2,000 years. `If we had used the actual real estate appreciation numbers that you would have enjoyed over the past ten years in our example, the leveraged return goes right through the roof and you would probably not believe it.
We also cover the subject of using leverage in some depth on our page about how to buy income property with no money down. That concept is as old as the "come-on" used in various real estate investing courses containing books and tapes, that are sold for hundreds of dollars, to thousands of people like you on TV every week. However, please believe us; learning how to buy property with no money down is just one the things you will need to know and understand in order to become successful in the rental property business. You will also learn that although you can buy real estate with No Money Down, it usually means you pay more for the property than you need to and don't enjoy the best possible terms.
Learn all you can about every aspect of the business. It doesn't take unusual intelligence or hard work to get rich in real estate. It just takes knowledge of some basics and then the willingness to follow through with what you learn. If you get confused or need additional information, join professional landlords in a local association. Post a question on a discussion page. We won’t wish you luck, because luck has little to do with success, but we will wish that you get started today.
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