ROI Study: Leveraged versus Cash Investments by Max Wilson, Real Estate Investment Strategist Max Business Group Real Estate Services

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1 ROI Study: Leveraged versus Cash Investments by Max Wilson, Real Estate Investment Strategist Max Business Group Real Estate Services There is no doubt one of the attributes by Max Wilson, that attract Real investors Estate Investment to real estate Strategist the ability and benefits of leveraging an investment. Max When Business buying Group other Real investments Estate Services like stocks the investor gets only what they pay for in a $1 for $1 value exchange. One pays 100% of the value of the stock on that day with 100% of those real dollars coming out of their pocket. Money is made only when the stock gets sold at a higher price than it was purchased for (yield spread) and through any dividends or splits that may occur during ownership. In real estate, a residential home owner, can receive 100% of the value of a single family residence for as little as 3.5% down (plus closing costs- which can be subsidized through negotiation with the seller). For a non-owner occupied single family residence that figure increases to 20% down (the owner doesn t live in the house). When purchasing non-owner occupied income producing properties, 20% down will get the investor 100% of the benefits- and those benefits may (should) include cash flows, tax benefits, and increases in equity due to principle reduction (reduction of principle due to monthly payments) and appreciation (from market appreciation, forced appreciation, financial appreciation, or from any combination of the three). Which strategy should I use? Most real estate investors take full advantage of leveraging to get 100% of the property s benefits for 3.5%, 10%, 20% down, or, 30% to 50% down when dealing with non-recourse loans which are typical when purchasing real estate through a self-directed IRA. But what if the investor can pay 100% cash for a property buying it like a stock on a $1 for $1 value exchange? The first question that flashes through my mind is: Which purchase strategy would produce the greatest return on investment? Strategy A: purchasing a property without leveraging (pay 100% cash at closing)? the investor will purchase a $130,000 property for $130,000 cash out of their pocket (no mortgage) Strategy B: purchasing a property by leveraging the investment (using a typical 20% down or in lenders terms- 80% LTV [Loan to Value ratio])? the investor will continue to purchase properties until they have spent the same $130,000 Total Out of Pocket funds. What do you think? (check one): Pay Cash Leverage the Investment (20% down) ROI Study: Leveraged versus Cash Investments 2009 Max Wilson, MaxBusinessGroup.com Page 1

2 From this question I have developed the following hypothesis (my guesses as to what analysis will show): H1: Purchasing a property using 100% cash will provide a greater return than leveraging the investment when only 1 property is purchased H2: Leveraging the amount to be invested (versus number of properties to purchase) will provide much greater returns than the same amount spent in cash purchases H3: Leveraging the amount to be invested will provide much greater Total Wealth Growth over the life of the investment The Research To answer this question I identified and analyzed three properties that report returns at three different levels of positive cash flow. These levels were identified from a study in which I investigated the investment habits of investors that purchased multi-family properties in Western PA from January 1 st to September 10 th I conducted that study using the REIA Report Investor as the tool to measure the financial performance of all the properties purchased. What I found was: 71% of all properties purchased reported a negative cash flow- of which -$79.53 = The average negative Cash Flow After Taxes per Unit per Month (-CFAT/U/M) 29% of these properties had negative returns greater than -$121 CFAT/U/M 29% reported having a positive cash flow at the following levels Low: 19% had an average return of $27.55 CFAT/U/M (lucky investor going it alone) Medium: 9% had an average return of $86.48 CFAT/U/M (learning investor with expert realtor) High: 1% had an average return of $ CFAT/U/M (investor that use my Busy Real Estate Investor System sm (BREISystem sm ) The three properties selected perform at or very close to the Low, Medium, or High positive cash flow levels listed above. Additional assumptions for analysis will also be that the investor: 1) will receive 9% of sales price in seller s assist at closing (negotiated), 2) will not occupy the property, 3) will only purchase positive cash flow properties (based on an 80% LTV), 4) has exactly $130,000 to spend, and 5) will only purchase properties currently available in the marketplace. To view all the assumptions made in the analysis, please review the actual criteria used in the analysis by viewing the Input Data Sheet on page 11 of the REIA Report Investor Leverage vs Cash Example (available for download in the November issue of Max s Real Estate Investment Strategies Newsletter. Method To begin answering my question I first analyzed all of the income producing properties available in the Western PA region and then selected one property from each of the three positive cash flow categories. I made every attempt to select properties that were like in location, price, and condition. I then ran analysis on each of the properties based on a 100% cash purchase and then on a 20% down leveraged purchase. When money was available for additional property purchases I used the original property selected in its category and duplicated it s returns as many times as possible. I then aggregated those findings together to achieve appropriate comparable returns on investment. ROI Study: Leveraged versus Cash Investments 2009 Max Wilson, MaxBusinessGroup.com Page 2

3 The Properties The three properties selected are listed below in their respective return categories: Low Return: 480 Shirls Ave, Washington PA Number of units: 4 / Price: $129,000 Medium Return: 413 Eighth Street, Ambridge PA Number of units: 4 / Price: $124,900 High Return: 145 Penn Ave, Mt Oliver PA Number of units: 9 / Price: $129,900 Note: Performance was based on third party reporting of income and expenses. For the method used in this case study it was not important to verify the income and expense data. The need was to find 3 like properties with like listing prices against three separate levels of returns. No purchase should be made without intensive investigation to achieve the most accurate and comprehensive list of income and expense data possible before analysis. The Findings Let s now look at each of the three hypothesis (guesses) I made earlier in this article and see how the research supports or contradicts my predictions. H1: Purchasing a property using 100% cash will provide a greater return than leveraging the investment when only 1 property is to be purchased As you will see below, in all three cases, when only one property was purchased, Strategy A: Cash Purchase had the highest returns on investment. The elimination of the mortgage (principle and interest payments) well offset the higher tax costs (the more money you make the more taxes you pay) to land it as the winning strategy. Low Return Property: 480 Shirls Ave, Washington PA (4 units) Medium Return Property: 413 Eighth Street, Ambridge PA (4 units) ROI Study: Leveraged versus Cash Investments 2009 Max Wilson, MaxBusinessGroup.com Page 3

4 High Return Property: 145 Penn Ave, Mt Oliver PA (9 units) Cash Purchase Wins when only one property is to be purchased! But what if you want to buy as many properties as you can with a certain amount of money? What happens if you don t restrict yourself to just 1 property? PS: By now, I hope you got that the first question in this paragraph is loaded will flawed thinking- it s not about the number of properties you buy but the importance of getting the highest return on your investment for the properties you do buy. This is the reason I am analyzing properties at three different levels of return in this article- so you can see the long term impact of your investments. Now, onto my next guess. H2: Leveraging the amount to be invested (versus number of properties to purchase) will provide much greater returns than the same amount spent in cash purchases As you will see below, when leveraging the money available for purchase, the return of investment skyrockets. Why? because you can conservatively purchase between 4 and 5 properties with the same amount of cash you used when you purchased only one property. In these examples it is easy to see how all four pillars for building wealth in real estate come together to create the highest of returns. By leveraging your investment money, you can receive 4-5 times the cash flows, 4-5 times the appreciation, 4-5 times normal principle reduction (no principle reduction in a cash purchase as there is no principle to reduce), and 4-5 times the tax benefits. Notice that only in the lowest of categories did the Cash Purchase strategy out perform the Leveraged property strategy- and only in Cash Flow After Tax factor. However, when combining all four pillars for building wealth (Accumulated Wealth End Year 1), the leveraged strategy wins hands down. Low Return Property: 480 Shirls Ave, Washington PA (Leveraged: buy 5 properties= 20 units) Medium Return Property: 413 Eighth Street, Ambridge PA (Leveraged: buy 5 properties= 20 units) ROI Study: Leveraged versus Cash Investments 2009 Max Wilson, MaxBusinessGroup.com Page 4

5 High Return Property: 145 Penn Ave, Mt Oliver PA (Leveraged: buy 4 properties= 36 units) Leveraged Purchase Wins when leveraging the amount to be invested! So, up to now, we have looked at a) returns for 1 property being purchased using both cash and leveraging strategies, and b) what the returns could be when leveraging the amount of available funds to purchase multiple properties. And, it should get better when I check my third and final guess. H3: Leveraging the amount to be invested will provide much greater Total Wealth Growth over the life of the investment Below you will see that when you use a leveraging strategy to the fullest of its potential it can have huge impacts on your long term wealth building goals- even when purchasing at the lowest levels of positive cash flow properties. I have provided you these analytical insights to show the one thing that is kind of hidden in the data- that in every case, where a leveraging purchase strategy was used, the investor s total out of pocket funds were completely returned to the investor years before they would have been, had a cash approach to purchase the properties been used. To show when those funds should be returned I have provided a Cash-on-Cash Return data chart for each of the properties. The number to the far right of the chart shows the year in which all of the TOOPF had been returned to the investor (Infinite Returns Start) for each of the strategies. I then calculated the difference in years between strategies (circled). I then used that number of years and repurchased the same type and number of properties again (since I have the same amount of money I started with at first) and calculated what the increase in income would be for those few years. As a final straw on the cash investors back, I calculated the difference in total wealth growth between strategies up to the year that all of the Total Out of Pocket Funds were returned to the investor- no matter which strategy took the longest. As you can see, the difference in using a leveraging strategy can make a huge difference in building wealth in a relatively short period of time(see figure in red box): $507,087 in 13 years for the lowest of investment categories (or about $39,007 a year) $748,240 in 11 years for the mid returning investment category (or about $68,022 a year) and $1,080,664 in 6 years for the highest return investment category (or about $180,111 a year). Please note that the differences listed above (and below) are FREE MONEY TO YOU. Both strategies spent the same amount of money- they just invested it using a different strategy. ROI Study: Leveraged versus Cash Investments 2009 Max Wilson, MaxBusinessGroup.com Page 5

6 Low Return Property: 480 Shirls Ave, Washington PA (Buy 5 more four-plexes yr 11= Total 40 units) Medium Return Property: 413 Eighth Street, Ambridge PA (Buy 5 more four-plexes Yr 7= Total 40 units) High Return Property: 145 Penn Ave, Mt Oliver PA (Buy 4 more 9-plexes Yr 3= Total 72 units) Leveraged Purchase Wins BIG when leveraging the amount to be invested multiple times! Any questions? ROI Study: Leveraged versus Cash Investments 2009 Max Wilson, MaxBusinessGroup.com Page 6

7 When to use a Cash purchasing strategy Is there any time when a Cash purchase strategy is best? Yes. I can quickly think of six scenarios in which it might be advantageous to purchase a property for cash. They are: 1. You can buy a property well below market value (the price someone at arms length is willing to pay for the property in its current condition and location in the marketplace) with the intent of refinancing the property in the very near future to extract as much equity out of the property as possible to drive further investing. This is a typical flipping type strategy (whether you update it or not). 2. You like the property but feel that the vacancy rate might be extremely high for one reason or another (violence, economic downturn in that area, unusually low unit mix- all units are efficiency apartments which typically produces very high vacancy rates in some areas). 3. You are looking to loose money or use your purchase as a tax shelter. If you are, you will want to consult with your accountant about IRS tax codes concerning active and passive investors. 4. You purchased a commercial building (retail or office) and are concerned of the possibility of losing some key, large volume tenants. Not having a mortgage could give you the buffer you need to hold onto the building until a suitable new tenant could be found. 5. You are buying internationally and do not meet local lending criteria 6. You have no job and can t qualify for a loan- but you have the cash to purchase a property. Case Study To help you get behind the numbers I have provided a full copy of the REIA Report Investor Leverage vs Cash report for the mid-category property used in this study. You can download your copy in the October 2009 edition of my FREE Real Estate Investment Strategies Newsletter. If you are not a subscriber, me using the link below and request this month s password (changes every month) to enter into my newsletter archive. I will send you a link to the Newsletter Archive page where you will enter the password. Once entered select proceed to be taken into the archive. Here select the October 2009 edition and click: REIA Report Investor: Leverage versus Cash Purchase Example. To see the base, single property analysis see This Months Top Property Pick section of the same edition. If you have questions about this article or the accompanying case study, or would like to find out more about how I help my clients maximize returns when buying, selling, or investing in real estate in Western PA, give me a call at or me at: MaxWilson@MaxBusinessGroup.com PS: To sign up for my FREE Real Estate Investment Strategies Newsletter, go to and select the Invest in Real Estate button at the top of the page and then select Free Investor Newsletter in the drop down menu box. Submit your address and follow the prompts. You will receive your free newsletter the first Wednesday of every month. Please feel free to forward the newsletter to any other investor, that you know, that would like to make more money in less time. ROI Study: Leveraged versus Cash Investments 2009 Max Wilson, MaxBusinessGroup.com Page 7