You might think that purchasing investment property is best done with all cash. After all, the interest payments associated with a mortgage work to negate your profits. However, by leveraging the bank's money, you may actually be able to increase your cash flow.
Consider the following:
Mr. and Mrs. Investor have their eyes on a $250,000 multi-family investment property. The property is a duplex that brings in $1,100 per month per unit for a total of $2,200 gross monthly income. Current interest rates are 4%. They figure 4% for vacancies allowance and 28% for annual operating expenses. They can purchase it all cash or they can use a mortgage which they are already pre-approved for.
Use the Cash on Cash calculator for the following purchases:
- All cash:
Mr. and Mrs. Investor purchase all cash (100% down payment):
Cash on Cash return = 7.18%
Cash flow = $17,952
- Mortgage at 4% interest:
Mr. and Mrs. Investor purchase using a mortgage at 4% interest with a 25% down payment:
Cash on Cash return = 11.54%
Cash flow = $7,210
- Mortgage at 6% interest:
Mr. and Mrs. Investor purchase using a mortgage at 6% interest with a 25% down payment:
Cash on Cash return = 7.14%
Cash flow = $4,462
- Mortgage at 7% interest:
Mr. and Mrs. Investor purchase using a mortgage at 7% interest with a 25% down payment:
Cash on Cash return = 4.77%
Cash flow = $2,983
While increased cash flow is a good thing, the Cash on Cash analysis allows us to see how we might improve our cash flow under different situations. For example, using the above scenarios, cash flow is at its greatest with the all cash investment. However, the CoC return is higher when purchasing with 25% down using a mortgage at 4%. With 25% down, Mr. and Mrs. Investor have used just $62,500 (as opposed to the full $250k) to purchase the duplex. If they were to do that same purchase three more times, their cash flow would increase to $28,840 (7210*4), a significant increase over the $17,952 cash flow attained with the all cash purchase.
This is a simplified scenario that does not take into consideration things such as closing costs associated with a mortgage and other factors. It simply suggests that purchasing investment property leveraging the bank's money under the right circumstances may have advantages. Buyers need to consider their own goals and financial situations when purchasing property of any kind.