To illustrate how leverage works in a real estate investment, we'll take the following investment parameters:
Purchase price of a duplex rental property of $250,000
Financing at 7.5% interest for 30 years
$3300 annual expenses for taxes, insurance and repairs
Rental of $1100/month for each of the two units
Let's look now at the ROI (Return on Cash Invested) with different cash up front down payments:
$250,000 paid in full in cash:
$26,400 in rents - $3300 expense = $23,100 NOI
$23,100 / $250,000 = 9.2% ROI
50% or $125,000 down payment:
$10,488 in mortgage payments + $3300 expense = $13,788 cash out
$26,400 in rents - $13,788 = $12,612 NOI
$12,612 / $125,000 cash in front = 10.1% ROI
20% or $50,000 cash down payment:
$16,781 in mortgage payments + $3300 expense = $20,081 cash out
$26,400 in rents - $20,081 = $6319 NOI
$6319 / $50,000 cash in front = 12.6% ROI
10% or $25,000 cash down payment:
$18,879 in mortgage payments + $3300 expense = $22,179 cash out
$26,400 in rents - $22,179 = $4221 NOI
$4221 / $25,000 cash in front = 16.9% ROI
As you can see, even though your risk increases with leverage, it might be a wise choice when you can increase your ROI by as much as 80% (16.9% is 84% increase over 9.2%) over the full cash in front option. And of course you've freed up over $200,000 to invest elsewhere.
