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Rich People Put Their Money: How Debt Can Control You (part 2)

A big difference between owning real estate investment and other investment types is the power of debt. A lot of people do not realize the strength of debt. When there is debt, amortization follows. Wealth is built in the amortization of the debt you shell out on a specific property. Say, for example, the $800k in debt you put in the building will have an array of tenants paying down your mortgage obligation on a monthly basis; that is the so-called amortization.

Let’s conclude the amortization in the example. Utilizing the loan terms the initial year of the loan will come out to have a $14k reduction from the owed amount. If the value of the property stays the same, that can also be seen as an increase in the same amount based on equity. In the event that we add that $14k to the after-tax cash flow, we are left with an all-inclusive after-tax return of a whopping 22.4%.

In this type of example, there is an assumption that the value of the property will not go high in value a cent; which is smart since assuming is another term for speculating, and speculations are considered risky in all types of investment. But, in multifamily having 5 units or other commercial investment real estate, it is noted that the property value is based on the income of the property it produces. Wealthy individuals love to control things. This is precisely the reason why rich people pay close attention to commercial units like multifamily apartment complexes in investing. Being that you control the expenses and income in a property, it follows that you also control its value. This simply means that you have a way to enhance income by increasing the rents or say, billing the tenants on their utilities, or incorporating any other source of lateral income to operational expenditures, you will also add value to the property.

Also, the other side of the coin is that if you lessen the expenses by renegotiating operational expenditure cost, reducing turnovers, billing tenants for utilities, putting in energy-efficient light bulbs and eco-friendly fixtures, or any other schemes to lessen your operational expenses, you will surely increase the value of your property.

Enhancing Value of Multifamily Units

Let’s have hat example once again. Say, this $1million building is composed of a twenty (20) unit apartment complex. The reason for the purchase of this property is because you have an eye on good opportunities; one of which is to add value both by decreasing expenses and of course increasing income. Nothing major in terms of renovation; just the things you could properly do after buying to help the bottom line.

Before buying, you realized that the previous owner had been in possession of the building for a bit longer, they had not been keeping up with market rents. You realized that there are some units in your area for which the rent is about $900-925, but your unit was only renting for $850. On the same and equal footing, the tenants were on a month to month leases, you went ahead and increase a minor amount of $25 to all units in month one. Of course, you wouldn’t want to keep the rent above the market value so you can keep your tenants. This simply added more than five grand of your income annually.

Another chance you smartly envisioned was in vendor costs. Over the last twenty (20) years, the vendors had slowly crept prices up above the rates on the market for their services. The previous owner was complacent with the operations and had close ties with his vendors so they never bothered to look at the prevailing market price.

On your first day of owning the complex, you were able to deal with the following monthly expenses, as follows:

  • Dumpster charge, monthly savings of $15 dollars or $180 annually
  • Cut grass expense, monthly savings of fifty dollars per cut or $1000 annually
  • Property management charge of 8% down to 7% or an annual savings of $1,600.00

This all does not seem as simple to do. But let us scrutinize how this will greatly affect our example.

After e=increasing your annual income by $5700 and simultaneously decreasing your operational expenses by $2780, you were able to increase your wealth by $8480 annually. The extra cash is significant, but the true advantage behind this is the fact that commercial real estate is valued based on the income it generates. Since you increased your income, the value of your property increases as well. That is direct proportionality.

In other words, your property is basically in a similar market and an asset class that gives it a similar cap rate of 8% that you purchase it for. Now that you have new schemes to add $8480 to your NOI or net operating income, this will give you a total NOI of $88,480. By dividing the NOI with your cap rate, we can therefore find the new value of the property. Thus, it reaches $1.106 million dollars. Have you seen that making minimal alterations in your approach would increase the value of your property by $106 thousand?

If you noticed, your mortgage did not change, and you still owe the same. You just increased the equity you possess in the property by $106k without putting an extra buck into the said investment. It is not magic.

Novel and Enhanced Tools and vehicles to know what all-inclusive return is now that you possess and added value, incorporate $8480 to your stable income, which will be an added $2968 due to the tax mandate.

This will take you to your novel total after-tax cash flow to $36472 or after-tax cash on cash return of 18.2%. Add in your entire $120k equity that has accrued in the initial year and you will have an entire return of 78%. Now that you have your strategies to generate all your income, you may be wondering the taxes will hit hard as soon as you let go of the property.

The reaction to that should be “why to sell it?” That is a great property. All you got to do is to hold on to this cash cow, but the entire equity out in a cash-out refinance, which is not a taxable event. Put some in a trust and hand it off to your legal heirs.

 

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Kaylee McMahon

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c: 469-990-4627 (text or call) IG: theapartmentqueen_

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