In our book, paying cash for a real estate transaction doesn’t even qualify as an investment. The returns are hideous, worse than plunking your money down into a government certificate of deposit. The reason is leverage and if you’re not taking advantage of this tool, you’re missing out on one of the amazing benefits of real estate investing. Let’s take a look at a very simple, specific example to give you an idea of the enormity of your miscalculation if you opt to buy your next property with cash.
Let’s say, n 1980, you decided to buy a rental property for $64,000 in cash. By 2010, the property is worth a $173,000, which seems like a nice little profit, but isn’t really. Once you adjust the 1980 price for inflation and compare what a dollar would buy then next to what a dollar would buy now, you figure that it’s as if you paid $167,000 for the house, expressed in real terms. That’s a paltry 3.4% increase over 30 years! Ouch. So how could you turn those numbers around and make that same investment shine like a happy star?
Leverage. The secret is leverage. What if, instead of paying cash for the house in 1980, you put down 20% of the purchase price ($12,800) and took out a long term loan for the rest? Run the numbers on a cash investment of thirteen grand versus sixty-four grand and you come out with a 480% profit instead.
That’s how people get rich with real estate investing. Consider that you’ve kept the place rented for most of the thirty years and the monthly rent covered the mortgage payment; the end result is that you never actually had to pay off the 80% you borrowed – the tenants did it for you. In case you haven’t realized it yet, this example shows why cash transactions kill you in a monetary system ripe with inflation, which ours is and will continue to be for the foreseeable future. A conservative system of borrowing is the way to create wealth in inflationary times. Anything else is simply putting your head on the chopping block and asking the executioner to be gentle.
The Creating Wealth Team
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