So you’re renting out your property, or maybe you have a whole slew of properties. You’re making decent passive income, but you want more. What do you do?

Rental rates are very strong right now, despite low interest rates aimed at incentivizing renters to buy. A combination for some low interest rate loans and high rental income leaves a nice spread for arbitrage.

I know a real estate investor that adds about 20 properties a year to his long-term rental portfolio. Simultaneously, he flips about 50 properties for quick, yet ridiculous profit.

So here’s what he does for his rentals:

1. He uses leverage.

This guy is a multi-millionaire. Sure, he can afford to buy all his properties cash, but why would he? He’s earning higher income than he pays in cash flow. Let’s go over a basic example that ignores time-value-of-money principles. We do this for simplicity.

Purchase Price:               $100,000

Loan Amount:     -$75,000

Closing Costs:      +$10,000

Cash Required to Close: $35,000

Now let’s assume you’re paying 6% interest on a 30-year loan. This is usually around the rate I’m able to get for borrowers, without waiting 2 months to close with a bank.

Interest Expense:   6% x $75,000 = $4,500

Now, let’s assume you can net 7% on your property after expenses.

Net Rental Income: 8% x 100,000 = $8,000

Interest Expense: -$4,500

Net Income After Interest =  $3,500

But you only put $35,000 into this deal. So you’re return ($3,500 / $35,000) is 10%. You essentially juiced up your returns, and you can do more deals, diversifying your risk between multiple properties. Otherwise, you would have earned 8% on your money, and would also have to take on significant risk in regards to your capital with just one property.

“Rental income provides me with lots of cash flow. Single-handedly responsible for making me financially free,” he says.

2. He has reserves for rainy days.

Leverage is great, but it also presents risks. Generally, those risks are mitigated if you have enough cash to weather the storm.

My father built luxury houses in unique locations such as Star Island, Indian Creek, and the likes. He took on large amounts of debt and risk, but was well compensated for it. However, in 2008 the market crashed, leaving his homes underwater from the principal he owed to the banks. As a result, he lost homes due to foreclosure. Evidently, this is a black swan event, but it is still better to err on the side of caution.

What did I learn from this? He essentially let his properties go when they were worth the least amount of money. Today, they are even higher in value than before 2007, and certainly wouldn’t be underwater. Had he enough cash to pay the mortgage payments, he would have been better off and kept his whole portfolio.

Ironically, using leverage may actually help you. For instance, you have to put less cash into the deal to earn the same rewards. Just don’t spread yourself too thin, and keep some reserves for unexpected events.

This is not limited to macroeconomic factors. We include unexpected repairs, upgrades, and other items specific to an individual property.

“I’ve levered quite a bit. But I’m always cognizant of how much cash flow and reserves I keep in the bank. Better safe than sorry,” he mentioned to me recently.

3. He finds great deals at the right time.

The biggest factor in any investment class is timing. You make your money when you’re buying, and buying at the wrong time can kill your returns. It’s important to keep in mind the general environment, but no one can predict with 100% accuracy what will happen.

Historically, up to 90% of your returns depend on market timing (macroeconomic factors), but that still leaves some dependence on individual asset picking.

For instance, factors like being next to schools, population growth, close transportation, trendy spots, and more can dramatically affect prices.

“I like to buy distressed properties. Often times, I need to touch them up before I rent them. Think properties that are encumbered with liens, have significant repairs, etc. That’s where you get the bargains. People just don’t want the brain damage,” he added when I asked.

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Written by Warren Ifergane.

To learn more about ICG, or to submit a deal for consideration, contact info@iferganeconsulting.com, or call 954.798.0726.

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