One of the many advantages of real estate investing is an approach known as snowball investing. The concept is simple, use the cash flow from existing properties to help fund the purchase of your next property.
To keep things simple, in the following example I will assume:
- Zero inflation
- Zero appreciation
- No rehab cost
- Zero closing costs
- 5% return after all recurring expenses
- All properties are purchased under the following conditions:
- Price 200,000
- Financing 25% down, 30 year fixed, 5% rate
Calculating what we need for one property:
- Cash to close: 25% x 200,000: 50,000
- cash flow: 5% x 50,000: 2,500
Assume you purchase one property per year.
|Property #||Cash to Close||Unit Cash Flow||Total Cash Flow||Out of Pocket|
What if we assume that rents and property prices rise by 5% per year due to inflation? Two things to keep in mind: 1) Debt service, your largest cost is fixed so your return rises with inflation. 2) Incomes historically track inflation, so the last column shows cash out in present value dollars; after correcting for inflation.
|Property #||Cash to Close||Unit Cash Flow||Total Cash Flow||Out of Pocket||Present Value|
Due to the inflation advantaged nature of real estate, even though prices rise, the present value purchase prices remain about the same. We could look at other numbers and such but I hope the concept is clear. Also, once the mortgages are paid off, your cash flow will increase significantly.
Using cash flow from current properties to purchase additional properties is one of many advantages of real estate. Other advantages include:
- Leverage - No other investment offers long term fixed rate financing
- Tax advantage - Due to IRS required depreciation, many investors have significant positive cash flow while off setting other income with tax losses.
- The ability to sell one (1031 exchange) one investment property for another with no tax consequence.
- Inflation advantage. Rents track inflation while your costs are largely fixed. So, your actual return rises during times of inflation.