If a landlord has several rental properties (maybe 1 or 2, maybe 10 or 20) and holds for the long-term, then after years of price appreciation and principal reduction, there will be a lot of equity in the houses. For example, if the current house price is $500,000 and the landlord owes the bank $200,000, then the landlord has $300,000 equity in that house.
If the landlord has five such rental houses, that is $1.5 million of equity sitting in the houses. If the landlord has ten such houses, that is $3 million equity. If the landlord has paid off the mortgages of some houses, that means even more equity.
I talked with multiple landlords. Some say: “Yes, I am free! No mortgages!” Some say: “I still have a lot of loan, but after years of paying the mortgages, the equity is increasing nicely.” Some say: “I still owe the banks some money, but I have more equity than the loan amount. And the loan will be paid off soon.”
Therefore, this is actually quite a common situation with landlords.
However, does it make financial sense to have substantial equity sitting in the properties? How can the equity be used to grow more money for the landlord?
(1) Pull cash out of the equity in houses to buy more houses. My wife and I would like to hold our properties for maybe another ten years. Do we just keep paying down the mortgages and increase the equity in the properties over time? Is there a better way?
In the past years, when we had a lot of equity in some of our properties, we used cash-out refinances multiple times as well as line of credit to pull some of the equity out, and used the cash to buy more properties, as demonstrated in my book. That reduced the equity in the houses, increased the leverage, increased the rate of return, and resulted in us owning more properties.
Similarly, you can pull the equity out to buy more rental properties. Then after several years, the equity in your properties will grow again due to principal reduction and price appreciation, and you can repeat to do cash-out, again and again. Or, you will do cash-out refinance on house A this year, then house B next year, then house C, etc.
By pulling cash out of the equity to buy more rental properties, the rate of return can be increased quite significantly. As shown in my book, the rate of return can be increased by 10% or more using proper leverage. Even if you increase your return by just 5%, say, from 15% to 20%, the difference is quite big after 20 years. As an example to illustrate this point, assume your initial investment is $300,000. After 20 years:
At 15% return rate: $300,000 x 1.15**20 = $4.9 million.
At 20% return rate: $300,000 x 1.2**20 = $11.5 million.
Therefore, a few percentage points in annual return can produce a huge difference in the end result. This method can potentially make millions of extra dollars.
(2) Pull cash out of the equity in the houses to buy stocks. While we keep our eyes open for more real estate deals, we do not want the money to sit around and do nothing, so we also put them into stocks. I do not invest in individual stocks. I do not have the talent to beat the Wall Street experts. I do not want the extra work to research stocks and the associated emotional stress. So I simply put money into an SP 500 index fund that charges a low fee of 0.04%. My 401k is 100% in SP 500 and I look at it only once a year. It is trouble-free and stress-free, and it saves me time.
Earlier this year 2020, with a line of credit on the rental properties, we borrowed $0.56 million from the bank and dumped it into an SP 500 index fund in late March and early April. It is now up over 30%.
The focus here is not trying to time the market. The point is: In the short term, the SP 500 goes up and down (No one knows what it will do tomorrow or next month). However, in the long term, it has returned about 10% annually on average from 1965-2019.
We are currently doing another cash-out refinance on two other townhouses, and if it goes well, we will be able to borrow about $350,000 cash from the bank. This will also be poured into the SP 500 index fund.
Then, maybe once a year, maybe every couple of years, whenever the equity grows sufficiently in some of the properties, we plan to do cash-out refinances or use a line of credit to borrow money from the banks and dump it into the SP 500.
Since the pouring into SP 500 will be over multiple years, we will be doing dollar cost averaging.
The SP 500 will crash; and it will boom. How to control its risk? I use two ways to control the risk:
(1) Pour money into SP 500 over multiple years with dollar cost averaging;
(2) Hold it for the long-term, for example, 10-20 years.
Then, it should revert to its historic average, which is about 10% per year. And we do plan to hold for a couple of decades.
(3) John and Peter. What we are doing above is like this: You borrow money from John at 4% interest. Then you turn around and give the money to Peter, and Peter pays you 10%. You sit at home and do nothing, and get 6% every year. You reinvest that 6%, and your wealth grows by compounding.
If you can borrow $1 million from the equity in your properties, that is $60,000/year for doing nothing. If you can borrow $2 million from the equity in your properties, that is $120,000 per year of passive income, that can go into the compounding magic.
Now the compounding magic. The loan that you owe the bank has a fixed amount; if you borrow $1 million, then it is $1 million. However, when you turn around and put this $1 million into SP 500, it will double or triple over the long-term. When it doubles after a number of years, then your 10% return is calculated based on the $2 million. When it triples to $3 million, then your 10% return is calculated based on the $3 million. In contrast, your loan from the bank is fixed at $1 million; it does not increase to $2 million or $3 million.
Your investment is compounding, but your loan amount is not compounding. The difference will be increasingly bigger after long-term investing. This means that your interest payment to the bank for the loan will become increasingly negligible compared to your profit, when you do this for 10-20 years.
Hence, as long as my rental properties can break even or produce a small positive cash-flow, the more I can borrow from the banks, the better.
Many years ago, I had a friend in China who had connections with the high level. He was able to borrow money from the bank at a super low interest rate, and then he turned around and gave the loans out to others at a normal market interest rate, making a difference of about 3%. Although the 3% difference was small, his base amount was big. So, do not look down on the small 3%. For example, if his base amount was 100 million yuan, 3% means 3 million yuan of passive income per year.
Most of us do not have such connections to make such easy money. But if you have a lot of equity in your houses, you can make such easy money too. And your difference is about 6%, if you hold for the long-term.
Furthermore, since the Fed has cut interest rates to near 0, it would be highly advantageous if you could lock in an interest rate of 3% or 3.5%. Since the interest payment in real estate is tax-deductible, after the tax benefit, you are only paying an effective interest of less than 3%, or a bit more than 2%. With the inflation being typically around 2%, it means that you are effectively paying nearly 0% in the real interest rate. It is virtually an interest-free loan.
Ask yourself: If you can borrow money from the bank at an effective real interest rate of almost 0%, why not borrow more money from the bank, and then turn around and plant that money to grow a “money tree” for your family?
Even if you plant only a small tree, it will grow over the years into a big “money tree” due to the compounding magic.
Therefore, think and grow rich. This article invites you to do some thinking, and do your own research. Then if you decide, borrow as much as possible from John at 3% or 4% interest rate, and give it to Peter and receive 10% return per year. And let the money compound for the long-term.
(4) Summary. The simple method that I describe in this article will help maintain the leverage and increase the overall rate of return, while spending very little extra time and little extra effort. Your wealth will compound much faster this way, than having a lot of equity sitting in the properties doing nothing.
Disclaimer: This article serves as a helpful tool on investing. However, laws and regulations and situations often differ from place to place. The reader should seek the services of legal, accounting and financial professionals, as such services are not provided by this article or this author. Investing has been a proven and fruitful opportunity for numerous investors. However, any investing also has the possibility to lose money, and events such as economic changes and local market conditions are not the responsibility of this author. While the author has used his best efforts to prepare this article, he makes no warranties regarding the accuracy or completeness of the contents. The author bears no liability and the reader is responsible for his/her own investing failures and successes.
我今年初拿到了$560000 loan，这篇文章里有提到。现在正在做两个出租房的cash out，tentatively approved, already finished appraisal. Hopefully will be done soon. 您可以多问几个银行。实在不行的话，可以找 local small commercial banks.
Grow Wealth by Maintaining Leverage
By David S. J. Meng
If a landlord has several rental properties (maybe 1 or 2, maybe 10 or 20) and holds for the long-term, then after years of price appreciation and principal reduction, there will be a lot of equity in the houses. For example, if the current house price is $500,000 and the landlord owes the bank $200,000, then the landlord has $300,000 equity in that house.
If the landlord has five such rental houses, that is $1.5 million of equity sitting in the houses. If the landlord has ten such houses, that is $3 million equity. If the landlord has paid off the mortgages of some houses, that means even more equity.
I talked with multiple landlords. Some say: “Yes, I am free! No mortgages!” Some say: “I still have a lot of loan, but after years of paying the mortgages, the equity is increasing nicely.” Some say: “I still owe the banks some money, but I have more equity than the loan amount. And the loan will be paid off soon.”
Therefore, this is actually quite a common situation with landlords.
However, does it make financial sense to have substantial equity sitting in the properties? How can the equity be used to grow more money for the landlord?
(1) Pull cash out of the equity in houses to buy more houses. My wife and I would like to hold our properties for maybe another ten years. Do we just keep paying down the mortgages and increase the equity in the properties over time? Is there a better way?
In the past years, when we had a lot of equity in some of our properties, we used cash-out refinances multiple times as well as line of credit to pull some of the equity out, and used the cash to buy more properties, as demonstrated in my book. That reduced the equity in the houses, increased the leverage, increased the rate of return, and resulted in us owning more properties.
Similarly, you can pull the equity out to buy more rental properties. Then after several years, the equity in your properties will grow again due to principal reduction and price appreciation, and you can repeat to do cash-out, again and again. Or, you will do cash-out refinance on house A this year, then house B next year, then house C, etc.
By pulling cash out of the equity to buy more rental properties, the rate of return can be increased quite significantly. As shown in my book, the rate of return can be increased by 10% or more using proper leverage. Even if you increase your return by just 5%, say, from 15% to 20%, the difference is quite big after 20 years. As an example to illustrate this point, assume your initial investment is $300,000. After 20 years:
At 15% return rate: $300,000 x 1.15**20 = $4.9 million.
At 20% return rate: $300,000 x 1.2**20 = $11.5 million.
Therefore, a few percentage points in annual return can produce a huge difference in the end result. This method can potentially make millions of extra dollars.
(2) Pull cash out of the equity in the houses to buy stocks. While we keep our eyes open for more real estate deals, we do not want the money to sit around and do nothing, so we also put them into stocks. I do not invest in individual stocks. I do not have the talent to beat the Wall Street experts. I do not want the extra work to research stocks and the associated emotional stress. So I simply put money into an SP 500 index fund that charges a low fee of 0.04%. My 401k is 100% in SP 500 and I look at it only once a year. It is trouble-free and stress-free, and it saves me time.
Earlier this year 2020, with a line of credit on the rental properties, we borrowed $0.56 million from the bank and dumped it into an SP 500 index fund in late March and early April. It is now up over 30%.
The focus here is not trying to time the market. The point is: In the short term, the SP 500 goes up and down (No one knows what it will do tomorrow or next month). However, in the long term, it has returned about 10% annually on average from 1965-2019.
We are currently doing another cash-out refinance on two other townhouses, and if it goes well, we will be able to borrow about $350,000 cash from the bank. This will also be poured into the SP 500 index fund.
Then, maybe once a year, maybe every couple of years, whenever the equity grows sufficiently in some of the properties, we plan to do cash-out refinances or use a line of credit to borrow money from the banks and dump it into the SP 500.
Since the pouring into SP 500 will be over multiple years, we will be doing dollar cost averaging.
The SP 500 will crash; and it will boom. How to control its risk? I use two ways to control the risk:
(1) Pour money into SP 500 over multiple years with dollar cost averaging;
(2) Hold it for the long-term, for example, 10-20 years.
Then, it should revert to its historic average, which is about 10% per year. And we do plan to hold for a couple of decades.
(3) John and Peter. What we are doing above is like this: You borrow money from John at 4% interest. Then you turn around and give the money to Peter, and Peter pays you 10%. You sit at home and do nothing, and get 6% every year. You reinvest that 6%, and your wealth grows by compounding.
If you can borrow $1 million from the equity in your properties, that is $60,000/year for doing nothing. If you can borrow $2 million from the equity in your properties, that is $120,000 per year of passive income, that can go into the compounding magic.
Now the compounding magic. The loan that you owe the bank has a fixed amount; if you borrow $1 million, then it is $1 million. However, when you turn around and put this $1 million into SP 500, it will double or triple over the long-term. When it doubles after a number of years, then your 10% return is calculated based on the $2 million. When it triples to $3 million, then your 10% return is calculated based on the $3 million. In contrast, your loan from the bank is fixed at $1 million; it does not increase to $2 million or $3 million.
Your investment is compounding, but your loan amount is not compounding. The difference will be increasingly bigger after long-term investing. This means that your interest payment to the bank for the loan will become increasingly negligible compared to your profit, when you do this for 10-20 years.
Hence, as long as my rental properties can break even or produce a small positive cash-flow, the more I can borrow from the banks, the better.
Many years ago, I had a friend in China who had connections with the high level. He was able to borrow money from the bank at a super low interest rate, and then he turned around and gave the loans out to others at a normal market interest rate, making a difference of about 3%. Although the 3% difference was small, his base amount was big. So, do not look down on the small 3%. For example, if his base amount was 100 million yuan, 3% means 3 million yuan of passive income per year.
Most of us do not have such connections to make such easy money. But if you have a lot of equity in your houses, you can make such easy money too. And your difference is about 6%, if you hold for the long-term.
Furthermore, since the Fed has cut interest rates to near 0, it would be highly advantageous if you could lock in an interest rate of 3% or 3.5%. Since the interest payment in real estate is tax-deductible, after the tax benefit, you are only paying an effective interest of less than 3%, or a bit more than 2%. With the inflation being typically around 2%, it means that you are effectively paying nearly 0% in the real interest rate. It is virtually an interest-free loan.
Ask yourself: If you can borrow money from the bank at an effective real interest rate of almost 0%, why not borrow more money from the bank, and then turn around and plant that money to grow a “money tree” for your family?
Even if you plant only a small tree, it will grow over the years into a big “money tree” due to the compounding magic.
Therefore, think and grow rich. This article invites you to do some thinking, and do your own research. Then if you decide, borrow as much as possible from John at 3% or 4% interest rate, and give it to Peter and receive 10% return per year. And let the money compound for the long-term.
(4) Summary. The simple method that I describe in this article will help maintain the leverage and increase the overall rate of return, while spending very little extra time and little extra effort. Your wealth will compound much faster this way, than having a lot of equity sitting in the properties doing nothing.
Disclaimer: This article serves as a helpful tool on investing. However, laws and regulations and situations often differ from place to place. The reader should seek the services of legal, accounting and financial professionals, as such services are not provided by this article or this author. Investing has been a proven and fruitful opportunity for numerous investors. However, any investing also has the possibility to lose money, and events such as economic changes and local market conditions are not the responsibility of this author. While the author has used his best efforts to prepare this article, he makes no warranties regarding the accuracy or completeness of the contents. The author bears no liability and the reader is responsible for his/her own investing failures and successes.我今年初拿到了$560000 loan，这篇文章里有提到。现在正在做两个出租房的cash out，tentatively approved, already finished appraisal. Hopefully will be done soon. 您可以多问几个银行。实在不行的话，可以找 local small commercial banks.