Is it better to be debt-free or to go into debt to invest in commercial real estate? Which personal financial strategy is best for you? Both have their advantages, but as you'll discover in this video, going into debt to invest in commercial real estate rather than being completely debt free can create so many more opportunities to build wealth, allowing you to use less capital to accomplish more.
Debt Free Personal Finance Strategy Benefits
- You don’t owe anything to anyone.
- Your cost of living expenses is reduced because you aren’t paying off debt.
- For some people, no debt means less stress.
- It gives you the ability to save because your cost of living is reduced.
Going into Debt to Invest in Commercial Real Estate Benefits
- You can use borrowed capital to invest in commercial real estate. Often the bank will lend up to 75% of the property and you will need a 25% down payment.
- Your money is at work because you are leveraging the bank's money to buy the property.
- You produce wealth by creating cashflow and building equity. When you invest in an apartment building the tenants pay rent with which you pay your expenses and mortgage, and pocket the remaining cashflow. Every month you pay the mortgage you're reducing the loan and creating equity in the property.
- It provides tax advantages. One of the greatest benefits of commercial real estate investing are the tax write offs. If you do it right, every year you will pay minimal taxes.
- The ability to create massive income growth and equity over time.
Debt-Free Investing vs Commercial Real Estate Investing
Below are two investment strategies, both starting with $400,000. In Strategy #1 we are buying one property and in Strategy #2 we are purchasing four properties.
Investment Strategy #1: Debt-Free Commercial Investing
Property: 1 5-Unit building purchased in cash and paid in full for $400,000.
With no mortgage payment, your income minus your expenses equals your cashflow.
Equity over 15 years: $700,000
Having a long-term outlook and being conservative in my predictions, let's say the property is worth $700,000 over fifteen years. You bought it for $400,000 and now your net worth is $700,000.
What choices can you make because of investing debt-free?
- Not many because your desire is to remain debt-free.
- Can you retire? With a cashflow of maybe $3,000 after 15 years, probably not. This strategy doesn’t generate enough wealth.
- When you pass this down to your kids what are you teaching them? They’re not learning anything from this except how to be debt free.
- It has few legal tax-advantages.
- You can use the $1.5 million to buy more property and increase your portfolio.
- You can use $1.5 million to retire.
- The ability to pass down a legacy to your kids. Along with giving them the property, you are teaching them how to invest, run the numbers, how to get along, be responsible property owners and good stewards. You are teaching them how to fish as opposed to just giving them fish.
- You have huge tax advantages. I have a video called Tax Benefits of Commercial Real Estate Investing, where I detail the numerous tax benefits of investing using this investment strategy.
- Have cash reserves: When you buy a property make sure it's not your last dollar.
- Don’t leverage more than 90% long-term: You may be able to get into a loan with 10% down but make sure it's for a shorter time, not a 10 year or 15 year loan because the market is going to ebb and flow. Make sure it's shorter so that when times get bad you can get out of it.
- Be a good operator: Learn how to manage the property properly, keep track of expenses, do your accounting. Also, if you have a property manager learn how to hold that person accountable. You need to learn how to manage the management company.
Investment Strategy #2: Commercial Investing Using Debt
This strategy using leverage is what we teach our students to use when investing in commercial real estate.
Properties: 4, 5-Unit buildings purchased for $400,000 each. You're leveraging the bank's money to buy the properties, applying a 25% down payment which is $100,000/property.
Portfolio Value: $1.6 million because we bought a $400,000 property but we bought it four times. We have the same equity as strategy #1 of $400,000, however the portfolio value is $1.6 million because we used borrowed capital to buy more property.
Equity over 15 years: $2.2 million/$550,000 per property
We purchased each property for $400,000, with a down payment of $100,000, which means we owed $300,000 per property. Over the next 15 years we paid off half so now we owe $150,000. If each of the properties is worth $700,000 and you owe $150,000 that means you have equity of $550,000 per property. We have four properties which means our equity now is $2.2 million. Your net worth is now $2.2 million.
Exit Strategy: Cash-Out Refinance
This is one of my favorite exit strategies. If the properties are worth $2.2 million, we can borrow 75% of that, pay off the mortgages and we'll be able to cash out and pull out $1.5 million tax free until we sell the property.
What choices can you make because of investing with leverage?
A Few Points Concerning Debt:
Short Term Debt: Don't do short term debt on real estate investing. Let's face it, the Coronavirus has scared people with short term debt. With their short-term loans coming due, they may not be able to refinance. Instead, I suggest you do 7 year, 10 year, 15 year, even a 30 year loan. Thirty year fixed loans are available for apartment buildings and it’s probably the safest thing you can do these days.
Paying Off Investment Loans: You may want to pay off your commercial real estate loan. Although I don't recommend it, you may have to do it if you are stuck in a bad deal. What's the solution to having a bad deal? The solution is don't do bad deals.
Risky Debt: Some of you have heard it said that debt is risky during bad times and it can be. However, after 20 years of investing, I’ve discovered these safeguards and it’s what we teach our students.
Debt can be an amazing asset to building wealth. On the other hand, debt-free investing, in my opinion could be economically irresponsible. For instance, if you have money sitting around and you have the expertise or access to knowledge to leverage that money and create more wealth and you don't do it, that could be a bit selfish but also economically irresponsible to you and your family.
Finally, are you stuck making commercial real estate decisions? If you are sitting on money and are stuck making decisions for whatever reason, I have the perfect video for you to watch. It’s called 5 Keys to Making Decisions in Commercial Real Estate and I do my best to cover all of the fears and unknowns that can keep you from building wealth investing in commercial real estate.