Bad example/improved example (long) - Posted by Sean
Posted by Sean on March 25, 1999 at 16:16:19:
Well, your risk scenario is a little off, don’t you think?? But let’s examine your scenario with a little more realism. You suggested as the model person someone who owns 10 properties free and clear.
Let’s assume, for the sake of simplicity, that all properties are worth $100,000 rent for $1,000 a month and have a net operating income of $10,000 a year. Let us also assume that your model person has $1,000,000 cash and wants to invest it in real estate. He purchases all 10 properties outright for $100,000 each.
Now let’s consider my “improved” person (not ideal, because ideal would indicate buying the property for no money down or possibly less than no money down). He also has $1,000,000 cash and decides to invest in real estate. He chooses to place 20% down on $100,000 properties that are exactly identical to the above properties purchased by person A. We can see that person B will soon own 50 properties 80 percent leveraged. We assume that closing costs for both parties are paid for by the Seller via a 3% credit. Person B gets an 8.5 percent interest rate, seller financing, interest only.
We will now consider three seperate months in which various things happen to determine who has made the better choice.
Month 1: Everyone pays, 10% vacancy - advantage person B
Person A receives $9,000 in rent and pays $666.67 in maintenance this month. He nets $8,333.33 for this month.
Person B receives $45,000 in rent and pays $3,333.33 in expenses. He also pays $28,333.33 in mortgage payments and nets $13,333.34 this month.
Month 2: 9 Units Refuse to Pay (10% vacancy)
No one pays person A this month. He suffers a loss of $666.67 this month.
Person B receives rent from 36 units this month (5 vacant, 9 won’t pay) for $36,000 income. He must pay $3,333.33 in maintenance and $28,333.33 in mortgages and still profits $4,333.34 this month.
Month 3: 40% vacancy/non-payment
Person A receives rent from 6 units at $1,000 each. That’s $6,000 and still pays $666.67 in maintenance for a gain of $5,333.33.
Person B receives rent on 30 units at 1,000 each for $30,000 income. He then pays $3,333.33 for maintenance and $28,333.33 in mortgages for a loss of $1,666.66.
Three month total Person A: $12,999.99 gain.
Three month total Person B: $16,000.02 gain.
Person A rate of return: 5.2%
Person B rate of return: 6.4%
Basically, even with bad luck, person B’s choices are totally kicking person A’s choices butt. Person A is the one with more risk, because he owns less units!
I am not impressed with your reasoning or your examples at all! You’re going to have to do better than that.
