One of the most common things I hear new investors say is their goal is to buy a duplex, pay it off, and live off the cash flow.
This is a mistake.
What? Isn’t cash flow everything?
But there’s also something called Return On Investment or ROI. ROI is the ratio of money gained or lost on a duplex relative to the money you have invested.
For example, if you buy a $100,000 duplex, and put 25 percent down, you would calculate your return based on the amount of your down payment; $25,000.
If you held that duplex for thirty years, however, and paid off the mortgage, the amount of your investment would be $100,000, and you would calculate your return based on that number. Of course, that’s assuming it doesn’t go up in value at all over the next 30 years; an unlikely scenario.
I met with a married couple the other day who owned their duplex free and clear. The investment property is not only a considerable distance from their home, but as retirees, they have a genuine desire to simplify their lives.
Of course, like all sellers, they want top dollar for their property.
They have almost $200,000 in equity, and after taxes, they were pocketing about $650 a month; a nice supplement to their retirement. However, that was only a 4.53 percent cash on cash return.
If they sold the property and moved the equity into a savings account, they would probably earn about 1.75 percent in interest, which would help them enjoy retirement and alleviate managerial responsibilities.
For comparison, however, I did an income property analysis worksheet on an eight unit building much closer to their home. While they would have to take on a very small mortgage, as a result they would receive the benefits of interest deductions and depreciation on their taxes, which would of course, increase their cash flow.
As my retirees no longer want to be property managers, I factored management expenses into my worksheet on the new building. Even with that additional cost, the new property gives them a 7.19 percent ROI and a cash on cash return of 8.36 percent. In real money, that’s a positive annual cash flow of $16,719.94 or $1393.33 a month; double what they’re taking in now.
You don’t have to be a retiree to worry about the return on your investment. As we approach the end of the year, it’s a good idea to do a property worksheet to determine whether your money is working as hard as it can for you.
And if you don’t know how, I’d be happy to help.
Paid off may not make you well off, after all.