In the past week, I’ve had two things happen more than twice in my corner of the Minneapolis duplex market.
I’ve had three prospective sellers who either owned their duplexe free and clear or were very close to doing so say they would rather stay put with their properties than move into another with a higher return on investment.
My prospective duplex sellers were content with a 5 percent cash-on-cash return on the buildings they owned.
This week I have also seen two new listings on the MLS; one a duplex and the other a four-unit apartment building, with anywhere from a 23 to 28 percent cash on cash return.
One needed some cosmetic work. The other didn’t need a thing. Both were in sought-after neighborhoods.
Why did the new properties fare so much better than those they owned?
There are several reasons.
We all learned about leverage in elementary school. Except back then, it applied to using a long stick or rod to move a heavy object with far less effort than it would have required had you simply tried to pick the boulder or whatever it was up.
The same idea applies here. Basically, you use a a down payment to leverage your way into more money.
You put down $25,000 and the bank helps you buy a $100,000 property. You use relatively little to buy a lot.
Second, depreciation. If you’ve owned an investment property for a long time, in all likelihood you’ve exhausted the two categories with the fastest rates of depreciation; personal property and land improvements.
When you can no longer use the savings these categories provide in your tax returns, you typically pay more in income tax.
A percentage of the interest you pay on a loan is also tax deductible. While Dave Ramsey will say you ultimately pay more in interest than you’ll ever save in taxes (and he’s right), waiting to have enough money to pay cash for a property will also cost you years in appreciation and principal reduction (paid by someone else).
Finally, the properties that were for sale actually had cash flows, even with mortgage payments, equal to or greater than the amount those owners were receiving on their paid for properties.
Many seasoned Minneapolis duplex investors have a difficult time believing a duplex can cash flow the first year you own it. In fact, most will say you have to pay into the property for a minimum of two- three years before it breaks even.
Times have changed.
And we probably won’t ever see opportunities like this again in our lifetimes.
Which is better? A five percent return on investment or a 28 percent return?
You tell me.