Debt has so many negative connotations and for that reason millions of people avoid debt by all means possible. However, when one knows how to invest with debt, it becomes the magic wand that makes the magic of passive rental income happen.
Let’s dive deeper into the topic.
I remember one time in 2018, I told a friend of mine that I’m going to the bank to get a loan to finance one of my projects. He kept on warning that debt is bad and that I shouldn’t do it, in his words, “Muna loan is not good at all not to talk about bank loan”.
This has been a narrative passed down from generation to generation.
What people fail to understand is the fact that there is positive and negative debt.
Good debt and bad debt.
Good debt generates cash flow not only to pay down the principal and interest but also to solve all other pressing needs, bad debt only solves pressing needs, but doesn’t generate cashflow.
The idea of taking on debt doesn’t generally evoke positive emotions. But with so many different types of loans and reasons individuals decide to borrow, it’s best to keep an open mind and consider every situation on its own.
What I will advice every investor out there is to run the numbers and ensure that they are taking debt only for investments that generate positive cashflow enough to pay down the principal, interest, and still solve pressing needs. Always run the numbers to ascertain positive cashflow or contact munarealestate.com to run the numbers for you.
When considering debt, one has to ask a big question, does the investment generate enough cashflow to cover the principal and interest pay down?
Particularly to real estate investors, Debt can become an opportunity when an individual’s expected rate of return on invested assets is greater than the interest rate a lender would charge if the borrower obtained a loan.
As interest rates rise, it becomes more difficult for borrowers to take advantage of the debt spread.
Not all debt is helpful to property investors. In fact, bad debt can affect your interest rates or even limit the amount you can borrow. Bad debt includes consumer debt such as credit cards and loans on cars, boats, or other personal property.
Once you eliminate bad debt, you will be able to maximise your borrowing potential for your property investments.
Start by paying off your debts with the highest interest rates and build a positive financial statement.
Good debt is debt you acquire to purchase more assets, and in the case of property investors, those assets are additional properties. One of the most attractive traits of owning a property as an investment, is that they almost always appreciate over time.
When you first acquire a property, there may not be much difference between the amount of debt you have on the property and the amount the property is worth. But each month, if you are making principal and interest loan repayments you will be reducing the amount you owe on the property. At the same time, the property is probably appreciating, so the gap between your debt and the value of the home is ever widening. At some point, it makes sense to cash in(refinance) on that equity and use it to buy another property.
Let me give an example of positive debt.
Muna walks into a bank for a mortgage loan.
A property for sale somewhere in east London.
4 units of 3bedroom apartments selling for £1million
The annual rental income from each unit is £25,000 giving a total of £100,000 per year.
Muna takes a mortgage loan 80/20
The bank finances 80% (£800,000)
Muna’s provides 20% (£200,000)
What happens is that the property is then acquired and the debt is paid down monthly and spread over 30years.
With annual appreciation(inflation rate) and development/ demand variables, the property will most likely go up 10% in value yearly.
This means that, as the £800,000 is being paid down, the property’s value after the first 365days becomes £1,100,000 and if the rate is stable, the property will have doubled in value in 10 years.
If Muna dedicates £90,000 yearly from the annual rentals to paying down the loan.
In 10years he will have paid down the £800,000 (80%) mortgage.
He will also have obtained extra £1,000,000 in appreciation from the 10% annual increase in value.
Purchase price = £1,000,000
Loan(debt) = £800,000
Down payment = £200,000
Property value in 10years = £2,000,000
Property sale = £2,000,000
From an investors perspective
Investment = £200,000
Profit = £1,800,000
Annual free cash flow = £10,000
This is a simple example of positive debt and how property investors do the money magic by having leveraged investments.
It is useful to note that there are a lot of variables to take into consideration when making projections for appreciation.
It is also useful to note that not all assets generate positive cash flow, and for this reason I recommend that you consult the Muna Real Estate Team to properly analyze your investments to make sure you are on the safe side and also when you intend to take on a leveraged(debt financed) investment.
I hope you enjoyed the topic, let me know what you think about debt in a comment!