If you’re even a semi-regular reader of this blog, then you already know that I’m a huge fan of buying and holding properties as rentals, because it can yield and infinite ROI (See the post on NOOP).
In a nutshell, NOOP demonstrated a repeatable process where you buy a property for cash (business credit, private investor, hard money, etc), rehab it as necessary, then pull all of your purchase, rehab, and holding costs out when your refi into a conventional mortgage. You then have positive cash flow, with zero invested, thus INFINITE ROI. (I have to tell you that as a finance guy this makes my heart beat faster)
But alas, opportunities to do this perfectly and pull all of your money out are exceedingly rare, and you’ll often be left with some of your own money in the property. That begs the question, then, as to how you go about deciding between two properties that will require you to leave a small amount of money behind.
Most people initially think that the decision should be made based on the amount of money left behind, so that if one choice is to leave $2500 behind in one property and the other choice is to leave $1000, then the $1000 property should be chosen.
I disagree. Here’s why.
The mechanics of this process requires a couple of things. First, that you buy at an absurdly low price. And second, that you refi at a relatively low LTV, say 60% or even lower. (This also makes your lenders VERY happy to do business with you).
In addition to high-ROI cash flow, the chief byproduct of this process, therefore, is EQUITY, and lots of it.
So I suggest that you not just look at the dollars left behind. Nope.
I recommend that you look at the cost of the equity that you’re buying. And the metric that I use is the Cost Per Equity Dollar.
Let me give you an example.
I recently purchased a rental home with an ARV of $120,000 in what’s considered a high-tax city for $53,000.
Now when I refi, I need to strike a balance between trying to pull all of my money out and having this home cash flow. In order to strike that balance in this case, my refi loan is going to be at 53% LTV. The result is that with my rehab, holding, and refi costs I’ll need to leave about $2,700 in the house when I refi.
That means my $2,700 net investment not only buys me monthly net cash flow, but it also buys $57,000 in equity.
That means I’m buying each dollar of equity for – get this – 4.7 cents.
Not too shabby.
So if I’m faced with a choice of two properties, one where I can buy my equity dollars for 4.7 cents each and another where I can buy them for 5.2 cents each, the decision becomes simple, and I choose the lower cost equity.
This is a much more meaningful decision criteria to use when evaluating your buy and hold opportunities, because it takes into consideration your cash flow, not just your net investment.
