The following article is written by my friend & client (and real estate investor) Darryl Kraemer, that originally appeared at his site DarrylKraemer.com
It is interesting how many times you are reading an article in a magazine or a newspaper, or when you are reading a book on Real Estate Investing, and the author focuses on one of two ways to get a return on your investment:
- Cash Flow (the life blood of any real estate investment) OR
- Appreciation (the speculation in real estate investment)
I want to talk about the third, sometime forgotten return in real estate investing, and that is:
Debt Reduction on your mortgage (thank you Mr. or Mrs. Tenant!)
Debt reduction is a key factor to take into account when you are analyzing the total return for a potential real estate investment you are looking at. You can thank your tenants for this return, as they are the ones who create it the moment they begin paying their rent.
When you pay your mortgage every month, the payment consists of two pieces: Principle and Interest, sometimes referred to as P+I. Interest is what you pay the bank, mortgage company or private lender in return for the risk they take on by lending you the money to buy the house. Principle is the part of your monthly payment that actually reduces the amount ourstanding on your mortgage every month.
Let’s look at an example:
Mortgage Amount: $100,000
Interest Rate: 5%
Amortization: 25 years
Term: 5 years
Compounded: Semi-Annually
Payment Frequency: Monthly
Based on these inputs, your monthly mortgage payment would be $582 per month. Of that $582, part of it pays the interest and part pays the principle. How much you ask? It breaks down like this for the first month:
- Interest: $412
- Principle: $169
Now, you may be saying that $169 is not that much, but remember, you aren’t paying it down. Your tenant is! Every month. They are reducing the amount of the mortgage outstanding just by the act of paying their rent.
A year later, the break down looks like this:
- Interest: $404
- Principle: $178
The amount of principle in every payment has gone up! As you (your tenant) chips away at the mortgage amount outstanding, the interest portion of each monthly payment is reduced because there is less of a mortgage balance to pay interest on.
Let’s look at a table from my investment property calculator that shows the break down of cash flow, debt reduction, and appreciation every year so you can see your total return on a potential investment.
After 5 years, when the mortgage term is up and it is time to renew, even with a 0% appreciation in your property value, you can refinance back to 80% LTV, pulling over $11K out of your property to use as a down payment on another. This is in addition to the over $10K in cash flow your property generated, even with a 5% vacancy allowance.
Darryl Kraemer received his B. Math from University of Waterloo in 1999, and his MBA from WLU in 2007. He holds the position of RadIT Solution Manager for Agfa HealthCare Canada, where he’s worked for 10yrs, and is responsible for business development for Canada. Darryl has pitched and won deals that are worth $1-2M all the way up to $65M.
Darryl also owns two real estate investment companies, and has grown them to 8 properties worth over $2M within 2 years. Darryl is an avid runner, triathlete, downhill skier and hockey player, having played varsity at the University of Waterloo. Darryl has completed 1 Marathon, 4 Half-Marathons, 1 70.3 Half Ironman and a hand full of shorter triathlons so far, with plans for more.
Darryl is a student of Tony Robbins, having completed his Mastery University in 2009, and most recently joined Armand Morin’s inner circle AM2.0 to immerse himself in Internet Marketing.
Darryl and his wife Robin are expecting their first child, a baby girl named Blake in May 2010, and are very excited for this new journey they are about to start.
For more information on Darryl, visit darrylkraemer.com.
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