Concept of Leverage

Leverage (debt) allows both individuals and businesses to grow exponentially. When dealing with leverage, it is important to understand the concepts of free cash flow, debt service coverage, and liens. As long as your net annual income covers your interest and amortization payment by a factor of 1.20 or higher, it will most likely be approved by the bank.

This factor (or debt service coverage ratio) is calculated as:

Gross rent - all operating expenses (property taxes, insurance, property mgmt cost, maintenance) = net monthly income

Divide Net Annual Income by Total Debt Cost = Debt Service Coverage ratio

Example:

  • Gross Rent = $800/month x 12 = $9,600/year

  • Operating Expenses

    • Property Taxes = $1,000/year

    • Insurance = $500/year

    • Property Management Cost = $960/year

    • Maintenance = $400/year

  • Net Annual Income = $6,740 = ($9,600 - $1,000 - $500 - $960 - $400)

  • Assumed Debt = $48,000

  • Interest = 6%

  • Amortization = 30 years

  • Annual Interest = $3,456 = ($48,000 * 6% + 30 year amortization)

  • Debt Service Coverage Ratio: 1.95 = ($6,740/$3,456)

  • PASSES DEBT SERVICE RATIO REQUIREMENT OF 1.20!

Why We Expect The Number of Renters To Increase

The 2008 Real Estate Crash affected many homeowners’ ability to pay their mortgage and resulted in the increase of renters. About one-third of people in the U.S. currently rent even with the rebound in the economy. While there are many factors that affect this statistic, we believe that there are several key reasons why the number of renters will increase over the next 15-20 years:

  1. Millenials are buying less homes compared to previous generations. Some factors that affect this include:

    • Less savings due to tough time finding jobs out of college 10 years ago during the economic recession,

    • Larger focus on happiness and appreciation at jobs vs. salary,

    • More interest to spend money on experiences such as travel than previous generations,

    • More flexibility and desire to move for a job,

    • Getting married and having kids later, and

    • More desire to live closer to city centers than the suburbs.

  2. Many are still wary of the real estate market and may not wish to buy another house when they just lost their house in 2008-2009.

  3. Some may have lower credit scores from excessive spending prior to the 2008 crash and not able to buy a house now.

  4. When there is another recession, we would only expect the number of renters to increase as the highly leveraged individuals living beyond their means would be unable to keep up with mortgage payments and downsize to a smaller single-family rental.

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