If you’re buying properties with the hope of eventually living off the cash flow or equity that those properties provide, then the reality is that you are going to need to build up a pretty substantial portfolio.
For the most part, one property is not likely going to be enough if you need to replace your current income. You’re going to need to keep buying properties over a number of years and if you buy well, you will eventually be able to reach your monetary goals.
When you’re starting out many investors are unsure of whether they should be paying down the debt or simply paying off the interest. While there is no right answer for everyone, if you are one of those people who is trying to maximise the size of your portfolio long-term, then it might be a mistake to try and pay down debt on a single property.
In fact, if you look at the numbers, you can realistically purchase two properties on interest-only loans for the same amount you might be spending trying to pay down just one property on principle and interest.
Let’s look at the numbers.
If you have a $1 million loan at 6% interest, you are likely paying around $60,000 per year in interest.
If that was a principal and interest loan, then you’d be paying something like $75,000 to $80,000 per year.
While that extra $20,000 might not seem like much, we can actually take those funds and use them to purchase another property.
In all likelihood, $20,000 is about the same amount of money you’d need to be paying to cover the difference between the rental income you’re receiving and the interest payments on a second property.
I would argue that you are far better off, funnelling that cash into a second property rather than trying to pay down the loan on the first one.
That’s because you are going to make far more money in the long term when you have two high-quality assets that are growing in value. If you think about it, with a $1 million loan you are roughly buying a $1.2 million property. If that property is seeing its value increase by 7% per year, which is the average of what you’d expect on a quality blue chip asset, then the equity increase alone is going to be around $84,000 per year.
Just by having that second asset, you are basically going to be seeing your equity grow far more than the benefits you would receive from paying down the principal on the first property.
Like we said at the start, if your goal is to eventually live off these properties and have them replace your income, the bigger your portfolio the better.
Even if you do toil away and eventually pay down the debt, you still probably won’t have enough to cover your living expenses on just a single property. Your return on investment is just so much better when you use the extra cash on another asset.
For the most part, two is always going to be better than one and by simply taking on a different loan, you can dramatically change the outcome.
