While income-producing multifamily properties are one of the ideal vehicles for creating wealth, there is yet another principle out there called “leverage and velocity”. This principle can have a profound effect on how quickly you achieve financial freedom.
The effect of compounding and leverage
Let us say you have $20,000 to invest. You put it into some vehicle that pays 10% interest compounded. After 7 years, that $20,000, just through compounding at 10% is $39,000. It is almost a 2 to 1 return which is not too shabby. Many people would be satisfied with this passive income.
So let us take a look at what happens with leverage. Let us take that same $20,000 and buy a house with 10% down and buy a $200,000 house with zero cash flow and just enough rent to pay the debt and expenses.
It has 5% appreciation. After the same 7 years that 5% appreciation is on the $200,000 so it is about $10,000 per year and through the compounding, the value of the house is $281,000 and your equity is now worth $101,000 because of the equity. That is a 5 to 1 return on your money through compounding and leverage. That is a whole lot better!
Effect of Velocity
Let us continue with that same $200,000 house with 10% down and 5% appreciation per year. After 2 years, the house has appreciated about $20,000. You can then take that $20,000 after two years and buy another house.
You can then refinance this house, pull out the $20,000 and buy another house. After 2 years, you now have two houses. If you do this every two years then after four years you have 4 houses and continuing that line of thought you would have 8 houses in 7 years. The value of those eight houses is $2.1 million and the equity is $270,000. That’s a 13 to 1 return through leverage and velocity.
Velocity is moving the appreciation every two years. You are going from one house to eight houses and $20,000 to $270,000 in equity from all of the houses. All of the houses combined are giving you more buying power every 2 years.
Think about it. If $20,000 became $270,000 in 7 years through leverage and velocity, then you could take $200,000 and do the same thing and create $2.7 million in seven years. You are just adding a zero to the deal.
Take this same principle and apply it to bigger deals. Buy an apartment. You are moving that much faster and your wealth creation is that happening that much more quickly.
Do not limit yourself and your vision to one kind of deal. Keep your eyes open for opportunities that are ripe for the picking. The ability to create passive income comes in many forms and the principle of leverage and velocity can help move it right along.