Forgive me. I've written about it before but like a Halloween bobbing apple, it keeps re-surfacing.

It's not that this is a difficult concept. It's just that it requires action. It nags. It pesters. It nips. It's the slip that shows, the tie that peeks out the back of your collar, the scuff on your boots, the dent in your fender.

If it weren't for the fact that you make investments to make money, none of this would matter. However, the whole premise for risking your capital is to maximize your returns ... balanced with minimizing your risk, of course.

This is the reason that we must clarify leverage rot. It erodes our profit. It defeats our purpose.
A quick example: Jones buys a 10 unit building for $500,000 investing 30% to a $350,000 loan. His initial investment, including the costs of purchase, is $165,000. His return in the first year of $7,000 equals 4%± of his total investment. He's happy.

Ten years later, Jones is radiant; his expenses have increased slightly, but rents have escalated to the point that his return is $30,500. "WOW!" Jones exclaims, "My return is 18% per year! ($30,500 / $165,000) I could never get an investment this good today!"

Poor Jones. He has overlooked the fact that his equity is no longer $165,000 because his rents increased; the value of his building has increased, too. Now, his building is worth $850,000 while his loan has decreased to $307,000. His gross equity is now $543,000. His actual return is really 6%, not 18% ($30,500 / $543,000).

"So what?" Well, if Jones could exchange his increased equity into a new investment and in so doing increase his cash flow, dramatically advance his future equity growth, and decrease his management... wouldn't it make sense to consider such a move?

"But is that possible?" You bet it is.

Jones could move up from 10 units to 20+ units. He could now afford on-site management thereby decreasing his personal management commitment. Typically, larger buildings are more efficient to run and deliver higher returns. Also, the larger the rent structure the greater the effect of inflation. (If the owner were to keep the existing building for another ten years and rents achieved a 5% annual increase, his rents of $81,500 would grow to $132,800. Whereas in a larger building, rents of $225,000 would grow to $366,500; a difference of over 180%. Remember, rents push equity.)

The point is this: As your rents increase, your building increases in value. This increased value is not imaginary - it is real, solid, tangible. The increased equity should also be earning wealth. To do so, however, it must be freed through re-investment (by way refinancing, exchange or sale and re-purchase.)

Reconsider, reevaluate, re-strategize. Stamp out leverage rot! The wealth you save could be your own! - MH