What is Debt Paydown and How Does it Factor into Your Return
Most investors calculate their returns incorrectly.
They don't consider all four types of returns your get on investment real estate.
When we calculate our returns on investment properties, most of us think cashflow. Or how much we make every month after we deduct expenses from the rents we collected. This is the most obvious return because you add a few bucks to your bank account every month. It's immediate and physical.
Appreciation is the next most obvious. It's less apparent because it's tied to the value of your property and doesn't immediately affect your bank account balance unless you sell and realize the gain in property value.
But debt paydown is a massive return that I see most investors completely ignore.
What is Debt Paydown?
Debt paydown is the reduction of your loan balance that comes with every mortgage payment you make.
So if your mortgage were $2,000 a month and $1,000 of that went toward your principal, then you paid down $1,000 of debt. Because you now control an asset and the debt against it decreased, your equity will have increased by the same amount. In other words, your total net worth is now $1,000 higher since you have less debt.
Debt paydown can be a powerful return and should not be ignored.
Another point a lot of people ignore, technically the higher your mortgage payment, the higher your debt paydown. Meaning in more expensive markets, it might be harder to cashflow but the debt paydown of these properties will be significant since the large mortgage payment covers more principal every month.
Now this doesn't mean purposely try to get a more expensive mortgage just to get more debt paydown. You are still paying more interest and as a whole your mortgage payment is still deducted from your cashflow.
But my point is, if you can't find any good investment opportunities because nothing cashflows, don't forget to account for debt paydown in your analysis.
The first property I bought breaks even on cashflow, but the debt paydown alone yields me a 50% return on my initial investment.