Amortization is a Big Word with a Big Impact

AMORTIZATION IS A BIG WORD WITH A BIG IMPACT 

Grow your equity, one step at a time.

I remember running my first marathon.  I didn’t start on the first day running the full 26.2 miles.  In fact, the first day of my training was a single mile.  I ran every day.  Not very much at first, but little by little I added distance.  After a while, I could run 3 miles without stopping, then 5, then 10 and eventually finished the marathon in Houston, Texas.

What a nice feeling to tackle and complete such a huge goal.

The key was to take it “one step at a time”.

WHAT IS AMORTIZATION

Amortization is a big word.  In the context of real estate investing it means paying off a mortgage on a property one step at a time.

Imagine paying off a $2 million dollar loan on a property.  What a nice feeling that would be.  You can accomplish this with amortization, in a series of small steps.

With every mortgage payment, part goes to interest and part goes to paying down the balance owed on the loan. 

In a 30-year amortized loan, a small part of the loan is paid off each month, until there is no remaining balance.  The debt is amortized over the course of the loan.

Did you know that the root of this big word is “mors” from the Latin term for death? 

Other words with this same root are mortal, mortician, mortgage, murder.  To amortize a loan is to “kill it off” gradually, one payment at a time!  I like that.

AMORTIZATION INCREASES EQUITY IN YOUR PROPERTY

The principal portion of your mortgage payments gradually reduce the debt on your property. This means your equity is gradually increasing.  And your net worth is growing.

Assets minus Liabilities equals Equity.  Amortization reduces the liabilities and thus grows the equity.

For example, you could purchase a multi-family property for $3,000,000 and receive a loan for $2,000,000 with payments based on a 30 year amortization at 5% interest.  Most individual investors wouldn’t have a million dollars in cash for a down payment, but smaller investors can join together in a group to buy these larger properties.

Your monthly payments would be approximately $10,736.43, effectively paid by the residents with their monthly rent.  At the end of one year, 12 payments, your principal payments would total approximately $29,507.31.  

At the end of ten years, 120 payments, your principal payments would total approximately $373,158.71.  Wow!  Notice how your equity builds over time.  The growth of your equity really accelerates with each year of the mortgage.

With amortization of your loan, you are, little by little, reducing one of your liabilities, the loan, the debt.  Reducing debt means greater equity.  And we like growing our equity.

THE A IN THE I.D.E.A.L. INVESTMENT

Among the five elements of our I.D.E.A.L. investment, Amortization is the “A”.  The five are Income, Depreciation, Equity, Amortization, and Leverage.  Real Estate can have all five of these working for you.

Most other investments don’t provide the amortization element.  They don’t have this ability of getting a mortgage on your investment. 

Sure, you can buy some stocks on margin.  But, the standard investment firm does not usually provide a 30 year amortized mortgage.  Real estate does offer this significant benefit.

And remember, with an income producing property like an apartment complex, the residents will be paying rent and thus providing the funds for the mortgage payments and other expenses.  In essence, the residents are paying off the mortgage each month for you.

Many of us who have owned our own homes over several years have realized how nice this amortization is.  I, personally, owned a home for all 20 years of a huge 20-year loan and remember the day the loan was finally paid off and we owned the home free-and-clear.  Very nice.

Amortization is one of the great elements of real estate as an investment.  We will look in another article at an additional benefit of securing loans on our properties, the element of leverage, next week.

AMORTIZATION WORKS OVER TIME

Multi-family investing is more like a marathon than a sprint. 

We are in this for the long term.  We normally will hold properties for at least 5 years, particularly when we make improvements to the property or operation in the first years.  This longer period of time allows the property to stabilize at higher rents and reduced expenses.

Amortization is a benefit available to us with multi-family investments, just as it is with those who buy and hold single family properties.  Amortization grows our equity, one payment at a time.  Slow and steady.

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