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The information in this podcast is for educational and entertainment purposes only. Nothing here constitutes financial, legal, tax or investment advice. Welcome to the Paul Morris Podcast. In this episode, I'm going to run you through a deal. I looked at this. This is a real deal. It was an $850,000 duplex. I looked at it this week. Duplex, two units they were renting at roughly $3,500 per unit. On paper it looked pretty solid. And then I ran the numbers at today's mortgage rates, about 6%. And here's what actually happened and whether I'd buy it. When I ran the math on this particular duplex, it was getting a 5 cap. And what a 5 cap is, it means that you're getting a 5% return on the amount of capital that you put into a deal. Very simply, what that means is if you bought $1 million property, this one was $850,000. But the math is going to be a little bit more complex. So if we use the round number of $1 million purchase, if you're net at the end paying all of your bills, you're paying your mortgage, you're paying all of the utilities, upkeep, you've got a vacancy rate, insurance, every single cost and you net out a total of $50,000. $50,000 on a million dollar cash purchase is going to produce a 5% rate of return. That is by definition a 5 cap. That's what investors talk about when it's a 5 cap. If it's a 10 cap, it's 10%. Finding a 10 cap is going to be nearly impossible to do, especially in a market like Los Angeles. You can find higher than a 5 cap in some areas, even in LA. But you know, this particular duplex was actually in a great area. So 5 cap is not bad, especially historically. Now the question really is, can you buy a 5 cap when the interest rates today are 6%? Would that still make sense? Because you're paying 6% on the money that you borrow, you're only getting a 5% return. So the shortest answer is no. But there is a way to make it work. If you're not over overpaying and you're also not hoping that rates will save you later, that particular deal will only work if you can add value or if you can increase the rental rates. And in this particular property you can do both. So that's why it makes it a potentially interesting purchase. So if you're looking at something that is a 5 cap and the interest rates are 6%. As soon as you borrow money at 6% and you're only getting a 5% cap cash on cash return, you're going to amplify the downside. Conversely, if you were buying a 5 cap when interest rates were 3%, that that delta between 3% the cost of money and the 5% that you're getting on a cash on cash is going to really increase your rate of return. Because you could put down 20% that's used this million dollar purchase again, or let's even say you put down 30%, that 30% is going to be $300,000 on a 5 cap. You're going to get 5% on the 300,000 that you put down. You're going to borrow $700,000 at a 3% rate and you're going to get a 5% return on that 700,000 less the 3% that you're paying for the money. So it's going to give you a 2% net net gain on the $700,000 portion of that purchase. So what you end up getting is you get the 2% on the $700,000, which is 14,000, and then you get 5% on the money that you actually put down. That's going to be $15,000. So you've got $14,000 plus $15,000. That gives you $29,000 return on your $300,000. It doesn't take much math to realize that you're very close to a $30,000 return on your $300,000 that you put down. That takes you all the way from a 5 cap to 10% return on your money. So that's where leverage that 3% interest rate makes such a big difference. It's going to essentially double the rate of return on the purchase that you've made. Now if you didn't get a 30 year loan, you got a five year loan. Now you've got that same piece of property, that's $700,000. It goes to 6% and you're actually going to be losing 1% on the $700,000 that you've borrowed. So that is $7,000. Now you take that $7,000 and you take that out of that comes as a deduction from the $15,000 that you're getting on the $300,000 that you put down. That takes your effective rate of return down significantly, takes it down almost 50%. Again, it's easy math. You're down to just over a 2.5 cap instead of the 5 cap that you bought it at. So now the question is, why in the world would I be looking at this $850,000 duplex that's only bringing in $7,000 a month? That, that gives you a 5 cap by the time you take out, you take out all of the costs associated with a property. And we did all of that math and it returns roughly 5%. And if you're borrowing at 6%, it's never going to make sense. So why in the world would we buy this duplex? And there's two great reasons that we're seriously considering this duplex. Number one, the $3,500 a month rent, believe it or not, is a fair amount below market. These duplexes are large duplexes. They're in a great area of town and you can get really probably $4,500 at market rate for it. Now, you know there is rent control that makes it more complicated, but these are short term tenants, probably not going to stay forever. So you can count on some price increases in the rent. You're also allowed a 3% rent increase. There's room for that because these units are below market. So you've got a built in cushion at your, at your 5 cap with a 6% interest rate. You're going to be losing some money