Should I pay cash or borrow to get a bigger lease motel?

This is a question I get asked a lot. Many people say oh I just want to pay cash for a lease business and it will make things easier. This is not necessarily the case.

The investment required or the costs of a motel will be reflective of the return derived from the motel. The return is usually assessed as a percentage cap rate and so a higher investment will achieve a higher dollar value return. This creates the basis for your decision to borrow or not to borrow.

As a very basic example (not allowing for any critical factors affecting the return) if you look at a motel lease requiring a $500 000 investment you would expect the return to be around $100 000 to $125 000 and comparatively a motel requiring a $750 000 investment you would expect around $150000 to $187 500. Using the lower of these figures it shows that the extra $250 000 invested could return an extra $50 000 per year. If you were to borrow the money to achieve this extra investment at 10% it would cost you $25000 per year in interest and you would retain the other $25 000 of it for yourself.

It is also important to remember that when you invest in a motel business it is not so much the amount of hours you put in but rather the type of work you do which is determined by the size of the business. For instance, a small 10 unit motel may require you to do all the physical cleaning where a 20 unit motel may allow you to have cleaners working for you and your role to be more of a supervisory nature. Both businesses, however, will require you to be there 24 hours a day 7 days a week.

If you look at the dollar return and the labour implications it seems to make sense to borrow the extra $250 000, still work the same 24/7 hours and use the extra income to repay the debt and build on your equity. The current lower interest rates suggest now is a good time for this option. Check it out with your accountant and see what their views are.