The Magic of Leverage The Greatest Real Estate Advantage By Fredrick Carroll
Investopedia defines leverage as the use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. In our industry we often refer to it as “other people’s money” or “OPM”. If used properly, leverage will significantly enhance your return on investment. This is easy to do if you invest in income-producing real estate but much more difficult, if not impossible, if you’re investing in stocks or mutual funds. Ignoring the fact that stocks, mutual funds, bonds and other investments are in turmoil at the moment, real estate has nearly always been the best use of investment dollars specifically because of the leverage capacity. Let’s say you have $100,000 to invest. If you invest it in stocks, bonds, or mutual funds, you can only buy a $100,000 stake as a shareholder. However, if you invest
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that same amount in rental property – a higher end single family rental, duplex, or in some areas even a quad you can leverage that same $100,000 into a much higher valued asset. You can purchase a $300,000 income-producing rental property, use only $100,000 of your own money and the bank – or even better a private lender - lends you another $200,000 at a fixed interest rate amortized over time. You may even be able to spread it over 25 or 30 years. You have positive leverage when the interest rate on your mortgage is lower than the overall return on the property. Compare this to investments in the stock market. It doesn’t even compare! Let me give you a personal example. I have a $300,000 property generating a net cash flow of $25,800 each year without any debt financing on the project. That’s an 8 percent cash-on-cash return on your investment ($25,800 / $300,000 = .086 or 8.6 percent).
REAL ESTATE OPPORTUNITIES IN INVESTING
