Leverage the Greatest Advantage for Real Estate Investors
Published on: Friday, December 18th, 2015
The Greatest Advantage for Real Estate Investors
If you don’t over-leverage your real estate investments, they will make you wealthy.
One of the greatest advantages of investing in real estate is your ability to use leverage. In finance, leverage is a general term for any technique to multiply gains and losses. In real estate, leverage allows you to achieve a much higher return on investment than you could without it. Real estate investing allows you to use leverage when you buy. It allows you to use it when you operate. And it allows you to use it across multiple tenants. Using leverage in your real estate investments can have a big effect on your financial statement.
More than any other alternative investment, real estate is designed to take advantage of leverage. Can you imagine what your banker would say if you came in and told him, “I want to purchase $1,000,000 worth of XYZ Company’s stock. Will you finance 80% of it and I’ll bring 20% to the closing table?” Most likely, the banker would laugh and politely ask you to exit his office. However, that is exactly what bankers agree to every day when making loans to real estate investors.
A wise real estate investor once told me “If you use leverage to your advantage, it will make you wealthy. However, if you over-leverage [take out too large a loan on] your properties, you will lose them.” I think that advice still rings true. If you use financing responsibly you will be rewarded. The properties will produce positive cash flow and grow in value. However, if you take on too big of a loan on your properties and take all your money out, you run a high risk of losing them. Taking out too big of a loan on your property than your property can support can cause them to no longer produce positive cash flow if the market goes down.
Let’s take a quick look at how leverage can be used successfully in real estate investing. It is used three ways in real estate to create wealth and massive income:
- Financing your purchase: Real estate is one of the few places that if you buy something for $100,000, you only have to have a small fraction of the purchase price. Banks will lend you a significant percentage of the purchase price. They will finance it and allow you to pay them back over time. Buying real estate using financing allows you to control more properties than you could if you paid all cash.For example, if you had $150,000 to invest, you could buy a duplex for all cash (no loan) that produces $12,000 a year in income. However, if you take the same $150,000 and use leverage, you can buy property valued at as much as $750,000. If the bigger property generates $6,000 a month in income and you subtract the loan payment of $4,000, you would make $2,000 a month. That is double what you would have made without using financing. By financing your purchase, you were able to buy a bigger property. That bigger property produced more income and increased your return on investment.
- Income Property Valuation: Investment real estate is valued by the income that it generates after subtracting out expenses. So, if you raise income or lower expenses, you raise the income and value of the property. If you do both, it raises the value and cash flow even more. Depending on the property, this increase can increase the value 10- or even 12-fold.For example, an increase in income or a decrease in expenses of $10,000 in a year could increase the value of your property by as much as $100,000-$140,000. Small changes to the performance of the property over time can make you huge amounts of money.
- Multiple Tenant Principle: Investment real estate with multiple tenants allows you to use leverage; real estate like an apartment complex, office building, or retail center. You can use maximize your return by making small adjustments across multiple tenants. Changes like small adjustments in rent. With one apartment it doesn’t make much difference to your income. However, when applied across multiple tenants, small changes can add up to create big results.For instance, let’s say you own a 100 unit apartment complex. If you raise rents $10 per month, you actually create $1,000 a month in extra income. Just imagine what happens when one day you have 1,000 apartment units. You make the same $10 rent increase, but this time it increases your income by $10,000 per month. By making small adjustments across multiple tenants it can increase your investment dramatically.
As you can see, leverage is one of the biggest advantages to investing in real estate. As long as you use it responsibly and avoid taking on loans that are too big for your properties, it can be your greatest asset. Real estate investments can benefit from it many ways. By putting down only a small percentage of the purchase price you can control much more real estate than you could without financing. It can be used by making small changes across multiple tenants. Or, it can be accentuated by making small changes in income or expenses over time. These changes can dramatically increase your income and net worth.