Leverage in Real Estate: What It Is and How Can You Make It Work for You
Imagine you could go to the bank and say “I have heard about a great stock that I believe will go up in the next few months. Can you lend me $20,000 to invest and I’ll pay you back once I get the returns?”. While this may sound excessive on the stock market, with real estate it is a reality accessible to every investor.
That is what leverage allows investors to do in real estate. Understanding its power can capitalize on the full potential of real estate to grow wealth and improve quality of life.
What Is Leverage?
Leverage is defined by Investopedia as “an investment strategy of using borrowed money to increase the potential return of an investment.” What leverage allows an investor to do is to use other people's money (OPM) to amplify returns on investments by multiplying buying power in the market.
The most profitable markets on the planet use leverage. One example is the futures exchange market. You can easily put in $10,000 and have a position in the market of $100,000, giving you a leverage of 10x. This means greater capital efficiency and a lower barrier of entry, as the investor needs only a small portion of the position (also called a margin) in order to control a big sum of money.
This can’t be done with stocks or bonds. When you buy either of those, you need to put in 100% of the purchase price, and the value could go to zero. A much greater sum of money is needed in order to purchase and get noticeable returns because the power of leverage isn’t readily used for buying stocks and bonds.
How Does Leverage Work in Real Estate?
If you purchase a $100,000 property using all the cash, you have all your money invested in one property. However, if you use your $100,000 to instead put a $20K down payment on five properties valued at $100K each, you now own $500K in assets for the same $100K investment. That is the power of leverage.
In other words, you can make money in a lot of different ways from a real estate investment. That is why you should calculate the Cash-on-cash return, which will contrast the cash income earned vs the cash invested in a property (including the interest rate on the money borrowed).
This will give you an overview on the return on the actual cash invested, giving a clearer picture on the investment’s performance.
How to Use Cash Flow to Pay for Your Investment
Another magic option with real estate is the option to pay your leverage with other people’s money: those of the tenants. You can build your equity as the tenants pay down the principal on your loan, making it a win-win situation for the tenants, the lender and yourself.
Besides that, you can depreciate the total cost of the property not only on the down payment you put in, but on the total cost of the property. You can even write off the interest paid on the loan, providing you great tax reductions just by owning real estate.
How to Benefit From Leverage Without Letting It Burn You
As the saying goes, with great power comes great responsibility. Leverage provides real estate investors access to greater returns than what their current funds allow. While this can mean outstanding returns, it also means a greater risk if wrongly managed.
The key is to realize and use wisely the power of real estate leverage, in order to make careful decisions that build wealth. You can, for example, put money in a downpayment and then spread the rest of your money across other properties, allowing you to diversify your portfolio and maximize your returns across multiple properties. If used correctly, this can quickly build your wealth and allow you to join the millionaires of the world; 90% of which have built their wealth through real estate.
If you’d like expert help to guide you through the ins and outs of creating lasting wealth with real estate investing, contact us here. At Titanium Investments we create a bridge for you to access greater financial security and freedom, leveraging the power of real estate to build generational wealth that always holds value.