Increase Your Real Estate Returns Using Leverage.

Leverage is the number one reason you can get such great returns on real estate. Most people don’t understand leverage or understand the principals that make leverage such a fantastic tool in your real estate investing arsenal.

First let me define leverage in the way it applies to real estate. You use leverage when you buy a $200,000 property with a 20% down payment and borrow the rest of the money from the seller or the bank. If you paid cash for the property you would need to come up with 200,000 and change at closing to take over a piece of real estate. You would be using no leverage and you would be looking for a return on your capital that would be similar to what you would get in other investments. If you made $2400 in rent per month and after expenses put $1500 cash in your pocket each month you would make $18000. This $18,000 would be your yearly return on capital invested. It is a good return and it is possible to make a good living buying property for cash. You can calculate your cash on cash return by taking your $18,000 profit divided by your $200,000 investment.

The number is given as a percentage. You would end up with a return of about 9% for the year. This is a good return on capital but not nearly what you can get if you use leverage to make your purchase.

Let me give you the same example but with a 20% down payment. You would have to bring $40,000 to the closing for your down payment and you would be financing $160,000 from the seller or the bank. Rates are relatively low now but they tend to be higher on investment property but I will use 6% rate of interest on the $160,000 financed. We can calculate what it will cost you in interest the first year by taking 6 % of $160,000. The amount of interest on your loan will be $9600. You are paying $9600 the first year of your loan in interest to use leverage. If you fully amortized the loan you will pay $959.28 a month principal and interest. This also leaves you the 160,000 in cash that you would have been investing in one property available in your bank account for other purchases so you are keeping your options open to buy more real estate.

Let’s take a look further at my example and see if you can actually make more money by using leverage.

You will still receive the same 2400 payment for rents per month except now we need to add in the interest cost into the calculation. You will still be taking in the 18000 a year but you have to pay your mortgage or at least the cost of interest out of cash flow. You will pay principal and interest of $11,511.36 out of your gross rents and your free cash flow at the end of the year will be only $6489 in our example. It looks like a lot less but let’s pencil out what return you can actually get by using leverage and not paying all cash.

We take the $6489 net gain for the year and divide it by the amount of capital invested which is 40,000 this time. So what looks like smaller gain in income becomes a much greater return as a percentage of your capital because the new calculation comes out to over 16% return on your investment.

Leverage is the key to profiting from real estate. It is possible to double or triple your return on capital invested by financing a portion of the deal. The lower your down payment the greater your return on your money.

It is VERY RISKY to use high leverage in a market like the present one.


All those confident calculations may and will go haywire when rates shoot up.


Please do BE CAREFUL, and if you are going to buy, Think Small

I agree with OffThePeak - now is not a good time to be using a lot of leverage in the property market.


That said, which market are we talking about? if parts of the US then buyig into a recovering market using a 30 year fixed mortgage may make sense.

OP is using a level of precision which reality does not have

I thought the OP copied the text from his High School textbook.

haha.

Looks like that. Or maybe he has taken it from a sales brochure

Or he's been wasting too much time reading Rich Dad Poor Dad.

He copy-pasted it from here: http://www.buzzbuzzhome.com/chat/new-home-projects/1744/increase-your-real-estate-returns-using-leverage

And what was his point, I wonder?


I prefer things written in English (or mind-spinning figures)