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Using Leverage as a Real Estate Investor

By: Elite Legacy Education, April 27, 2017

The general belief that money helps to earn more money is true in this case. As a real estate investor, you can use this idea to your advantage to earn more. Ideally, you will want to use leverage to amplify your gains (and hopefully not losses – since it works both ways).

 

What type of real estate investments should you use leverage for?

We mentioned in our previous article on house flipping that you should avoid using leverage for that particular approach to real estate investment. However, there are other opportunities where leverage really comes in handy as a real estate investor. You should utilize financing options specifically for rental properties, whether they be residential or commercial. The reason for this is that the better interest rates on financing products are offered for rental units and personal properties.

In fact, it is common practice for real estate investors to take advantage of leverage through financing options. This way, they can maximize the value of their portfolio by putting cash to the most profitable use. Investors typically want to put the least amount of cash down on as many properties as possible, while still being able to meet interest payments.

 

If you’re not taking advantage of leverage, you’re leaving money on the table.

We do have some words of caution when it comes to the use of leverage. Consider some of the following perspectives:

  • Leverage amplifies not only your gains, but your losses too. This relates specifically to the capital gains on the property. If housing prices rise, you will experience it in multiples of however many houses you own. On the other hand, if housing prices decline, your loss is also a multiple of how many houses you own. This also applies to whether the differential between the rent payments and debt payments is in your favor. If your rent payments are higher then the margin is amplified, whereas if debt payments are higher then your loss is magnified.
  • Using leverage involves interest payments. So long as these interest rates are lower than your rate of return on the investment, it likely is worthwhile. You must be able to meet the regular interest payments, typically on a monthly basis, by having the necessary cash on hand. You will run into trouble if you maximize your use of leverage without the means to meet interest payments as they come due. This could quickly backfire, so make sure you’re prepared.
  • Interest rates depend on your credit history. Your credit history will have an effect on the levels of interest rates offered to you by various financial institutions. If it’s below a certain threshold, you may not even be qualifiedfor a loan. There are always other options for receiving financing, but you will be subject to higher interest rates if you have a poor credit history.

 

Where can you find access to means of leverage?

The answer lies with financial institutions and other investment groups that are willing to lend you some capital. You can find financing options to leverage your investment at the following:

  • Banks
  • Credit Unions
  • Home Mortgage Companies
  • Private Investors

 

How to figure out how much you will make using leverage.

There are two perspectives to consider when determining your additional profits from the use of leverage. First is the property gains aspect of the investment, and second is the fixed income aspect (i.e., rent payments).

Let’s start with the capital gains perspective:

  • You will need to provide some sort of estimate as to how much you think the area’s housing prices will either increase or decrease during the year. If you think they’re going to decrease, then you need to find a new area. We want to focus on how leverage will amplify gains, rather than losses so this would require an immediate remedy.
  • Once you estimate how much you think property values will rise, you can take this capital gains value and multiply it by the number of additional properties you were able to buy through the use of leverage. This total represents one way leverage has multiplied your gains.

 

As for the fixed income perspective through rental payments:

  • You will need to compare your monthly rental payments to your monthly debt payments. Your debt payments will consist of both principal and interest components. Ideally, your rental income will exceed the sum of these two parts, so that leverage amplifies your gains.
  • Take the difference between these two values and multiply it by the number of additional properties that the use of leverage has allowed you to purchase. Assuming that rental proceeds are higher, then this total represents the additional profits enjoyed from the use of leverage.

 

Sometimes, debt isn’t always a bad thing and can actually help to improve the long-term value of your real estate investing business.

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