Understanding and maximizing leverage opportunities that real estate presents is essential when seasoned investors analyze the full potential of various property types. Leverage and risk exist in every type of real estate and in all forms of investment. Learning how leverage can benefit the investor distinguishes the professional from the amateur. Today’s friendly lending terms make serious leveraging opportunities available in every real estate marketplace.
Whether the investor is building, acquiring one or more residential properties, acquiring income properties or assorted commercial properties, there are ample opportunities to leverage investments and/or rental income. It is the ability to leverage that allows the investor to get the greatest return from every real property investment.
Leverage Defined
Leverage must be part of an overall real estate investment strategy. Investopedia describes leverage as; “the use of various financial instruments to increase the potential return of an investment.” Leverage is used heavily in many businesses, on stock exchanges, in commodity markets and in most real estate investments.
In a typical residential or commercial real estate investment, the investor leverages the cash down payment and the mortgage amount, also known as “other people’s money.” Leverage is realized when the property gains short term or long term value and the investment is measured accordingly.
A simple purchase of a $100,000 property with a 20% down payment of $20,000 is the perfect example. If the property gains 5% in value per year, we get a clear picture of leverage. The buyer invested a relatively small amount ($20,000) to put “other people’s money” to work on their behalf. After 12 months, the property’s appreciated value (5%) is $105,000. After 5 years, the appreciated value will exceed $126,925 a gain of $26,925, which is healthy return on your cash outlay of $20,000 and on the 80% mortgage used to complete the purchase.
And, 5% appreciation for real estate investments is considered low to savvy investors, who always look for higher appreciation rates. If they have done the research and invested in well-situated properties, their leverage increases accordingly.
Another common use of leverage is created when rental income increases. However, like equities, real estate is a marketplace driven by supply and demand. If property values decrease because supply exceeds demand as in 2008 or if rental income slips, losses can occur and leverage is lost.
It is the investor’s responsibility to invest in properties that will appreciate or whose rental income capabilities will increase, not decrease. If properties increase in value, the portfolio posts gains and leverage potential increases, making more cash available for other investments. Lenders like real estate as collateral and rising property values increase the investor’s net worth as well as their potential to borrow.
Improvements Can Increase Leverage
Whether building a home or investing in an existing residence or income property, you can increase the value and increase your leverage with quality improvements. For residences, investing in baths, kitchens and interior glass doors that open the house to better traffic flows and increase spaciousness have proven to be sound investments that pay dividends down the road.
Increasing energy efficiency can also be rewarding, especially for income properties that have potential for higher rents. The less your tenants have to spend on energy, the more they can pay in rent. Income increases definitely increase the investor’s leverage.
Investing in real estate offers potential for dynamic profitability. However, leverage can provide even greater profits. That explains why real estate investors always have an eye open to leverage potential.
When planning your next real property investment, be sure to do your homework and research the appreciation potential. If you see it, go for it, but if in doubt, a better, more defined opportunity with better leverage potential will come to market in 2017.
