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Leverage is a term we learn in elementary school. Levers give us power to move things we could not move with our own strength. Leverage in real estate works the same way. A basic example. Let's assume a remodeling opportunity has a purchase price plus repairs value of $50,000 and potential $20,000 profit. If you had only $50,000 with which to buy houses, how many remodels could you do? One. And earn $20,000. If you had $50,000 and access to loans for 90% of all property purchase and rehabilitation costs, then how many houses could you buy? 10. And earn $200,000 (less interest). That's leverage. LEVERAGE AND REAL ESTATE You cannot continuously grow your real estate real estate holdings without leverage. You can make a fortune without it. But much less of a fortune than if you had used leverage at the right time in the right way. Every investor uses it. If they don't, then they are lying or they do not understand WHAT they are leveraging. Subject To's leverage someone else's finances. Wholesaling leverages an investor's time. Even someone who had the cash to buy as much real estate as they wanted, would probably still be better off using leverage. The rates on decent real estate are relatively low vs. long-term stock market returns. Even borrowing against property to a low leverage and putting money for the long-term in the stock market may outperform "no leverage at all" depending on your tax situation. The rates are low because with the appropriate controls, a lender can be reasonably sure to get paid, or to get the property as collateral instead. A lender typically makes sure it doesn't lend "too much" against the value of the property(loan to value) and has a clean title with title insurance. LEVERAGE IS RISKY Lenders can often get a borrower near 100% leverage. Is that too much? What risks come with leverage. The more leverage, the higher the potential return on the investment actually made. The more leverage, the more likely the investor will lose his investment if the market for real estate goes down. Let's return to our earlier example. In both cases, the investor had invested $50,000. But what happens with a real estate market downturn? Assuming any potential profit from the deal vanished, AND, the market plunged another 15%, the person who used no leverage lost 15% of his investment, or $7,500. And the other investor? He loses it all - and then some. His total loss is $75,000. That means he lost his $50k plus another $25k, just to get out of the deal. (Bankruptcy often-times makes more sense.) Leverage is not just free money that a bank is using to help you get rich. You are taking risk with your capital when you use it. Or, you pay very high rates and points for the right to use it. And with risk, comes reward. If you have questions and would like more dedicated and one-on-one/small group education, we can set up live in-person or on-the-job learning sessions - upon request or at a regularly scheduled time. Related Articles -BASIC EDUCATION OVERVIEW - Basic Investing ARV - After Repair Value Birddogging Contract for Deed Dealing with Contractors Estimating Profits Evictions - A Primer Executory Contract Foreclosure Overview Foreclosure Types Overview Hard Money Loans - a/k/a Asset Based Lending* Lease Options Leverage MAO - Maximum Allowable Offer Multi-Family Investing Basics as Presented by David Lindahl on March 4, 2006 No-Money Down Real Estate Investing Options Part-Time v Full-time Passive Investing For Beginners Pre-Foreclosure Profit Calculation Remodeling for Beginners Rent vs Buy Is Really Rent vs Sell Seller Financing as Investor Buying Tool Skiptracing Subject To Wholesaling Return to Listing Return to Investor Education |
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