Leverage: The Most Important Concept in Real Estate Investment
So, what is leverage and how can you use it?
When it comes to real estate investing, “leverage” is one of the most important concepts that will come into play. In a nutshell, leveraging is using outside influence to increase your investing power.
The great thing about it is, you can leverage “Other Peoples Everything” (OPE).
Many think of money when they think of leverage but money isn’t the only thing you can, or should, leverage when it comes to real estate investing. The wonderful thing about leveraging is that it can apply to anything. You can leverage other people’s influence to gain access to a property or a person, as well as other people’s time, knowledge, experience and abilities; the point is, you never need to use 100% of your own resources (and shouldn’t); in fact, the likelihood that you won’t have all the resources needed to handle the entire process on your own is high and that’s fine. Anything and everything that other people have, when combined with your own resources, will increase your power and gain.
But, as stated, the most common type of leveraging, when people think of it, is “Other People’s Money” (OPM), like that from banks or private lenders.
And, by the way, private lenders are key to the biggest success in the real estate investment business. To be a success, you must learn how to find private lenders. But I digress; more on private lenders another time and back to leveraging for today.
The biggest example of using leverage in real estate investing is using the power of someone else’s money to control a property with just a small amount of money out of your own pocket; this really makes the difference when it comes to big gains.
While similar to leveraging investments in the stock market by using margins, leveraging real estate funding is much more beneficial because you are able to borrow against the entire amount, not just the 50% margin allowed by law in the stock market. With real estate, it’s typical to borrow up to 80%; sometimes even as much as 95%.
A good example is the following (for the sake of simplicity, I have used round numbers; these figures do not reflect the actual percentage rates of appreciation at this time):
You purchase a property for $100,000. You only put 10% of the sale amount down and borrow the other $90,000. Even though you have only used $10,000 of your own money, you control a $100,000 asset. If you were to rent the property for enough to cover your mortgage and other expenses, including taxes, and the property appreciated in value at 5% per year, then in two year’s time you would own a property worth $110,000. If the principle amount on the mortgage had been paid down by $2000, you would have a profit of $12,000 on a $10,000 investment if you were to sell. Now, most people would assume that your return on investment was 5% per year for a total of 10% for the two years; however, you borrowed $90,000 and your tenants (theoretically) have paid your mortgage payments, which would mean that your actual return on investment would be 60% per year.
OPM: That is the biggest secret to amazing wealth building in real estate investment.