As a real estate investor, you need to be well-versed in all the strategies available to you when building your investment portfolio. One such example of a method that successful investors use to increase their own portfolio’s net worth is leverage. Knowing what leverage is in a real estate transaction and how to use it can be the difference in your portfolio staying at its current worth and taking the next step towards your success as a real estate investor.
What is Leverage in Real Estate?
In the world of real estate investing, leverage refers to using borrowed money in order to purchase a property. As an investor, leveraging funds from outside lenders keeps you from having to come up with all of the necessary funds in order to purchase a property on your own. The ability to leverage funds in order to purchase a property is one of the reasons that real estate investing is such an attractive concept.
How Do You Leverage Funds?
Leveraging funds to purchase an investment property revolves around the idea of using outside party’s money first in order to increase your own returns. Obviously, you still have to repay those parties with interest, but leveraging funds means that you don’t have to put your own capital into the purchase of the property. You can leverage funds from private lenders, banks, hard money lenders or credit unions. The idea behind leveraging funds from one of these sources means that you can purchase a property that you can’t afford on your own, or you can use your personal cash to spread across multiple investment properties.
Examples of Leveraging Funds
To gain a better understanding of how to use leverage in your real estate investments, let’s look at a couple hypothetical situations.
- Depending on the type of loan that you’re attempting to obtain, you may be required to put down a 20% down payment. Let’s assume that you’re interested in a hypothetical investment property that’s going to cost $500,000. The 20% down payment would come to $100,000 which leaves you with a $400,000 loan. If you’ve ever heard established real estate investors talk about using “other people’s money,” this is often what they mean. Even if you have the $500,000 on hand, you may not want to sink that much of your money into a property up front. Instead, you can use the $400,000 loan from a mortgage institution, credit union or private lender. Yes, you’ll owe interest on the repayment, but by leveraging funds from an outside source still allows you to keep more of your money in your pocket upfront. If you have found multiple properties that are going to provide promising returns, you can spread your remaining $400,00 across them, or even use more of those funds as a down payment on other leverage attempts.
- Let’s consider one more example of leveraging funds in order to buy multiple properties. Some real estate investors specialize in purchasing distressed properties which have a lower initial asking price. Let’s say for the sake of our hypothetical leverage that you find an abandoned property in a good neighborhood that’s only going to cost $100,000. You have the cash on hand, but also recognize that the house is going to need roughly $125,000 worth of work. Yes, you could pay $100,000 for the property, but depending on the size of your cash reserve, it may leave you cash strapped when you’re trying to pay the $125,000 in renovation costs. Instead of spending a full $100,000, you could be better served by leveraging $50,000 from a private lender. Even if they charged 3% interest on their loan, you could be better served by leveraging half the price of a home and repaying them over the course of the next 60 months, especially since the property’s appreciation will increase your net worth.
Obviously, the choice between leveraging funds and using your own cash to fund your real estate investments is up to you. As there are pros and cons to both methods, it’s important that you choose the strategy that best suits your own investment goals. Leveraging funds is a great tool, especially if you plan on being invested in a given property for the long-term. Using other people’s money ensures that you’re in a position to use your own money more effectively across multiple deals or for needed renovations in your investment property.
While some conventional financial experts teach that debt is always bad, that’s simply not the case. Debt can be a useful tool if you know how to make it work for you. Since homes typically appreciate in value, using debt in order to fund a real estate investment is considered “good debt.” Leveraging good debt has long been a tool used by successful real estate investors, and can also work for you.
Streitwise has used modest, conservative leverage to purchase acquisitions for the offering. While there are benefits to completely funding an acquisition upfront without leverage and there benefits to heavily leveraging a purchase, Streitwise’s conservative leverage structure gives flexibility during economic uncertainty. It’s important to be aware of offerings out there that heavily leverage purchases (typically over 80%) as their flexibility during uncertainty may be at-risk.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.