Real Estate Buying & Investing
Leveraging Real Estate
to Generate Wealth
Investing in real estate can provide a multi-source income. But you don’t want to end up with lemons when you thought you were ordering lemonade. Knowing when and how to leverage real estate is the best way to make sure you end up with the financial return you want.
The most straightforward example of leveraging real estate is a mortgage where you’re using your own money to leverage the purchase. A small down payment means you can leverage the rest from your lender. Beyond the home you live in, you can make money from an investment property—a property bought with the intention of earning a return, either through rent, resale, or both. A common property investment strategy is BRRR (buy, renovate, rent, refinance, repeat). To take advantage of leveraging real estate, you do not have to have a high income or assets. You just need enough credit and the ability to evaluate risks.
To leverage real estate, you’ll need to know the equity requirements and what assets you can safely borrow against. You’ll also want to make sure you aren’t depending on your return investment right away, as profit can take time. It is possible to earn significant profits or steady cash flow when you leverage real estate, but it is important to take care with every decision. Knowing the market will help you gauge when a deal will be successful and when to walk away.
Know Your Options
Everyone starts out in different places. If you have never bought a house, or property, then buying your first with a value-add is an effective way to get started. You learn the buying process, and you get to make your first purchase with an investor mindset. If you already own property, then you may have equity in it, or you may be able to refinance some of the cash out at a low interest rate. Talk to your buyer’s agent about what is the best option for you. They will be able to point you in the right direction. You might qualify for an option you are not aware of.
Ways to Access Leverage
The easiest way to access leverage is to use your own money. In the case of a mortgage, a standard down payment gets you a house in which you want to live. If you purchase the property as an investment, you may be in a position where your lending partner furnishes some—or all—of the money. Some sellers may be willing to finance some of the purchase price of the property they wish to sell. Under such an arrangement, you can purchase a property with little or no money down. It is important to remember that you should check all available options to you to properly evaluate the risk and reward of the investment.
When you leverage your real estate investment purchase, you still get to depreciate the total cost of the property, not just the cash you put into it. This gives you a significant tax deduction each year. You’re also able to write off the interest paid on the loan, which during the first several years is the majority of your loan payment. This provides another great tax deduction each year. Real estate has some great tax benefits, and leverage allows you to take advantage of the interest deduction and depreciation on an amount much greater than what you’ve invested.
The Dangers of Leverage
Leveraging does come with a downside. It can work against you, just as much as it can work in your favor. In real estate markets where prices fall significantly, homeowners can end up owing more money than the house is actually worth. For investors, declining prices can reduce or even eliminate profits. If rents fall too, the result can be a property that cannot be rented at a price that will cover the cost of the mortgage and other expenses. If you are contemplating becoming a landlord, there are many factors to consider.
Leveraging Many Properties
A huge advantage to leveraging many real estate investments is the equity you will build over time. When you first purchase your properties, your equity is limited to the amount of cash you put into the deal. Over time, as the income from the properties pays down the principal on your loan, you’ll be building equity that your tenants will be paying for.
A problem, when multiple units are involved, is when real estate investors put down as little money as possible. The goal is to leverage your money by taking control of the assets while only putting down a portion of the value. Should the amount you get in rent decline too, the result could be to default on one or multiple properties. If you use cash flow from that property to pay the mortgage on other properties, the loss of income could produce a domino effect. This could end with your entire portfolio in foreclosure over one bad loan on one property. For this reason, it is important to have a contingency plan so that you can comfortably grow your property portfolio without a huge risk.
Avoiding Leveraging Risks
Profiting for leveraging real estate comes down to common sense. Just like any investment, real estate comes with risk. Although you can use leverage to your advantage, there are a few key things you want to make sure you avoid to give you a better edge in the market.
Most importantly, don’t assume what will happen before it happens. You can’t always use past performance as an indicator of what will happen in the future. If you see that property values have risen in a specific area over a certain period, that doesn’t mean they will continue on the same path. You’ll also want to budget yourself accordingly and know what you’re getting into. If you put down a lower down payment, the amount of your loan will be higher. That means you’ll have to make a larger monthly mortgage payment. You should plan for the possibility of lower vacancy rates, a tougher economy and bad tenants. Ultimately, you’re responsible for the mortgage payment, so you must make sure you can keep yourself afloat in any situation.
Be Realistic about Growth
Using the first home as financial leverage to buy the next is a great strategy, but the momentum it creates should not be undervalued. Cash isn’t usually the choke point for beginners. Cash might seem like the problem, but the real problem is usually talent, resources, or strategy. This is where a buyer’s agent can help keep you on course.
Be conservative in your appreciation expectation. Just because property values and rents have increased annually in your target area in recent years doesn’t necessarily mean they will this year or in the years ahead. It’s much safer to build your financial strategy around a slightly lower expectation and then be pleasantly surprised if returns are higher than you anticipated.
Even if you have no shortage of cash, if you don’t know how to deploy it correctly, it’ll go to waste for sure. So, for the first deal or two, when you’re cash strapped and struggling, try to grind out maximum returns from your deal. It increases not only your return, but your self-confidence. It may also help you use a diversification strategy when your portfolio grows. When you have multiple cash-flowing investment properties, cash flow from one property could help offset the monthly expenses of another. It’s smart to make sure all your eggs aren’t in one basket.