Many people want to use real estate for wealth-building, as time has proven it to be one of the most consistent investments with positive returns. However, purchasing real property often requires much more upfront capital than investing in stocks.
Fortunately, financial leverage can eliminate barriers to buying real estate. What is leveraging in real estate, and how can you use it to build wealth as a real estate investor?
What Is Leveraging in Real Estate, and What Are Common Types of Leverage?
In finance, real estate leverage is when you borrow money to take advantage of an opportunity to get a high return on an investment. Many successful real estate investors use leverage to maximize their gains.
To illustrate: Imagine you found an opportunity where an investment of $10,000 would grow to $25,000, netting you $15,000. If you didn’t have the cash on hand, you might borrow the $10,000.
Of course, that loan has interest and fees, and for this example, imagine those equal $1,500. Clearly, the loan is worth the expense because you still earned $13,500 (after you subtract the $1,500 in loan costs from the additional $15,000 you gained.)
Now, consider common examples of how buyers use leveraging in real estate.
The most popular form of real estate leverage is securing a mortgage on a primary residence. You take out this loan from a lender to get a home, which usually increases in value.
A home equity line of credit is when you take out a loan using the equity you have built in your home to secure the debt. Investors like using HELOCs because the interest rates can be much lower than other loan types.
You can also borrow money from anyone willing to lend to you, such as a friend, family member, individual financier, or a private lending group. While these loans might have higher rates and interest, they can allow more flexibility in how you use them.
An investor who operates through a separate business entity often qualifies for business credit, whether as a credit card, line of credit, or other loan type. These loans are a smart way to protect your individual assets when doing business.
Portfolio loans come from private lending institutions, such as Associates Home Loan. These products provide flexible lending requirements for borrowers who don’t meet conventional lending standards. Also, you can often receive your funds more quickly.
How Do You Calculate Leverage?
To use leverage correctly, you have to calculate whether the return on the investment is worth the cost of the loan using one of two popular methods.
The loan-to-cost ratio tends to be more popular for commercial real estate construction. Here, you would compare the size of your loan to the cost to complete the project. You might also prefer LTC if you’re planning to rent your property investment.
On the other hand, a loan-to-value calculation is where you divide your mortgage amount by your property’s current value. Consider using this method if you’re going to flip your property, and remember you should use your after-repair value if you’re going to renovate the dwelling.
What Are the Benefits of Leveraging?
Leveraging real estate allows you to capture unique benefits when investing, even for those who have substantial cash on hand.
Boost Your Returns for More Income
Good investments yield more of a return the longer you have them, so the sooner you can enter the real estate market, the better. For instance, leveraging can help you to buy low and sell high if you’re a flipper. If you plan on leasing property, you can get into a hot market quickly.
Rapidly Build a Portfolio
Instead of putting all of your money into one piece of real estate, you can use leverage to get multiple properties for a diverse portfolio. These numerous income streams provide you with more financial stability.
Furthermore, you can build your reputation as a flipper or landlord as you purchase additional properties. A good track record helps you hire others to do the legwork so you can generate passive income with real estate.
Hedge Against Inflation
Real estate is one of the best investments because land is a finite resource. That’s why property consistently increases in value over time.
However, that means the longer you wait, the more expensive it becomes to make a purchase. Leverage allows you to get into the housing market when interest rates or home prices are low. Plus, if you’re a landlord of a rental property, rental income increases with inflation, which protects you from any devaluation of currency.
How Do You Avoid Risks While Leveraging?
All investments have inherent risks. However, when you make calculated decisions, you can minimize the odds of serious problems.
Know the Potential Dangers
Recognize that you may have times of low, slow, or no cash flow. For example, you might not flip a home as quickly as you wish, expenses might be higher than you expected on a renovation, or a rental property could sit vacant.
Owning a property comes with inherent risks. Market fluctuations can lead to declines in property values, potentially resulting in a low return on your investment if you decide to sell.
In such cases, you could lose your property and any collateral if you can’t afford to pay the loan you’re using for leveraging. Defaulting also hurts your credit score and reputation as a businessperson.
Manage Risks With Calculated Moves
Greater risks mean greater rewards, so you can avoid problems when leveraging by taking well-thought-out steps. Do the following:
- Start with realistic facts and figures about the market and how much you can earn from renting an investment property or flipping.
- Make a large enough down payment for your property to lower loan interest rates and fees.
- Start slowly, and don’t invest in too many properties too early.
- Even as you gain experience, stick to a business plan and avoid getting too aggressive in the market.
Working with a responsible loan officer can help you understand your options and make profitable decisions.
Find Reasonable Loans That Help You Start Leveraging Real Estate
If you’re ready to start leveraging real estate and want a loan process that’s even smoother and more flexible than what banks can provide, talk with Associates Home Loan. We’ll help you find ways to make leveraging work for your circumstances.