Real Estate Success Secrets: Understanding the Importance of Leverage

Posted on 17. Sep, 2010 by in General

by BawldGuy Axiom – Tuesday, September 14th, 2010

Leverage — Possibly the most misunderstood concept in all of real estate investing. The short version is this: Leverage, in the context of the acquisition of real estate, isn’t primarily about the size of the down payment. Since I was a kid, all I’ve heard from even veteran investors is about how well they did, due to superior leverage — read down payment. As the down payment decreased in size they deemed the leverage of higher quality. Their thinkin’ was not only wrong, but eventually led many of them into an ambush of their own making.

If you never digest any concept but this one, you’ll go far.

There are two sides to the Leverage Coin — Positive and Negative. There’s nothing complex or sophisticated about it. Either the property’s return is greater than the cost of the borrowed money — better known as Positive Leverage — OR — The property’s return is less than the cost of the borrowed money — which is Negative Leverage.

Whether the down payment was 0% or 90% — the real estate investment’s yield was either more or less than the cost of the borrowed money. If the 0% down investment sported a 6% loan and returned 4%, the leverage was negative — period — no debate. If, on the other hand, the 90% down investment had a loan interest rate of 10% but returned 12%, the leverage was positive — no debate.

Treat the concept of leverage with the same absolute respect you grant gravity. The positive AND negative consequences are equally predictable and reliable — equally rewarding and deadly. They both work every time they’re tried. Leverage is one of the Laws of Investment Physics.

Though the down payment can make a difference, it’s first and foremost the relationship between the cost of borrowed money and the ultimate return of the property — from acquisition to sale — or any time during the holding period.

The rest is happy talk. Don’t ambush yourself.

Tags: , , ,

Comments are closed.