When it comes to real estate, finance, and investing, the language used can be a bit confusing and overwhelming. Today we want to take a closer look at real estate leverage and what it means to you, as a buyer and investor.
What is Leverage?
Leverage, by definition, is when you use borrowed money (or capital) or some other financial tool to increase the return you receive on a particular investment. It’s not an uncommon at all. As a matter of fact, most people purchasing homes with mortgages are using leverage.
Take a closer look at the example in this Investopedia article and you’ll see how it works. The example provided is that you are putting 20% of your own money, or $100,000, down as a deposit on a $500,000 asset or home. The other 80% of the purchase price is borrowed money. If the value of the property appreciates 5% over the course of a year, the net worth of the borrower, as the owner of the property, is now $525,000.
If that same borrower had said, “I only have $100,000 and I don’t want to borrow any money,” and thus purchased a $100,000 home outright, that same 5% appreciation would only be worth $5,000 instead of $25,000.
So if an individual is in a position to borrow, the end return on the investment stands to be much higher.
It takes money to make money, and that is especially true when it comes to real estate. While a mortgage company is the most traditional route, many investors will seek private capital or other means of investment. No matter what you choose, you’ll want to make sure you understand the numbers and negotiate the least amount of interest possible – something that will also help you to maximize your ROI.
There are Drawbacks
There are, of course, drawbacks. You need to have a strong understanding of the home you’re buying, the real estate market in general, and the area in which you are purchasing. While in the scenario above the individual’s net worth was increased by $25,000, a simple deflation in the value of the home could result in a negative impact and a decrease in the net worth.
Talk to your financial advisor or lawyer if you need help understanding your own financial position and whether or not leveraging the money you have to purchase a higher valued property is right for you. Once you’re ready, your real estate agent will be happy to help you find a property that fits the mold.