Growing up in the United States, you probably have been taught debt is bad. Pay for things outright or with as much money down as possible, even when buying a home. However, these real estate investors might surprise you with their reasons for buying properties with leverage.
Increased ROI and Tax Relief
When you buy a property with cash, you are limited to the amount of money you have on hand. However, when you use leverage to finance your purchase, you can potentially buy much more expensive property. Real estate leverage, like a mortgage, also allows you to buy a property with less money down, which can increase your ROI.
Accordingly, leverage enables you to buy multiple properties, which can further increase your ROI. Just be sure you can afford the monthly payments on the loan you take out to finance your purchase.
Another benefit of buying real estate with leverage is that it works in your favor when property values increase. If the value of the property you purchase goes up, the amount of equity you have in the property also increases. This can help you make a profit when you sell the property or refinance the loan.
Lastly, this option allows you to take advantage of tax relief through depreciation on the properties you can. This can save you a considerable amount of money each year, which can be used to reinvest in other properties or cover the costs of owning and maintaining your real estate portfolio.
Builds Your Portfolio Faster
There are several benefits of using leverage to purchase real estate. The main benefit of using leverage over cash is that your return on investment will be higher. Generally speaking, since you are putting less cash into the deal with leverage, your return on your cash invested is higher than it would be if you purchased the property with cash.
The other main benefit of leverage is that it allows you to build a portfolio much faster than if you had to use all cash.
Bill Samuel is a full-time residential real estate developer at Blue Ladder Development.
Michael Hausam is a licensed Realtor and Mortgage Loan Originator. He runs the Hausam Group.
Top Benefits of Using Leverage to Buy
There are four primary benefits of buying real estate with leverage, financing a portion, rather than using cash. The first focuses on the upside when there is a gain in value. The second focuses on if the market crashes and value is lost. The next addresses opportunity cost and the final benefit concerns a worst-case personal financial circumstance.
They are as follows:
● Leverage maximizes your return on investment. For example, if you buy a piece of real estate with cash for $1,000,000 and it increases in value by 10%, you have made 10% on your money. If, on the other hand, you finance 80% of the purchase and contribute only $200,000 in cash, that same 10% increase in the value of the real estate means that you’ve earned a 50% return on your money!
● If the market crashes and the value of the real estate decreases, your exposure to the loss is limited to the amount of cash you’ve put in.
● Putting less cash in a real estate deal allows you to use the remaining cash for other opportunities [or] investments. The basic concept: don’t put all your eggs in one basket.
● If decreases in one’s financial situation occur and the mortgage payments are unable to be made, the lender ultimately forecloses and takes the house. Just like with benefit number two, losses are limited to the amount of cash put into the deal. This final benefit is a justification for getting as big of a loan and putting as little down payment as possible.
Limits Liability and Protects Properties
Owning a property outright can potentially make it a target for litigation. Most real estate investors, myself included, try to keep a loan-to-value ratio of 75% by stripping equity out of rentals periodically. Using leverage limits liability and protects properties. In addition, it keeps the company’s credit rating impeccable, which aids in acquiring the next investment.
Allows You to Buy More Properties
Buying real estate with leverage allows you to keep more of your cash liquid, enabling you to purchase more properties at once.
If you were to use all of your cash to purchase a property, all of your funds are tied up in that property, so you aren’t able to purchase additional ones until you turn a significant profit from that first property.
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