Real Estate Investing - Leverage
Leverage is simply the power to control a large investment with a small amount of money. For example, you can leverage investments in the stock market. If you have $10,000 to invest, you can purchase up to $20,000 worth of stock. That’s a 50% margin, which is the most the government will allow.
With real estate, on the other hand, people regularly achieve a 90% margin. They do this anytime they buy property with a 10% down payment and a 90% loan. Why is it easy to borrow 90% or more to buy real estate, but only 50% to buy stocks? Good question! It’s because the risk of real estate going down in value is very low and the risk of stocks going down in value is very high. Stockbrokers will tell you that a good day on the stock market is when only one-third of the stocks go down in value, and two-thirds go up.
Let’s say that you buy a house for $100,000, pay $10,000 down, and take out a loan for $90,000.Now you control a $100,000 asset but have invested only $10,000. If you rent the house for enough to cover the mortgage payments and expenses, and if the house appreciates in value 5% per year, in two years, it will be worth over $110,000. The mortgage will have probably paid down $1,000 to $2,000. Let’s say you could sell it for the $110,000. After you paid off the mortgage, you would have between $21,000 and $22,000 instead of the $10,000 you originally invested.
What was your return on investment? You bought the property for $100,000 and sold it two years later for $110,000. Many people would say your return was 5% per year or 10% total, but that’s all wrong. Here’s why! You originally invested $10,000, which was your down payment.
You borrowed the rest and your tenants made the payments while you owned the property.
When you sold it, you got back between $21,000 and $22,000, which was the difference between the sale price and what you owed. This means your actual return on investment was between 55% and 60 % per year! Not bad huh?
But here’s the beauty of the program. You don’t sell the house. Instead, you take $10,000 of the equity out of the first house and use it to buy a second one, and the whole process starts over again — except now you have two as