The Best Way To Make Money with Real Estate – Use Leverage: This is a concept that not too many people know when talking about personal finance. This is the concept of leverage. What is leverage and how does it make real estate so lucrative. What this means is that you are using some of your money (the down payment) and then the remainder of the property cost is being taken care of by other people’s money (mortgage).
So to put this in different term. There is a hypothetical $200,000 property. You have $50,000 to put down. The property is purchased with $50,000 however the actual property is worth $200,000.
If this property appreciates (goes up) in value to $250,000, that means that you more than doubled your initial investment of $50,000!
If you’re a video person (like me), here is a great video explaining the concept:
The Best Way To Make Money with Real Estate: Why leverage is important
Let’s take a look from another article on the subject:
“Leveraged real estate investing can increase the profit margin on your investment properties. For example, let’s say you have $50,000 cash on hand. You can use that money to do 3 things:
- Buy a $50,000 investment property with all the cash you have on hand. This equals a 0% leverage.
- buy a $100,000 investment property with the $50,000 cash you have on hand and use an investment property financing method – like a bank mortgage loan – to borrow $50,000. This equals a 50% leverage.
- Buy a $200,000 rental property using the $50,000 cash you have on hand and use an investment property financing method to borrow $150,000. This equals 75% leverage.
Which option did you choose?
Assuming property values increased 7% this year, here’s how much you made off your investment property.
- If you chose option 1, your investment property value is now $53,500 and your net gains is $3,500.
- For option 2, your investment property value is now $107,000 and your net gain is $7,000.
- If you choose option 3, your investment property value is now $214,000 and your net gain is $14,000.
You probably see the pattern: by using more leveraged real estate investing, you’re also increasing your ability to purchase higher value investment properties, which in effect increases your net gain when property values appreciate.”
So in this hypothetical scenario, your $50,000 investment could have made you $3,500 if you bought a property outright, or if you used 75% leverage – you could have made $14,000. Huge difference!
How do you calculate leverage?
Do to this you:
Divide the financed amount by the house’s value. Another term for this in the “loan to value” ratio. So if you want to keep to the same example the numbers work out like this: Financed amount $150,000, House value $200,000.
150,000/200,000 = 0.75. This is the loan to value ratio.
Also: If you’re a real estate investor that is looking to improve your efficiency and looking to reduce your tenant related headaches, consider checking out Buildium. Their property management software is top-notch and will take your business to the next level.
Other options – Home Equity Loans
This is another way to tap into leverage if you already own the home. If your home mortgage is paid down, you may qualify for a home equity loan or home equity line of credit. This is a loan that is offered on the equity in your home. Using this loan, you are able to pull this money out and use it for other things – like other investments.
Risks to avoid
Like anything in life, too much is usually a bad idea. Over-leveraging yourself on real estate by putting down the bare minimum amount can put you in a bad situation if you don’t do your homework. If your are purchasing a home as an investment, the minimum amount you are required to put down is 20%. This is probably due to the house bubble/crash in 2008 when rental properties were being purchased for 5% down or less.
If you are trying to leverage your money and considering putting down less than 20%, there are some factors to consider:
- Home value
- PMI (Private mortgage insurance)
In the future, you may decide to use this property as a rental. Making sure that the numbers are viable is very important. PMI can be a large additional expense. Mortgage companies use PMI as a way of protecting themselves if a buyer defaults – since the buyer has far less “skin in the game” than the mortgage company does.
Another thing to mention is never rely on appreciation. Appreciation is when a home’s value increases due to the market (current demand) and what other homes have sold for in the area. Appreciation is a double-edged sword, meaning it can become depreciation as well. Always use leverage cautiously!
Another way to leverage your money through real estate is by investing your money is by investing with real estate backed loans. This is done through a service such as Peer Street. It’s definitely an option to entertain if you don’t have the experience to tackle real estate yourself but want to enjoy some of the benefits.
The Best Way To Make Money with Real Estate: Conclusion
Most people thinking about “investing” as a method that strictly uses their own money only. Using leverage you are not only using your money but other people’s money. This combined approach lets you tackle much larger properties and improve your returns on that scale. This is why the best way to make money with real estate is to use leverage and multiply your potential gains! Leverage gives you great power but remember, if you take too big of a risk – you could lose it all. Use leverage wisely and it will be your best ally in the path to wealth!
Did you like this article, consider checking out some of our others: