Increasing real estate net worth with leverage
Build wealth in real estate by using financial tools that limit your personal stakes while giving you access to capital to expand your portfolio. For example, leverage is an excellent method real estate experts use to borrow funds and use debt to invest in a property with potential growth. As a result, after making renovations or when the property eventually appreciates, you get more profit out of your initial investment.
On the other hand, leverage can work against you, especially in times of fluctuating interest rates. Continue reading below as we’ve put together this balanced perspective to help you make informed financial decisions and successfully increase your real estate net worth with leverage.
How does leverage work in real estate?
Imagine you want to buy a house worth $750,000, and you already have that amount in savings, so you go ahead and pay upfront ready to spend the next 20 years trying to turn a profit and make that money back. However, instead of tying your cash down to a single property, you can use leverage to claim home ownership with a much smaller initial investment.
For instance, if you put a 20% down payment on the house at $150,000 and fund the rest of the payment over 10 years with a mortgage, that means you own the property with a fifth of the cost. Thus, if the property appreciates by 5% in a year, its value will increase to $787,500, giving you a nearly $40,000 gain in a single year. That’s effectively a 25% return on your initial investment. As a result, leverage works by magnifying property gains and losses.
Benefits of leverage
Increased Purchasing Power
Consult with a property rental manager in Baltimore as leverage can be a powerful tool to start your real estate investing journey. If we continue with the example above, even if you don’t have $750,000 lying around to buy a property upfront, you could still purchase a house with that value with the 20% down payment. Some financial tools may even require a much smaller down payment, allowing you to build your portfolio with limited capital.
On the other hand, if you do have such large capital, instead of tying it down to one house, you can use it to fund a down payment on multiple properties. Thus, no matter how much you’re worth, leverage can be a useful tool to expand your purchasing power.
Amplified Returns Through Appreciation
Retire early by using leverage to your advantage to accumulate wealth. For example, if you’re able to put a $150,000 down payment on two properties and each of them yields a 25% return on your initial investment, that’s a $75,000 return in a single year. This magnification effect is what expert real estate investors do to increase their net worth over time, and could be a sustainable path for you to create wealth.
Aside from that let’s not forget you still have leftover capital that can go towards renovating the property and reselling it to turn a fast profit. Alternatively, you could also make it a rental property that can pay off its mortgage and generate steady income for you.
Risks of using leverage
Financial Risk Due to Debt Obligations
Remember that for all its benefits, leverage can still be a double-edged sword. While it can secure your financial freedom and help you accumulate wealth by amplifying your returns, it can also be brutal when it does the same with your losses.
For instance, if you miscalculate and your property value declines, you could find yourself struggling to cover your mortgage payments on a house that’s now worth less than your initial investment. As a result, leverage could plunge you into more debt, limiting your financial flexibility and making it harder to recover from unexpected expenses.
Impact of Interest Rate Fluctuations
Another risk you have to weigh when using leverage is the impact of interest rates. If you’re using a loan with a variable interest rate to finance your purchase, a sharp increase in rates could wipe out your profits. After all, you’d have to use whatever profit you earn to finance the sudden increase in your loan repayments due to the higher interest rates.
Thus, investors using adjustable loan rates could face more uncertainty. On the other hand, if you opt for a fixed rate, you could end up locking in before interest rates crash, forcing you to spend more money on loan repayments in an economy where loans are cheaper.
Importance of debt management for real estate investors
1) Maintain Positive Cash Flow
Keep the well from running dry by investing in tools that help you manage your debt efficiently. For instance, do you have a system for tracking your taxes, utilities, and other expenses to ensure your rental is still turning a profit? The last thing you want to do is shortchange yourself in a market full of uncertainty. Thus, proper bookkeeping can help you ensure your cash flow remains positive, even in the face of vacancies.
2) Reduce the Risk of Overleveraging
Make sure to research different rental investment tips and find the one that aligns with your goals to avoid overleveraging. Some investors make the mistake of taking on too much debt too quickly because they look at loans as free money.
However, this perspective couldn’t be further from the truth. On the contrary, you have a long-term commitment to pay these debts off, so you have to ensure you strike a balance between your debt and equity ratio. In the long run, it also keeps your credit score high and gives you more leverage in future dealings.
Get the most out of your capital
Get the most out of your capital by using leverage to expand your purchasing power and enjoy the benefits of amplified returns. After all, why finance an investment with your money when you can pay it off in the future with borrowed capital? However, if you decide to utilize leverage, you have to be strategic.
Remember that it magnifies losses just like it magnifies your gains. Thus, you have to anticipate potential interest rate fluctuations and your debt obligations. That’s why proper debt management is essential for all real estate investors.
