Leverage and How to Use it Properly - Real Estate Investment Tip

Leverage is one of the most powerful tools that investors use to acquire larger properties, increase their returns, and scale their portfolio faster to build net worth. The main advantage is that leverage allows real estate investors to accelerate their returns by reducing the amount of money they personally invest while reaping 100% of the rewards.

Typically, multifamily property investors put down a reduced amount of the purchase price and the remainder of the purchase comes from what is affectionately known as “other people’s money” or (OPM). OPM is borrowed money usually in the form of a loan from private lenders, banks, or institutional mortgage lenders.

To better illustrate, let us start by referencing the Buckingham investments financial model whereby our multifamily property investment appreciates at 5% annually in our LA market. This 5% appreciation rate is based on well established, long-term historical averages for the area. Now consider the example of investing $100,000 on an all cash, multifamily property purchase using the same 5% appreciation rate. After one year, the buyer's equity would increase by $5,000 to $105,000.

By applying the use of leverage, our investor can now use the same $100,000 as a 25% down payment on a $400,000 multifamily property investment. Under this scenario, the investor’s equity grows by $20,000 to $120,000 in the same one-year period as the 5% appreciation is on the full $400,000 investment regardless of the down payment. The return on equity is now 20% instead of 5% by using leverage. We calculate the return as follows: appreciation/down payment or $20,000/$100,000 = .20 or 20%.

However, it is also noteworthy that the use of leverage will dilute your appreciation gains over time as equity builds signaling that it is time to re-invest in progressively higher value properties over time. This is how our Buckingham investors build a staggering amount of net worth as part of an overall long-term investment plan.

Once your investment/equity goals have been achieved, it is time to sit back and enjoy the cash flow that comes along with it, only now you are worth millions of dollars as well. Imagine the financial freedom that comes along with putting the power of leverage to work for you today!