Leveraging Money to Increase Your ROI

I’m sure you have heard the term leverage. What does that actually mean?

When we refer to leveraging money in real estate, it refers to utilizing other people’s money to acquire property or to increase your return on investment. To show you how it works and the power of what it can do for your real estate deal, I will give you two examples comparing one without and one with leverage.

So, if you look here, we have a project that we're analyzing.

The purchase price of the property is $180,000 and the closing costs are $5,000, which makes a total investment of $185,000. If we don't get leverage on it, a mortgage in this case, our total cash invested is going to be $185,000.

Now, this project is going to generate gross income of $1,600 with a vacancy factor of $44 per month, which will be a gross effective income of $1,556 monthly.

Our operating expenses are going to be about 30% of the gross income with an operating income of $1,076 per month. On an annual basis, this will amount to almost $13,000.

Using that information, for total cash invested of $185,000 and a cash flow of about $13,000, our cash-on-cash return for this project is going to be about 6.98%. And keep in mind, that is without borrowing or leveraging our money at all. In this example, we are going to put up the $185,000 ourselves, and we will obtain the aforementioned values in return.

What does it look like if we were to get a mortgage on this?

This is the same project with a purchase price of $180,000. The financials will be pretty much the same, except for the mortgage payment part. The only difference here is that closing costs are going to be a little more because you will have the addition of a mortgage, origination fees, an appraisal, and a few other things that will increase the closing costs a bit.

The total investment with the mortgage is $187,000. The mortgage is going to be 80% of the purchase price, which is $144,000. If you take the total investment minus the mortgage, the total cash invested is going to be $43,000.

If we take this mortgage and plug that into the mortgage calculator, using a 30-year term at 3%, the monthly mortgage payment is going to be about $600.

If we take our net operating income minus the mortgage payment, that will be our cash flow on both a monthly basis and an annual basis. If the total cash invested is $43,000 and the annual cash flow is about $5,600, our cash-on-cash return with leverage (mortgage) is going to be 13%. That's a pretty big difference compared to leveraging no money at all. In fact, it is almost double!

Furthermore, if we have $185,000 of capital lying around, we can buy a little over four houses with that same capital, assuming we're able to get a loan for each house. Following the second scenario, each project is going to take $43,000 of cash invested.

Now, multiply by the annual cash flow by 4 and we're looking at a cash flow of about $22,000. This is almost a $10,000 difference compared to the cash flow if we bought the property using exclusively our own cash. It is a fairly significant difference when we were able to use leverage.

This is the true power of real estate. Not many other investments out there allow you to borrow money against the asset and allow you to actually acquire that asset.

Therefore, use leverage! Utilize other people's money to your advantage to maximize those returns. It is very common to see numbers like this when you're taking out a mortgage or leverage. Other forms of financial leverage in real estate can come in the form of wraparound mortgages, private mortgages, and seller financing.

You could also do home equity loans from other properties to finance this property. And, you can do other asset-based loans. For example, you could borrow against your stock portfolio to secure 100% financing on a real estate purchase.

And finally, even partnerships are a form of leverage, if you do the math. It's an expensive form of leverage, but it is a form of leverage nonetheless.

In conclusion, leverage is definitely something you want to incorporate into your own real estate plans. As you can see, there are certainly a lot of advantages to leveraging other people’s money to increase your return.

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