We all know the great benefits of investing in real estate: cash flow, tax write-offs, and a hedge against inflation. What happens if you want to invest in something that is too large for your pocket? I learned that it is all about how you can utilize capital in a potential real estate deal.
Coming from a background of small business owner to working at fortune 500 corporations and now investing in commercial real estate projects, I have realized how these organizations and professional investors are using money to earn higher yields and returns.
When deciding how to invest your hard-earned money, you must truly understand leverage. The idea is simple: leverage allows you to move more money with less effort! For example, it is much quicker and easier to save $250,000 to buy a $1 million piece of real estate and get a loan for the other 75% of the required funds than saving $1 million to buy the property without a loan and all in cash. This is Real Estate Investing 101. Let's look at two investment scenarios, one using only cash and the other using a leverage (loan). We will use the following assumptions to illustrate the difference:
There's a multifamily property with a purchase price of $5 million and the maximum loan-to-value (LTV) at 75%. The interest rate is at 5.0% and the hold period is set at 5 years. The sale price after 5 years is at $7,806,711.
As you can see, by using leverage to help finance your investments , you are increasing your rate of return. As you borrow money and take on the obligation to repay that amount plus interest , the risk element of your investments increases. But as you know, whenever there is a greater risk, there is a greater reward . The power of leverage provides more liquid capital for investing and reinvesting , and higher returns for investors. Many beginner investors are cautious to use loans and leverage to help make their deals happen, but risk and reward are two sides of the same coin. Leverage is the way to greater returns and wealth creation for investors.
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