Real Estate Investing Primer on Leverage
weight. Leverage in real estate enables you to control an expensive piece of property with a small amount of cash.
First, let examine a property you buy with no leverage. Let’s assume you buy a $100,000. condo. For simplicity sakes, let us also assume that there were no other costs in acquiring the property. Our third assumption is that the property increases 10% per year in value (appreciation). You buy the property on January 1 by investing $100,000. On December 31 the condo is worth $110,000. Your investment has earned you 10%. If we are able to rent that property for $1000 per month, and we assume expenses of $167/month, we have additional income of $10,000. Now our investment earned a total of $20,000. For example:
Annual appreciation $10,000
Gross income: 12 months x $1000=$12,000
Expenses -2000
Our net benefit $20,000
Without looking at any tax advantages we have earned $20,000 ($10,000 appreciation and $10,000 income) or 20% on our $100,000. This is pretty good!
Now let’s see how leverage works. Instead of paying cash for the $100,000 property let’s put up $20,000 and borrow the rest.
Annual appreciation $10,000
Gross income: 12 months x $1000 $12,000
Expenses w/o interest -2,000
Interest expense for $80,000, 7% loan
for 12 months is -5,574.
Our net benefit $14,426
In the leveraged example we earned $14,426 on our $20,000 investment. This is a return of 72%. This is what leverage is all about. Now keep in mind we have not even considered that you are paying the mortgage down ($813 the first year) or the depreciation that you can write off ($2909 the first year).
The reason I mention this type of leverage is that you can now buy a condo in WCI’s Grand Isle and CONTROL that condo for only ten percent for up to 1 ½ years. In The Colony you can do it for 20 to 30%. If the condo appreciates 10% a year, and you have no expenses (you will not – they are not built yet) you 10% will be worth , on paper, more than double what you put in.
First, let examine a property you buy with no leverage. Let’s assume you buy a $100,000. condo. For simplicity sakes, let us also assume that there were no other costs in acquiring the property. Our third assumption is that the property increases 10% per year in value (appreciation). You buy the property on January 1 by investing $100,000. On December 31 the condo is worth $110,000. Your investment has earned you 10%. If we are able to rent that property for $1000 per month, and we assume expenses of $167/month, we have additional income of $10,000. Now our investment earned a total of $20,000. For example:
Annual appreciation $10,000
Gross income: 12 months x $1000=$12,000
Expenses -2000
Our net benefit $20,000
Without looking at any tax advantages we have earned $20,000 ($10,000 appreciation and $10,000 income) or 20% on our $100,000. This is pretty good!
Now let’s see how leverage works. Instead of paying cash for the $100,000 property let’s put up $20,000 and borrow the rest.
Annual appreciation $10,000
Gross income: 12 months x $1000 $12,000
Expenses w/o interest -2,000
Interest expense for $80,000, 7% loan
for 12 months is -5,574.
Our net benefit $14,426
In the leveraged example we earned $14,426 on our $20,000 investment. This is a return of 72%. This is what leverage is all about. Now keep in mind we have not even considered that you are paying the mortgage down ($813 the first year) or the depreciation that you can write off ($2909 the first year).
The reason I mention this type of leverage is that you can now buy a condo in WCI’s Grand Isle and CONTROL that condo for only ten percent for up to 1 ½ years. In The Colony you can do it for 20 to 30%. If the condo appreciates 10% a year, and you have no expenses (you will not – they are not built yet) you 10% will be worth , on paper, more than double what you put in.
Comments(0)
If you have cash to use that is a great article....If I had loads of cash...i would go to the convential investor .com
Good article GFous!
Your comment makes we want to have a discussion of what a creative investor is.. To me the conventional investor does not do leveraged real estate.
Gregg,
I didn't mean it as an attacking comment. I learned how to leverage from your article. My point was that I personally didn't have the $100,000 anyways, so I would have to be creative and leverage.
Brandon