There are many compelling reasons to invest in real estate.
That said, when it comes to ROI — what every investor wants — leverage is quite possibly the most significant component of a real estate investment.
In this article, we define leverage, explain how it works, and demonstrate how it can supercharge your portfolio — even in a balanced market.
What is leverage in real estate?
In real estate, leverage refers to the act of borrowing money (using debt) to purchase and benefit from a property. In most cases, this is done by way of a conventional mortgage.
Leverage is the norm in real estate. The vast majority of homes are purchased using a mortgage and, really, homeownership would be impossible for many without using leverage.
What makes leverage powerful in real estate?
Unlike most investments where you only make financial gains on the amount you’ve invested, using leverage in real estate allows you to make gains through market appreciation on the full value of the property — not just your investment (the down payment).
Leverage, simply put, allows you to multiply your ROI.
Here’s an example:
If you invest $100,000 in a stock and it increases 10%, you’ll gain $10,000 ($100,000 x 10%).
If you make a $100,000 down payment on a $500,000 condo (20% is typically required when purchasing an income property) and the market rises 10% in value, you’ll have gained $50,000 in equity ($500,000 x 10%).
Same level of investment — but 5x the return.
AND, this does not include gains you’ve made through cash flow and mortgage paydown.
Even at a 3% appreciation rate — which used to be the norm in many Southern Ontario markets — through leverage, that could equate to earning 15% through stocks or other investments.
The other advantage of leverage in real estate
When using leverage to purchase an income property, you not only get the instant benefit of ROI multiplication, but your tenants are the ones paying off your debt (mortgage) — not you.
Even if the market never moves an inch pricewise after you buy, your return on investment could still be as high as 400% once your mortgage is paid off (assuming a 20% down payment).
Are there risks?
From market corrections to illiquidity, there are a number of potential risks you should be aware of when it comes to using leverage. We discuss these risks and how to mitigate them here.
What’s interesting, though, is that homebuyers often don’t think twice about using leverage to buy a home; mortgages are seen as a standard part of the homebuying equation.
This should be comforting for those thinking about purchasing an income property as this speaks to real estate’s track record of safety and predictability: one of the best reasons to invest in real estate.
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