3 Myths about Using Leverage to Buy Real Estate
Back to Basics – What is leverage?
When used in connection with buying real estate, leverage means using borrowed capital to purchase property. Any property purchase that requires a loan is using some leverage, and leverage increases as the loan size relative to the purchase price increases. A property purchased with 20% cash down and an 80% loan (an 80% Loan to Value ratio) is more highly leveraged than if purchased with 40% down and a loan for 60% of the purchase price (60% LTV).
Myth #1 – Leverage is always “risky.” To many people the word leverage means risky in the sense of “dangerous.”
Especially after the credit meltdown of 2008, mortgage debt and leverage took on negative connotations. Correctly applied however, leverage introduces a perfectly acceptable level of risk and increases the investor’s return on the property.
Investors seeking to use leverage to their advantage should focus on buying properties with strong cash flow and in areas of stable rental demand. Using these selection criteria will help ensure that there is adequate cash available for not only loan payments, but also for any unforeseen expenses that might arise.
Invest Amarillo’s properties have both large positive cash flow and strong, stable rental demand typical for the Amarillo, Texas real estate market. See http://investamarillo.com/the-amarillo-market/.
Where you buy makes a difference. To illustrate, let’s look at an example of rental duplexes that are currently for sale in two markets. Both would be purchased with an 80% LTV using a standard 30 year amortizing loan at 5.00% interest. Expenses include repair reserves, property insurance, property taxes and property management fees.
Location: Amarillo Los Angeles
Purchase Price: $115,000 $379,000
Cash down: $ 23,000 $ 75,800
Loan Amount: $ 92,000 $ 303,200
Annual Rent: $15,000 $33,000
Expenses: $ 5,500 $13,000
Net Operating Income: $9,500 $20,000
Loan Payments: $5,900 $19,530
Excess cash flow: $3,600 $ 470.
This example clearly illustrates why buying a property in one market is significantly riskier than the other. The Amarillo property has a very comfortable amount of cash flow after debt service, while the Los Angeles property is projected to have almost no cash flow. In fact the Los Angeles property’s much lower cash flow would not allow it to qualify for a standard loan—banks don’t want this level of risk either. An investor would have to come up with another $75,800—a total of $151,600 down—to make this property work to qualify for a 60% LTV.
Invest Amarillo chose the Amarillo market not only because of the stable demand for quality rental units, but because our properties there offer such strong cash flow. This not only greatly reduces the risk of our real estate, but increases the return for our investors. All of Invest Amarillo’s current inventory generates excess cash flow after debt service. Check it out at http://investamarillo.com/properties/all/.