The Super Power of Real Estate Leverage
Real estate is an asset that can be purchased without having toshell out the full amount up front. Usually, when a property is purchased, buyers have some cash is a small percentage (now 10-20%) of the full purchase price but depending on individual circumstances, could be a higher percentage, down payment.
Where does the rest of the money come from? Wise investors use Other Peoples Money (OPM).
Here is how it works:
With real estate, property can be purchased using mostly a bank’s money which is really OPM. As an investor, you can then rent out the property and use the rental income reived from tenant to pay the bank back. Again your using OPM. This principle is called leverage.
When considering where to put your money as an investor, one must consider what will give the best Return on Investment (ROI) and leverage can play a big role in this.
Mr. Stock bought $10,000 in stocks in Company XYZ, while Ms. Condo invested her $10,000 as a down payment on a $100,000 property, which she then rented out.
After one year, both the stock market and the real estate market appreciated 10%. The good news is that both Mr. Stock and Ms. Condo made money. What is an investors’ key objective? Yes, to make money! Yes, it’s great that they both made money but the real question is: “What was their ROI?”
In Mr. Stock’s case he invested $10,000 in Company XYZ and made a 10% increase ($1,000) at the end of one year. So Mr. Stock realized a ROI of 10%.
In Ms. Condo’s case, the $100,000 property she purchased also increased in value by 10%; it’s now worth $110,000. So her initial investment of $10,000 plus the property’s increased value of $10,000 after one year, earns her a ROI of 100%. She doubles her money!
An investor can use leverage in the stock market as well, by buying on the margin ( the margin is basically a loan again OPM to buy more stocks) but at the end of the day…YOU the investor…HAVE TO PAY BACK THAT OPM LOAN! The great thing about real estate is that you can use OPM to buy the real estate property when you get a mortgage. As well, when you have a property that is rented out and cash flows to you, then by using OPM effectively someone else is paying off your mortgage for you. The stock purchase strategy does not provide for that extra layer of leverage. This is the super power of real estate leverage!