Would you like to expand your real estate investment portfolio? Let’s talk about leverage, which is one of the best ways to invest in real estate.
Before jumping into leverage, however, it’s important to understand what home equity is – because that’s what you are going to use to grow your real estate portfolio. In short, home equity is the value of a home minus the outstanding mortgage on the property. If your property is worth $ 250,000 and you owe $ 100,000 on the mortgage, you have $ 150,000 in equity. The more equity, the higher your return on investment (ROI).
Real estate investors often use leverage to buy more than one property. Because the more real estate leverage an investor uses, the more wealth he can build up. Leverage provides real estate investors with other benefits, such as: B. the diversification of your investments. Investing in both commercial and residential real estate, for example, can be a boon in a recession.
Now that you understand equity, let’s talk more about leverage.
What does it mean to use your real estate?
You may be asking, “What is Real Estate Leverage?” In simple terms, real estate leverage is when you use debt to increase your potential return on investment.
Basically, this means that you are borrowing money from a lender to buy a property.
By using real estate, you can afford more real estate investments than with your own money. By using a lender, you can now leverage leverage to buy multiple investment properties.
How does leverage work in real estate?
Let’s say you want to use your primary residence to start a real estate empire. Your lender allows you to borrow up to 80% of the home value through a home equity line of credit (HELOC).
In this scenario, you have a home of $ 250,000 so you can borrow up to $ 200,000. Subtract the $ 100,000 you currently owe on the mortgage and you have $ 100,000 to invest. You can use this to buy a rental property directly.
Congratulations – you have just used real estate to expand your portfolio.
If the value of your $ 100,000 investment property increases 5% in one year, it is worth $ 105,000. Thus, your net worth has increased by $ 5,000.
If you take advantage of leverage, you can increase your returns. Instead of buying a $ 100,000 property directly, you can use that money as a 20% down payment on a $ 500,000 property. Let’s say the value increases by 5% after 12 months. Your real estate investment is now worth $ 525,000, and your net worth has increased by $ 25,000. That’s $ 20,000 more than if you bought the $ 100,000 property directly.
Boom: The Power of Leverage.
Why use leverage in real estate?
A common myth is that all debts are bad debts. When you think of debt normally, you don’t get a warm and fuzzy feeling, do you? You likely have a negative reaction, thinking of debt collection companies. However, real estate debt is just the opposite; instead of a loss to you, it is actually a gain.
Proper use of equity can be a positive lever, especially when used to increase wealth rather than consumption. Having equity in your property doesn’t necessarily add net worth. However, access to this equity may be possible, especially if it is used to expedite your other resources to cover your debts.
This form of debt financing is to your advantage in a growing market. If you have the time, finances, and patience to await a falling market, you will be rewarded with a successful investment when real estate markets are strong.
In essence, you can invest little to no money and gain an increase in your return on investment while waiting for a market to collapse.
More on the leverage of BiggerPockets
How does the use of real estate build wealth?
People know the concept of investing in the stock market for a return. When you invest $ 100,000 in the stock market, you pay that money upfront in cash. To double your money, the stock must go up 100%.
However, a real estate investor looking to use real estate to build wealth can only spend $ 20,000 on an investment of $ 100,000. This house only needs to upgrade by 20% for you as an investor to double your money.
Everyone starts in different places. If you’ve never bought a home before, buying your first one with added value is an effective way to get started. (A “value add” is when you are working to increase the property’s value – usually through renovation.) You learn the buying process and can make your first purchase with an investor mentality. If you already own a home, you may have equity or you may be able to refinance to get some of the money at a low interest rate.
If you own a home with equity but cannot access the equity – for example, because you haven’t reached the 20% minimum equity required for most payout refinances – now may be the best time to sell. Many markets are currently inflated, and if you’ve lived in the house for two years, profits are tax-free. There are many options available, from equity to sales and HELOCs. Make sure you take the time to consider them all.
When you have equity to borrow against, a HELOC will act like a credit card for your home. It uses the existing equity that you have in your home, which allows you to use the funds as you see fit. And just like a credit card, you don’t owe anything until you put the capital in.
HELOCs are a highly recommended strategy for buying more real estate.
What are the advantages of using real estate to build up wealth?
Aside from increasing your potential ROI, there are other reasons to consider using real estate.
- Increased monthly cash flow: You may have enough cash to buy a real estate investment outright. However, leverage allows you to buy more real estate and generate more rental income.
- Increased tax deductions: Property investors can often deduct mortgage payments and rental property improvement expenses from their taxes. The more real estate investments you have, the more you can withdraw.
- Diversity reduces the risk: Leverage allows you to buy more rental properties – ideally in different classes – that can protect you from the dangers of real estate investments.
Increase Your Investment
Imagine being friends with hundreds of real estate investors and entrepreneurs. Now imagine if you could have a beer with each of them and casually chat about failures, successes, motivations and lessons learned. That’s our goal with The BiggerPockets Podcast.
What are the risks when using real estate?
While exploiting real estate can be a great way to build wealth, it is not risk-free.
1. Risk of foreclosure
When using your property, keep in mind that a lender holds a lien, which is a mortgage or trust deed against your property. The lender thus has the power to foreclose your property if you default on your loan, which means that you would lose everything you invested in that property.
2. Lender terms and conditions
Carefully decide who to do business with.
When using real estate, investors have no consumer protection as real estate loans are considered corporate loans. You want to stay away from lenders who appear dishonest or unethical. High interest rates are a red flag, as are unfair lender terms and conditions or hidden fees in the fine print of your contract.
What if the value of your property goes down instead of increasing? In this case, you owe more than the value of your property. This is definitely not the way you intended it to be wealth accumulation.
For example, let’s say the value of this $ 500,000 property drops 5% in the first year of ownership. Your $ 100,000 investment is now worth $ 75,000, and your net worth is down $ 25,000.
If you bought a $ 100,000 home all in cash, a 5% decrease would decrease its value by $ 5,000. Yes, your net worth was still going down – but that’s better than losing $ 25,000.
4. Loss of rental income
Your finances can suffer further damage if rents fall along with property values. Remember that the value of your rental properties is directly related to what prices you can charge your tenants. Tenants pay less in a shrinking and competitive market, which means your income goes down. If so, you may not have enough monthly income to make your mortgage payment and you could lose your investment if the situation doesn’t improve quickly.
This is an example of overleverage, which means you owe more on your loan than your monthly cash flow is bringing in. For example, let’s say you have two properties with $ 2,000 total monthly mortgages. If your monthly rental income drops to $ 1,500, you are now over-indebted by $ 500 per month.
The more properties you use, the greater the hit you take, of course. Leveraging more real estate can multiply your ROI from real estate appreciation, but the opposite – asset depreciation – also applies. Your net worth goes down when you own a property that is depreciating in value and, of course, it falls even faster the more properties you own.
With the risks in mind, using real estate to build wealth is still an excellent financial investment. By minimizing these hazards, you can potentially increase your net worth and your real estate investment business.
As the saying goes: there is no reward without risk.
Be thorough with your due diligence. Check an investment property carefully and the seriousness of your lender. If the market is not moving in the direction you want, long-term considerations should be to wait until it rises again.
Because what goes down on the real estate market has to go up again at some point. You may need a little more patience when using real estate to build wealth. However, this does not mean that leverage is a bad idea, as the increased financial benefits tend to outweigh the risks with this type of investment.