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THE POWER OF LEVERAGE IN REAL ESTATE

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How Leverage Works and How Can You Benefit From It

I did not post for a long time,I was thinking an educational post can benefit us all. LEVERAGE how you can use it and create financial independence and in some cases wealth. The younger you start investing, the better.


How leverage works is shown in the following example, which I’m oversimplifying a bit to make it easier to understand. Let’s say you are buying a duplex for $60,000. You plan to use it as a rental property. Each of the two units is rented at $500 a month, so its gross income is $12.000 a year.

The seller owns the building free and clear of debt and wants all cash. You have the $60,000 to pay all cash but you learn that you can get a mortgage loan for up to 80 percent of the $60,000 at 12 percent interest. Taking out this loan would mean you could. buy the property for as little as $12,000 down. Which would be better for you?

Should you give him a down payment of $12,000 and take out a $48,000 loan at 12 percent, or give him the entire $60,000 so you won’t have any interest to pay and any debt to worry about? Let’s figure it out.

Understanding The Math

First-year interest charges on the mortgage loan of $48,000 would come to about $5,760. Subtracting this from your $12,000 gross income would leave you only $6,240 to cover all your other expenses. (We’ll say these other expenses are going to total $4,440.) That means you’ll net only $1,800 a year. That’s tiny, you might think, compared with what you’ll be getting if you buy the property outright.

A cash purchase will net you $7,560 since the only money you’ll have to pay out of your $12,000 gross will be the $4,440 for taxes, insurance, maintenance, and other operating expenses. There’ll be no loan to pay interest on.

But wait! What really counts is the yield you’ll get the return on the capital you invest. The yield will be only 12.6 percent ($7,560 + $60,000) if you put up the full $60,000 in cash. You’ll get 15 percent on your money ($1,800+ $12,000) if you put up only $12,000 and finance the rest of the purchase price with the $48.000 mortgage loan.

Maybe you’re thinking you’d still rather pay cash because otherwise the rest of the $60,000 will be sitting in a savings account drawing interest at 5 to 7 percent. If you had it all invested in the property you’d be getting more dollars in total. Sure, you’d be better off with all your $60,000 invested in property.

But why just that one property? Aren’t there other properties you can buy under similarly favorable circumstances? With a little effort, you might end up owning $300,000 worth of properties and netting 18.3 percent on your entire $60.000. Moreover, you’d then have $300,000 working for you-not just $60.000.

If the properties you owned increased in value only 5 percent per year, you could sell them in four years for an additional profit of 100 percent on the $60,000 you’d invested in them.

But that’s not the only advantage of using borrowed money to help you pay for a property. You also save on taxes because your personal investment can be written off for more depreciation This is one of the tax angles that build wealth. Contact us with any questions you may have we would like to help you with your new investment.

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