Although leveraging real estate may sound like jargon, it is a simple concept. Simply put, leverage in commercial real estate means using another’s money to buy their assets. The real estate’s value appreciates over time and generates income for the buyer. A buyer can own a rental property after borrowing 80% of the purchase price while keeping 20% as a margin. Thus, leveraging helps investors reduce the amount required to buy the property. Without leveraging, only wealthy people would be able to own real estate.
Advantages of Leverage
Leverage can improve the return on investment or cash-on-cash return on a property. Rental property also includes non-mortgage expenses that consume half the rental income. Therefore, rental property can only provide the maximum return of 7.5%. However, a long-term property mortgage with minimal interest can get a cash-on-cash return of 14.6%. Therefore, an investor’s value gets doubled through leverage.
Leveraging applies the BRRRR method of investment – buy, renovate, refinance, and repeat. One needs to invest in multiple properties to get a better return. If an investor buys one property in cash and another buys five identical rental properties, the second investor will get almost double the return. Even when the property’s value appreciates, the investor with more properties will remain in profit.
Leverage can protect an investor against inflation in the real estate market. Even though the desired property value appreciates, the investor can apply the BRRRR investment method to go through various properties. Eventually, leveraging can help the buyer build a solid real estate portfolio.
Types of Leveraging
There are many ways to leverage commercial real estate as there are various common ideas.
A traditional mortgage is the primary buyer’s most common form of leverage. Banks offer low-interest rates to first-time buyers. A buyer can also use owner-occupied financing to cut the down payment and get even lower interest rates. Even though it takes a month to close the loan and a detailed analysis of the credit report, leveraging a rental property is simple through a traditional mortgage. As banks allow a maximum of four mortgages, one must graduate to portfolio lenders to own more properties.
Traditional mortgage lenders dispose of all the loans after paying them off. However, portfolio lenders keep the loans in their portfolios for the entire duration. Portfolio lenders are also more flexible than banks as they make the lending decision based on the deal quality. Even though they check the buyer’s credit history, the lending remains quicker.
The term HELOC stands for Home Equity Line of Credit. It is a rotating credit secured against a fixed asset. It is a term loan where the lender takes the property on default of the loan. Investors can apply for a HELOC against their rental properties in addition to their primary residence. A HELOC can also cover the following property’s down payment or pay for the real estate’s repairs and renovations. The HELOC balance can be paid according to the buyer’s schedule.
Credit Lines and Credit Cards
Credit cards can be used to buy real estate; however, investors fail to realize or negotiate the maximum credit limit. As credit cards are not secured against any property, a buyer does not have to pay for record liens, title searches, and foreclosure risks. A credit line can also secure a property, finance the renovations, and cover the down payment.
You can use leverage in real estateto produce profitable results. Even though leveraging can multiply the investment, one should analyze the market before jumping to conclusions. A higher loan-to-value ratio is always preferable for real estate.