Beginning Real Estate Investing Understanding Leverage
This is one of a series of articles on beginning real estate investing. One of the fundamental concepts to understand as you are beginning real estate investing is the concept of leverage. Leverage is the ability to move or control something very large with a very small object or force. Leverage as it applies to real estate investing is the ability to control high value properties with small amounts of your own cash.
To understand why this is important, and why leverage is so valuable, an example will help. Let’s assume you are just beginning real estate investing and you have $20,000 cash to invest. The exact amount is really unimportant, so long as you understand the principle involved. To illustrate the power of leverage, let’s assume you are faced with three possible choices of how to invest your $20,000.
Choice one is to purchase a small single family home with a purchase price of $20,000. The market rent for this home is $250 per month, or $3,000 per year. For purposes of this illustration, let’s pretend there are no such things as taxes, Realtor fees, or any other costs involved with purchasing a piece of property. Wouldn’t that be nice? As a you are beginning real estate investing you’ll soon learn otherwise, but for now let’s indulge in a little fantasy.
Choice two is to purchase a duplex for $40,000 by putting our $20,000 cash down and borrowing the additional $20,000. The market rent for this duplex is $500 per month, or $6,000 per year. The monthly payment on our loan is $200, so positive cash flow is $300 per month, or $3,600 per year. Not too bad, considering we are just beginning real estate investing.
Finally, choice three in beginning real estate investing is to purchase a multi-unit apartment building for $140,000 by putting $20,000 cash down and borrowing the additional $120,000. The market rent for all the units in the building totals $1,500, and our monthly loan payment is $1100, leaving us a positive cash flow of $400 per month, or $4,800 per year.
Let’s see which of these three situations best demonstrates the power of leverage. To do this we need to make a simple calculation, called Return On Investment (ROI) for each choice. This is a very important calculation to learn as you are beginning real estate investing. ROI is calculated by dividing the amount of return we get back in a year’s time by the amount of cash we have invested.
In choice one, $3,000 return divided by $20,000 gives us a Return On Investment of 15%. Not bad, considering we’re just beginning real estate investing, but let’s see if we can do better. Choice two gives us a return of $3,600 per year for the same $20,000 invested, so our ROI is $3,600 divided by $20,000, or 18%. That’s excellent, but we still have one more choice to look at.
Choice three gave us a return of $4,800 on our investment of $20,000, so our ROI is a whopping 24%! Why so big? Because even though we’re just beginning real estate investing, we were able to “move” or control a much more valuable piece of property with a very small “lever”… in this case, our $20,000. What gave us that leverage? The ability to use Other People’s Money (OPM), but that’s a topic for another article.
Until next time, I’ve written another in-depth article called Beginning Real Estate Investing.
Now, go make more offers!
Crush The Biggest Obstacle to Your Success in Real Estate... or Anything Else! Download my FREE report HERE!
Tom Dunn is a successful real estate investor and author of the popular DealFiles Real Estate Investor Stories free newsletter. You are welcome to share this report, unedited and in it's entirety, with anyone you like. You may not remove this text. 2007 by Tom Dunn. Website: DealFiles.com e-mail: tom@dealfiles.com
Beginning Real Estate Investing? Increase Your Profits With The Magic Of Leverage
When you invest your money in things like RRSP's or stocks and bonds your leverage is zero because you have used your own money and none of other people's money. When you buy a home with a mortgage you have used leverage, which is common in most all real estate investments. You own the down payment of coarse but the lending institution owns the res...
The Advantages And Disadvantages Of Investing In Real Estate
There are many advantages and disadvantages of investing in real estate one of the advantage of investing in real estate is, real estate is an investment that can give you income for the rest of your life. If you buy properties and rent the properties out it can give you life long income. Another advantage of investing in real estate is you can use...
Beginning Real Estate Investing
Never before have so many people, from all backgrounds and circumstances, investigated beginning real estate investing. If you have ever thought about buying and selling property for profit, or even if you're just curious, this article is for you.There are several different paths to beginning real estate investing, but I’m going to suggest on...
Beginning Real Estate Investing - Four Tools You Must Have
Another in a continuing series of articles on beginning real estate investing. In this installment, I will explain the basic tools that no serious real estate investor should be without. There arent many tools you must have, but there are a few.There are some things in life that are indispensable, and the same is true when you are beginning real e...
Private Money Real Estate Investing One Clause You Should Never Forget
When you use private money for real estate investing there are several clauses your lending agreements should never be without. One of those clauses is the Substitution of Collateral clause. Heres how it works.Wouldnt it be great to be able to just swap one property for another on your mortgages? Of course it would, and when you use private money f...
Why Use Private Money For Real Estate Investing - Reason 3
Its been said by wiser folks than me that one of the very best things about investing in real estate is the ability to leverage high-value properties with very little cash. If thats true, and I believe it is, then doesnt it seem reasonable that if you can borrow more money, you can leverage more property? Of course it does, and using private money ...
Real Estate Investing
Real estate investing is an excellent alternative to investing money in the stock market if handled correctly. More and more people have become involved in real estate investing over the years and with the information available on the internet, that trend has continued to grow. The problem is that investing in real estate is much more difficult and...