Thursday, January 10, 2013

Rental Property Investing - Leverage

A few posts back, we touched on the concept of “Leverage” and now let’s expand the conversation. By definition, it’s simply using borrowed money to increase your return (aka profits) in an investment property. It is a legitimate investment strategy, but is best applied to ‘good cash flow’ properties, which would appear to have a probable likelihood of future appreciation.

Consider the following investment, as a simple illustration:

Property Purchase --  $200,000 (all cash investment)
            Recent/Projected  Market Growth – 5% per year
            After Year 2 -- $220,000
            ROI – 10% (on cash invested)

            Purchase Price   --  $200,000
            Cash Investment --  $60,000
            Recent/Projected Market Growth – 5% per year
            After Year 2   --  $220,000
            ROI – 33% (on cash invested)

This is a simplistic illustration and assumes the property is in a growth market,
which expects price appreciation – in this case 5% per year. It would not
be a realized gain, unless the property was infact sold after year 2.  But you can see based on the market assumptions which are made, the potential to increase your return goes up significantly in the second scenario.

In the case of a flat market (no growth), the return would be the same (0) - but you would have $140,000 to put towards other properties. For the record in a declining market, the negative return would be less in the first scenario - but you would also have more cash at risk ($200,000 vs. $60,000).

This gets the conversation started on Leverage, with more to follow when we consider the annual financial performance of the property.  Again, seek out experienced commercial realtors within your market to assist you in implementing a successful Leverage Strategy.

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