Friday, November 27, 2015

When Maximum Leverage = Negative Leverage

In a world of low interest rates and plenty of commercial mortgage options, how could we ever experience “NEGATIVE LEVERAGE?"

Surprisingly, it happens and when it does - the fall out becomes a cash flow problem and an investment property - which becomes best described as a “POOR INVESTMENT”.

Firstly, here’s how it occurs (mathematically). Consider the following illustration:

Property Purchase 1

I - Price - $100,000 (no mortgage) 
w/ Annual ROI on Cash Invested of 6% (Yields $6,000 /yr.)

II - Price - $100,000 (mortgage of $80,000 @ Int. Rate of 7%) w/ Annual ROI on Cash Invested -1.23% (Yields -$1385.40/yr).

In the above example, NEGATIVE LEVERAGE is created by the fact that the mortgage rate is above the overall return component as shown in ‘I’ (no mortgage). If for whatever reason, the mortgage interest rate exceeds the basic return component for the property, you will find yourself in a NEGATIVE LEVERAGE situation.

Market opportunities where maximum leverage is often promoted, may well lower your initial investment requirements, only to create cash flow problems once mortgaging costs are factored in. Best practice here - is investigate mortgage options available on any prospective investment and compare it back to the basic return component which the cash flow provides.

The concept of LEVERAGE is widely accepted strategy in the real estate industry – keep the focus on “POSITIVE LEVERAGE”!

How does your market area look as we close out 2015.? Has it been a good year to add to your portfolio, or to sell investment properties? 

Ready – Willing - & Able to be of service in Windsor-Essex - give us a call!

Mark Lalovich
Office: (519) 966-0444
Cell: (519) 259-5434

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