4 Caveats to A Leverage Strategy

If applied on the right property investments and in the right market conditions, leverage is an excellent strategy. Check out this article from “DON CAMPBELL” a foremost Canadian authority on real estate investing. The numbers do not lie - if you pay particular attention to the investment illustration outlined.

But to guard against the ‘downside’, as you look to employ a LEVERAGE strategy, consider the following four “caveats”:

Source: Instphil

1. Cash Flow is KING – ensure the tenant/revenue base is stable and secure. This includes the covenant of the tenants, lease terms, current occupancy levels, and debt service coverage on current income/expenses.
2. Low Down Payment means HIGHER MONTHLY PAYMENTS – completing a deal with a low down payment, often becomes problematic if the monthly mortgage payment is beyond a comfortable level. If the market conditions deteriorate and vacancies rise, this problem often will only get worse and the monthly payment harder to meet.
3. Projecting for APPRECIATION – markets do not always go up, despite recent trends, and you must be realistic in assessing this variable, both with respect to your own market and the specific properties being targeted. In a stalled or declining market, properties which have stable cash flows thrive and are insulated from a negative market.
4. Maximum Leverage vs. POOR INVESTMENT – no money or low down payment deals on a poor investment property, typically leads to negative results. Do not let attractive leverage opportunities, compromise your ability to stay the course on targeting good property investments.

Leverage is a great strategy, but it requires sound discipline in its application.

Tells us about your use of leverage in your market. Again, we love to tell you about our own backyard here in Windsor-Essex, so feel to reach out to us!

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Mark Lalovich
mark@lalovichrealestate.com
Office: (519) 966-0444
Cell: (519) 259-5434

The World Of Leverage

No matter what market you are investing in across Canada, the principal of leverage (WHEN APPLIED TO THE RIGHT INVESTMENT PROPERTIES), has worked extremely well in recent years. Although there are many benefits, the primary ones remain –

• Can significantly enhance the ROI of the property
• Allows you to acquire additional properties & build a portfolio faster

Our definition for LEVERAGE remains the same – ‘the use of borrowed money to increase the return on an investment property’. It is considered a legitimate investment strategy, and one that is best suited for properties with both good cash flows and those having a good probability of future appreciation.

Source: Resi

A simple illustration highlights the concept in a growth market:

1. NO FINANCING – STRAIGHT CASH PURCHASE

Purchase Price $200,000 (all cash investment)
Market Growth Projection – 3% per year
After Year 2 - $212,000
ROI – 6% (on cash invested)

2. 70% FINANCING – 1ST MORTGAGE OF $140,000

Purchase Price $200,000
Cash Investment $60,000
After Year 2 - $212,000
ROI – 20% (on cash invested)

Again, this is an illustration which is based on strictly price appreciation. There is no analysis of the property’s monthly/annual cash flow, which would typically come first. If in fact the property was actually sold after year 2, the total ROI would be even more in favour of Scenario 2, and the % difference greater.

On the matter of building a portfolio of properties faster, you can see by allocating $60,000 by property, you should be able to acquire ‘3 properties’ by leveraging your cash investment. The key is to work this strategy on the RIGHT INVESTMENT PROPERTIES.

Does leverage still work in a flat market (no growth)? Or a declining market (negative growth)? Tell us your stories, we’d love to hear them - both positive and negative. Call us anytime regarding our home turf here in Windsor –Essex!

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Mark Lalovich
mark@lalovichrealestate.com
Office: (519) 966-0444
Cell: (519) 259-5434