Leverage in real estate

By your real estate dude

Ever since one of my grade school teachers taught the class about the power of the lever, I have been fascinated by the basic physics of leverage. As a matter of fact, I found leverage to be quite useful as a young man while working as a construction laborer. It took me no time at all to realize it was a lot easier using leverage when shoveling dirt than it was muscling through it and straining my back. But it wasn’t until I began my carrier in real estate that the idea of leverage took on an almost miraculous meaning.

The term “leverage” as it is used in investing, is a fancy way of describing the use of other people’s money to purchase investments rather than using your own. If I take out a loan in order to purchase a rental property, I am using the bank’s money rather than my own. I am using “leverage”. The use of leverage is very common in real estate. If you own a home, you probably used leverage when you bought it. However, it is not quite so common in other types of investments.

At one time in my life, I tried my hand at the stock market. I took a stab at various stocks, traded here and there and even made a little money on an IPO. Like many of my peers at the time, my eyes were glued to the pulsating values of my meager holdings as I tried, in vain I might add, to turn my little sow’s ear of a financial picture into the proverbial silk purse. The problem was I didn’t have enough capital to start with. If I wanted to purchase $100,000 worth of stocks, I had to cough up $100,000. I didn’t have that kind of money, so my gains in the stock market were small at best and I soon lost interest.

It was about that time that my wife and I purchased our first rental property. My grandfather had been a very successful real estate investor and I felt that perhaps I might be able to recreate his success. The market seemed to be on an upward track, so we took the leap and bought the property in San Diego for the sum of $135,000. We got it rented the first month and crossed our fingers. Two years later, we sold the property for $185,000 to the tenant. After all was said and done and the costs of the sale were subtracted, we had made about $45,000. Taking our net gain of $45,000 into account, our $135,000 property had appreciated by about 33%. That’s a pretty good return in itself, but it doesn’t include the magic of leverage.

You may remember that in order to purchase $100,000 worth of stock, I would have to come up with $100,000. By contrast, using the magic of leverage we purchased $135,000 worth of real estate with an initial investment of only $27,000. We were able to use “leverage” in order to take our light investment of $27,000 and do the heavy lifting of buying an investment worth much more. Just like shoveling dirt as a young man, I discovered that investing was a lot easier using leverage than it was trying to muscle my way through it using my own limited funds. Leverage also had the almost magical ability to increase the amount of money that we made on any given investment. For example: we spent $27,000 and in two years time made an additional $45,000. That was a return on our investment of 166%!

So, what’s my point? If you have not considered the advantages of using leverage in your investment plans, you may wish to do so. Real estate offers a tremendous opportunity in this regard and may well be the investment vehicle you’ve been looking for.