Making the decision to enter into the real estate investing market can raise a number of questions. You’re likely hearing all sorts of confusing terms like ‘OPM’, ‘leverage’ and ‘ROI’. While there is a bit of a learning curve to some of these phrases and steps in the process, it doesn’t have to be confusing. As real estate professionals we are always here to support you in stepping into this rewarding, potentially lucrative and fun industry.
What does leverage in real estate investing mean?
Broken down into simpler words, having leverage in real estate investing just refers to how much money you borrow to finance a property compared to the value of the property. The word ‘leverage’ is used because you are leveraging other people’s money (OPM- usually a bank’s) to maximize your opportunities for investment purchasing.
Factors to consider when creating leverage in real estate
You own 100% of the appreciated value
When it’s time to purchase a property, whether as an investment or personal use, you have a couple of options.
Option 1 is to take your payment (let’s say $50,000) and use it to buy a $50,000 property. Second option is to take that $50,000 and use it as a down payment, securing a loan or mortgage for the remainder of a $200,000 property.
- In the first example you are creating no leverage. If the value of your property increases by 10% in a given year, you would profit $5000.
- In the second example, if the value of your property also increases by 10%, you would gain $20,000.
When looking at the numbers it’s pretty easy to see why creating leverage using other people’s money can help you increase your overall ROI (return of investment). The more leverage you use, the higher your potential gain will be as your properties appreciate.
Create a reserve fund
A smart real estate investor knows that the market can change quickly, and it’s essential to have a reserve fund to cover any possible cashflow concerns and emergency payments. You always want to hope for the best, but you can only win by also planning for the worst. If something happens and your rental unit is empty for a couple months, you need to be able to cover the costs so you don’t default on your mortgage payments.
Do your research on the property
Jumping at the first property that you can afford isn’t the way to go about making a smart investment. Be sure to do your research on the neighbourhood, the potential costs, and who your renter might be. You want to choose a property that will be suitable for your ideal renter so that finding someone to live in it doesn’t prove to be a difficult task. For example, if the neighbourhood is mostly families with young kids, you want to make sure the home has multiple bedrooms, a fenced backyard and maybe even a bathtub so that when it comes time to show, the renters that are most drawn to the area aren’t feeling disappointed in the amenities you can offer.
Negotiate a loan repayment you can afford
It’s possible that at some point your unit might sit empty for a few months. You need to choose a repayment schedule that you can handle, even if you don’t have the cash flow coming in to cover it every month.
Do your due diligence
This is an essential step in the investment property buying process. The last thing you want to be faced with after the sale is costly repairs because the home wasn’t inspected thoroughly. Having to put $25,000 of repairs into a $100,000 purchase will throw your whole investment budget out the window. If you do have to make some repairs or upgrades, restrain yourself from going for top of the line products (and prices). Your investment property should match the quality of the rest of the neighbourhood, but it doesn’t have to stand way above it.
Give strong consideration to a NEW property
Buying a pre-construction condo rather than a home already on the market might be the best way to create leverage with your investment. Pre-construction homes often require a minimal down payment which could increase your leverage from the beginning. The unit will also likely appreciate before you even take possession, so you will be profiting almost immediately. And you won’t have to deal with any unexpected maintenance or repair costs out of the gate!
Smart Leverage: Borrowing to Accelerate Real Estate Wealth Building
When it comes to investing in real estate, you don’t have to be bound by the cash you have in your bank account. Learning how to make use of OPM to secure loans or mortgages will help you to grow your portfolio and ultimately increase the possible returns from your investment properties. As you progress through the world of real estate investing, you’ll quickly notice that the higher your leverage, the higher your profit margin can be.