Leverage in Real Estate investing is the use of borrowed money to increase your profits in an investment. Just a quick recap before I get into the caveats that you need to know to keep your investment sound. Remember I said that if you had $100,000 to invest and you purchased a small income property for $100,000. which had an appreciation at an average of 7% per year. At the end of the first year of operation, your property would be worth $107,000. That's a better return than a savings account, but if you had leveraged your investment by putting your $100,000 down on a $500,000 income property, at the end of the first year, it would be worth $535,000. So which is the better investment? The one that returns $7,000 or $35,000? Using leverage in your real estate investments can have a big effect on your financial statement.
Rule One--Put the minimum down on a good property, find one which has a strong likelihood of appreciating in value. Stay away from questionable properties in run down areas. If you use leverage to your advantage, it will make you wealthy.
Rule One A—Negotiate. You make money in real estate when you buy not when you sell. I've written this before, but it's worth saying again. You can't sell a property for more than it's worth, but you can buy one for less than it's worth. Always always remember you make your money when you buy.
Rule Two—Positive cash flow is everything. Properties must produce positive cash flow each year and over time should grow in value. If you over-leverage (take out too large a loan) your properties, you risk losing them. Remember, properties are like race horses, they can make you a lot of money but they require care and feeding and come with expenses. Taking out too big of a loan on your property means your monthly expenses may be more than the property can support. We live in the “now” not in the future. The key is a positive cash flow now. The second key is the resale value—but that’s in the future.
Rule Three—Focus on your returns. Investment real estate is valued (when it comes time to borrow against it or to resell) by the income that a property generates after subtracting out expenses. So, if you can raise the income or lower the expenses, or both you will make more money now AND raise the future value of the property.
Depending on the property, this management technique can increase the value of your investment by double digit multiples. Small changes to the performance of the property over time can make you huge amounts of money.
Rule Four—More is better. Just as multiple properties are better than one property, multiple tenants are better than one tenant. Unless you own single use building like a gas station, multiple tenants allow you get past bad months so your vacancy rate can be kept low. Nobody wants to own a huge vacant building. So there is wisdom in owning an multi-units like an apartment complex, an office building, or retail center. Ideally you will always have some tenants, your expenses are likely to increase a bit over time but you can maximize your return by making small cost of living or inflationary adjustments across multiple tenants. A small increases in rent, when applied across multiple tenants, can add up to big results.
If you own a 10 unit apartment house and raise each rent $25 per month, you actually create $3,000 annually in extra income. By making small adjustments across multiple tenants it can increase your investment dramatically.
Rule Five—You can get rich slowly. But forget trying to get rich quick. Investing is not for the faint of heart nor for the impatient. Being a landlord comes with tenants—and they're not all nice. Investing comes with bills, and you will do yourself a favor to pay them on time. And speaking about time, investing and managing real estate takes time. You will find yourself investing weekends in fix-ups and repairs, and more. But in the end, it must be worth your efforts.
Rule Six—Save your emotions for your spouse. If a property is not producing, if you can't keep tenants, if you have bought a property you can't manage: sell it. Don't keep a property just because you got a great buy or one day it might start to generate a positive cash flow. If it's time to get out of the real estate investment business, come to grips with that before your investments are no longer being managed properly. When it's no fun anymore, get out.
Rule Seven-It's OK to let others do it for you. There are many ways to profit from real estate investments without the hands-on daily management issues. But just one is the FTSE NAREIT Mortgage REITs Index Fund (REM). This ETF follows an index that measures the performance of the residential and commercial real estate, mortgage finance, and savings associations sectors of the U.S. equity market, allowing investors to get exposure to both the front and back end of real estate. With a portfolio of 30 mostly medium sized firms, and with a YTD return of 26.06%, REM also boasts a handsome annual dividend yield of 11.88%
Dane Hahn is a real estate professional serving Sarasota and Charlotte Counties. Reach him at dane.hahn@gamil.com or by phone at 941-681-0312. See him on the web at www.danesellsflorida.com
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