Palm Beach Signature Properties

Financial leverage is a term associated with financing that refers to the use of borrowed funds to acquire investment property. When compared to the value of the property, the amount of leverage increases as the amount of borrowed funds increases, and conversely, decreases when the amount of borrowed funds decreases.

For example, a real estate investor who borrows $80,000 to acquire a rental property valued at $100,000 would be getting a higher financial leverage than an investor who borrowed a lesser amount (say only $70,000) to purchase a rental property valued at $100,000.

Of course higher leverage isn’t necessarily better for the investor than lower leverage, and vice versa. Because leverage has a direct impact on the investor’s yield, the investor must consider how the cost of borrowed funds (i.e., the interest rate) differs from the rate of return on the property that would occur without financing.

In other words, depending on whether the investor might expect to receive a higher or lesser yield when borrowing funds to purchase an investment property compared to paying all cash, the investor is confronted with three types of leverage that could occur during the acquisition of investment real estate.

1) Positive leverage

Positive leverage occurs when borrowed funds are invested at a rate of return that is higher than the cost of these funds to the equity investor. In other words, positive leverage is simply putting money to work to earn more than the money costs to borrow.

The result of positive leverage is an increased yield to the equity investor over the amount that would have occurred without borrowing. The investor benefits both from the investment’s yield on equity and from the difference between the cost of funds and the earnings on those borrowed funds for each dollar borrowed. Therefore, in this case, an investor can be making money on every dollar borrowed.

2) Neutral leverage

Neutral leverage refers to an investment situation where the cost of funds to the investor is exactly equal to the yield of the investment into which they are invested. In this situation, the borrowed funds have no effect on the yield to the equity investor, nor does it change with the amount borrowed for investment.

3) Negative leverage

Negative leverage occurs when borrowed funds are invested at a rate of return that is lower than the cost of those funds to the investor. The result of negative leverage is a decreased yield to the investor over the amount that would have occurred without borrowing. Therefore, in this case, with negative leverage, the investor is losing money (return) on each dollar borrowed.

The housing market has its ups and downs. Occasionally, the market sees a decline, while other times it is booming. No matter what, individuals have invested in real estate and have achieved high returns. Nevertheless, there are two reasons why investors invest. The first is to buy a property in disrepair (flipping property) and the second is to buy the property to rent it out.

Flipping property

There are many people who like to find properties in disrepair, fix them up, and then sell them for more money than they have invested in them. Real estate investors easily make tens of thousands of dollars on a single transaction. They can then take the money they earned and put it toward another property. The cycle goes on and on until the real estate investor has created their own real estate empire.

It is important, however, that the property after it has been fixed up is not overly priced or potential buyers will not look at the property. You want to sell the property as soon as possible. It is ideal to sell it before the first mortgage payment is made so that the highest profit can be made after paying off the mortgage.

Investing in property as rentals

When investing in a property to use it as a rental, a lot of money can be acquired over a long period of time. This is a way to create a steady income. You do, however, still need to make sure the property is in good condition. You don’t have to spruce it up like you would a property you would flip, but it has to be livable. You want to make it as nice as you can because that can determine how much rent you charge.

There are many investors who rent so many properties that they do not have to have a day job. The rent they receive from their properties takes care of their income each month.

Financing

There are two ways you can invest in property. You can use funds that you already have or you can finance through the bank. If you must get a mortgage, you can obtain one at a fixed rate. The idea, though, is for you to pay the mortgage off as soon as possible so that you can enjoy your profits.

All-in-all, there are many benefits to investing despite how you invest. The biggest advantage is the income that you can achieve through investing.

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