Leverage in Real Estate: Using Other People's Money To Invest
TL;DR - Leverage is a powerful tool that you can use to increase your investment’s ROI or buy more properties. Just make sure to use it safely. Start slowly at first, learn and grow, and then ramp it up over time!
You want to get into real estate investing. Really, you do.
But it takes so much money!
The down payments are large enough.
If you want to buy an investment property full-on?
Yeah, good luck.
The truth is that not many people have the liquid capital to fund real estate investing.
So instead, they use something called leverage.
You’ve probably heard of it before — just maybe not with real estate.
So buckle up…
You’re about to learn the art of using other people’s money to fund your investments.
Leverage in Real Estate: Using Other People's Money To Invest
What Is Leverage?
In real estate, leverage is using other people's money to finance your investment.
This could be in the form of a loan from a bank or private lender. Or, it could be through partners who invest with you in a property.
There are two main types of leverage: debt and equity.
With debt leverage, you take out a loan to finance the purchase of an investment property. The loan is secured by the property, which means that if you default on the loan, the lender can foreclose on the property.
With equity leverage, you bring in partners to invest in a property with you. These partners could be family and friends, or private investors. You own a percentage of the property, and they own a percentage.
Why Use Leverage?
There are two main reasons why people use leverage to invest in real estate:
To increase their return on investment (ROI)
To buy more properties
Let's say you're looking at two properties. Both are worth $100,000.
Property A is being bought completely in cash.
Property B is being bought with leverage, meaning that the buyer is taking out a loan for $80,000 and putting down $20,000 of their own money.
If both properties increase in value by 20%, then the investor who bought Property A will see a return on their investment (ROI) of 20%.
The investor who bought Property B will see an ROI of 100%.
The reason for this is that the investor who used leverage only had to put down $20,000 of their own money. So when the property increased in value by 20%, their investment just doubled.
Another reason people use leverage is to buy more properties.
Let's say you have $100,000 to invest in real estate. You could use that money as a 20% down payment on one property worth $500,000.
Or, you could put down a 20% down payment on five properties worth $100,000 each.
Using leverage, you can buy more properties and increase your chances of seeing a return on your investment.
Leverage Options
There are several methods to leverage capital. You can choose from:
Mortgage loans, such as:
Fixed-rate mortgage loans
Adjustable-rate mortgage loans
Home equity loans (HELOC)
Private loans
From people you have a connection with
Business partners, family, friends
And more!
You have plenty of options to choose from if you want to leverage.
But remember to leverage safely.
How To Use Leverage Safely
Now that you know what leverage is and why people use it, let's talk about how to use it safely.
There are two metrics you need to consider when using leverage: your loan-to-value (LTV) ratio and your debt-to-income (DTI) ratio.
Your LTV ratio is the amount of money you're borrowing compared to the value of the property. For example, if you're taking out a loan for $80,000 on a property worth $100,000, your LTV ratio is 80%.
Your DTI ratio is the amount of debt you have compared to your income. For example, if you make $50,000 a year and you have $25,000 in debt, your DTI ratio is 50%.
Ideally, you want your LTV ratio to be below 80% and your DTI ratio to be below 50%.
This will help you avoid defaulting on your loan and ensure that you can afford your monthly payments.
Also, make sure that you’re being very conservative with your cash flow estimate.
Calculate for the lowest possible rent you can get and the highest possible expenses you’ll be paying.
Doing this guarantees that you’ll be making a good investment.
And don’t leverage too much to start out!
Begin with a 20% down payment. Once you’ve leveraged capital a few times and understand how to do it, then you can go after fancy strategies.
Right now you’re in the beginner stage, which is awesome!
Take this time to learn and grow as a real estate investor.
Build up your capital so that you have money if you make any mistakes.
Start easy, then ramp it up!
Final Thoughts
Leverage is a powerful tool that can help you increase your return on investment and buy more properties.
But it's important to use leverage safely.
Keep your LTV and DTI ratios in check. Be conservative with cash flow calculations. Don’t overleverage to start out. Build up capital to bail you out of mistakes. Learn, grow, and take your time!
With leverage, you can build your real estate portfolio faster than you’ve ever imagined. Just take baby steps, then ramp it up!
As always…
Happy Hunting!
How We Can Help You
Does investing in real estate sound intriguing to you? Would you like to learn more? We’d love to be of value!
At Undoor, we pride ourselves on teaching new and experienced investors how to maximize their gains with minimal stress. Our goal is to help you fall in love with real estate and real estate investing. What we’re most passionate about is maximizing investment gains for people like you.
Do you want to get key insights and advice that’ll help you get ahead of the game? Don’t hesitate to contact us for any and all real estate wants or needs.
