Real Estate Leverage - the Top 4 Don'ts

[Jennifer Griner]

Real Estate leverage is the use of borrowed money to increase your profits in an investment. Building wealth via real estate requires the use of leverage.

Let's assume you have $100,000 to invest and you purchase a small income property for $100,000. Let's assume that income properties have been appreciating at an average of 7% per year. At the end of the first year of operation, your property is worth $107,000. At the end of year two, it is worth $114,490. Now let's assume that you put your $100,000 down on a $500,000 income property. At the end of the first year, it is worth $535,000. At the end of the second year, it is worth $572,450. By using leverage or borrowed money to purchase a larger income property, you have increased your profit by $57,960 in just two years.

To get the full advantage of leverage, put the minimum down on a good property which has a strong likelihood of appreciating in value. Stay away from questionable properties in run down areas.When you purchase a piece of real estate, you make use of leverage when you borrow money towards the purchase price.

Avoid these high risk behaviors and you have a far better chance of realizing success in using real estate leverage.

1. Don't Count on High Levels of Appreciation
Many a real estate investor has gotten into financial trouble by looking at past history, even if recent, and relying on the future to produce the same results.Even if property has been appreciating at a 12% to 20% rate for a number of years, counting on that rate to continue is an extremely risky proposition. It can cause you to overpay for properties, expecting to realize the difference at sale from appreciation. If it doesn't happen, you're holding a loss or worse.

2. Don't End up With Too High a Payment
It can seem like a great investment to control a property with a very small down payment. You're looking at the numbers and seeing a really high return on investment due to your low cash outlay.The problem is the higher payments that come with higher leverage. Should the market soften or your properties experience higher-than-expected vacancy or credit losses, you could find yourself unable to maintain those higher mortgage payments that seemed fine at the beginning.

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