Leverage: Good or Bad?

Leverage is one of the most powerful tools we as humans can use.

Think about it.

With the right amount of leverage a person can move a large boulder weighing hundreds and even thousands of pounds by themselves.

When it comes to business and finance and most specifically real estate, leverage is the way individuals can create massive wealth.

A basic definition for leverage: use borrowed capital for (an investment), expecting the profits made to be greater than the interest payable.

We have talked about all the ways real estate makes individuals money. Check out this post here.

Income producing real estate is one of the very few businesses that you can invest as low as 3% in and own 100% of the asset. Yes. You can own 100% of something that you only have a 3% commitment/investment in to.

They key to that investment is whether or not that the investment makes you money. Owning a home and living there paying your monthly mortgage is not an investment.

Owning an income producing piece of real estate that pays you more than it costs to own is investing and leverage allows you to do this.

Think about this. If you were to go to your bank right now. And let’s say that bank is a publicly traded bank and you can actually buy stock within that bank. That bank will not loan you money to purchase their own stock. They would never do this. But they will give you a loan on an income producing piece of real estate.

Some of the detractors out there are saying:

Is too much leverage a bad thing?

And I would say yes. But if you are getting a return on the money you borrowed greater than the money its costs you to borrow it. Then you should be in a winning position.

Early in my investment career I took the conservative approach. I paid off five single family homes. But then I said, I must increase my portfolio and the quickest way to do this is by leveraging the wealth and assets I have already accumulated. I doubled my net worth when I made this decision and this is how.

There is a number in business that is looked at called Return on Equity (ROE): ROE is a gauge of a corporation’s profitability and how efficiently it generates those profits. The higher the ROE, the better a company is at converting its equity financing into profits.

When I took one of my houses that I had paid off. It was worth $100,000. Each year it generated about $12,000 in income. And profits (net income) of about $7,500.

So $7,500/$100,000 = 7.5% return on that $100,000.

Let’s say I take that house and I tap in to the equity. I access $50,000 of that equity and I invest it in a $250,000 income producing real estate. That generates $25K a year. and 15K a year in net income.

So now I still have the $7500 of net income from the house I tapped for the equity. And an additional $15K of net income from the new $250,000 asset.

$7,500 + 15K = $22,500. Now I am getting 22.5% return on that $100k versus a 7.5% return.

This is the power of income producing real estate and leverage.

To your success and your future.

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