It’s a fact that many new real estate investors purchase properties solely with cash. Commonly, this is because they have the money available and don’t want to deal with banks or other lenders. But, this is a sign that their investment kung fu is weak. They think that getting a loan to purchase real estate comes with extra costs and restrictions, and while they’re kind of right, that doesn’t mean that using a loan is necessarily a bad thing. There are costs involved with using loans for your real estate investments, but they are often greatly outweighed by other benefits – specifically, that of utilizing leverage.
What Is Leverage
In short, leverage is one of the biggest advantages of investing in real estate. With many other types of opportunities, investors are required to have all of the funds needed up front. If you wanted to purchase $50,000 of stock in a company, you’d need $50,000 in cash. To buy precious metals or invest in a private business, the same rules apply.
When it comes to real estate however, things are different.
Real estate offers leverage through the use of lending tools like mortgages and hard money loans. These financial options allow investors to use other people’s money to maximize their returns. Want to purchase a $100,000 home? In most cases you won’t need more than $20,000, and often you’ll be required to put down less than that.
Expand Your Reach
This allows real estate investors to greatly expand their reach. Higher-dollar properties that would be well out of the price range of most people are suddenly an option, and so are the high-dollar returns that come along with them.
Without leverage, a real estate investor with $50,000 in cash would be hard-pressed to find a viable investment opportunity. With leverage, this amount could easily finance properties worth up to $250,000, greatly expanding the number of potential options out there.
Multiply Your Returns
By reducing the stake that you have in any given deal, you’re also multiplying your returns.
Say you’re considering purchasing a property that will cost you $100,000 to acquire and fix up, and you plan to sell it for a profit of 20%. After all of your expenses and time put in, the home will eventually net you $20,000 – not a bad return for a few months of work.
Now what if you were using leverage? With leverage, you could use just $40,000 of your own money and make an investment of $200,000. If this generates the same 20% return, you’re looking at walking away from the sale with $240,000. After paying back the loan and taking out your initial investment, you are profiting $40,000 with no more work than the first deal using all of your own capital. This isn’t just an extra $20,000 – it’s turning a 20% return on your invested funds into a 100% gain.
Enjoy Tax Deductions
Real estate is full of tax deductions. Things like insurance costs, professional fees and property taxes can be written-off by investors. While most of these benefits are available to all investors, items like property depreciation caters more to people adopting the buy and hold strategy. For short-term, fix and flip investors though, using leverage offers its own tax benefits.
With real estate transactions, the interest paid on loans can be deducted when calculating your tax obligation. For traditional loans the savings may not be that great, but it can be significant on hard money loans where rates can run up to 14%. These loans are hugely popular among investors because of how well they work for fix and flip transactions, and this tax deduction is frequently considered the icing on the cake.
Leverage is one of the best ways to grow your wealth in real estate. While only using your own capital to fund your deals can still be a successful strategy, it can also severely limit your long-term earnings. Using financial tools like hard money loans allow you to expand your investment reach, increase your returns and provide money-saving benefits that are valuable to both new and seasoned investors.