Real estate investing gets more interesting, gratifying, and possibly more profitable when you use other people’s money. That’s why learning more about investment property financing, and real estate leverage can come in handy when investing in the South Florida real estate market.
What is Leverage in Real Estate?
Leverage in real estate refers to how much capital you can obtain to fund an investment property compared to the property’s value. When you hear the term “leverage,” it’s because you’re leveraging other people’s money to maximize your ability to purchase more investment properties with less of your own money. In general, the higher your leverage, the greater your prospective Return of Investment (ROI).
When both rental and property values are rising, leveraged real estate investing is ideal. As rents and property value increase, their monthly home mortgage loan for rental property remains steady, while the property develops generates larger earnings. Over the last couple of years, rents and property values in South Florida are appreciating considerably. Creating a perfect environment for the investor who understands how to acquire real estate investments with leveraged money.
Generally speaking, the most common way to leverage your investment in real estate is with your own money, crowdfunding, or through a mortgage loan.
The Very Best Conditions for Leveraging Real Estate
Using leverage money in real estate investing is best when property values and rents are increasing. If values and rents are slow or decreasing, the advantages of using leveraged money can be outweighed quickly, with loan payments increasing your operating expense for the property.
For leveraged investors, there are two important practices to achieve ideal success. Develop a smart investment strategy and perform comprehensive due diligence for every prospective property investment.
Leveraging Real Estate Investments with Mortgages
There are various methods to obtain financing to purchase an investment property. The most typical kind of financing includes conventional fixed-rate loans or adjustable-rate loans.
A fixed-rate loan is a mortgage loan that has the exact same rate for the life of the loan, which is typically 15 or 30 years. The interest rate never changes, no matter the state of the real estate market. Primarily. This is why you should obtain a 30-year home mortgage compared with a 15-year home mortgage. This is especially true since mortgage rates are substantially lower amid the Coronavirus pandemic.
Specifically, smaller mortgage payments, coupled with a predictable mortgage interest rate and the ability to refinance the mortgage in the future, are just a few of the benefits that make a fixed-rate loan beneficial. One potential downside is that fixed-rate loans tend to have a slightly greater interest rate than the adjustable-rate mortgages, at least initially. This slightly higher rate is mostly the lender’s effort to protect itself should there be any changes in the market since your interest rate can’t change.
Adjustable-Rate Mortgage Loans
An adjustable-rate mortgage (ARM) or loan is where the rate of interest is adjusted periodically based upon real estate market conditions. In general, there’s always a chance that your interest rate may go down. However, this generally only happens when the real estate market slows down or crashes.
Fortunately, preliminary interest rates are generally lower on an ARM compared with a fixed-rate loan. Typically, an adjustable-rate loan might be a good alternative if you can’t find a lender who will give you a fixed-rate loan for less than 9 percent. After a couple of years of an ARM, you might have the ability to refinance your loan and get a better interest rate on a fixed-rate home mortgage.
ARMs are also a great alternative to fixed-rate mortgages if your investment strategy is to sell the property during the initial rate period, which could be for a 2, 3, and a 5-year term.
Advantages of Leveraging Real Estate
When you leverage real estate investments, you can buy more or bigger investments than you would by paying all-cash. Instead of acquiring one investment property for $500,000, you could leverage 5 investment properties by paying a down payment of $100,000 for each.
Additionally, when you finance rental properties with an investment mortgage loan, you are most likely to get more return on the money you’ve invested compared with purchasing it with all cash.
Risk of Leveraging Real Estate
Before you leverage real estate, you must also understand that in some cases., the strategy can work against you. For you to take advantage of real estate investments successfully, property values and rental rates should be increasing in your local market.
If not, you run the risk that your rental income may not be able to cover the mortgage payments and other operational expenses. The impacts of unfavorable leverage are even higher if multiple units are involved. One bad loan might lead to the failure of an entire portfolio.
Can you Have too Much Leverage?
There might be times when real estate values decrease the number of years in a row. If this happens, you will more than likely be “underwater” on your home mortgage, especially if you invested with only 0% or 5% down.
If lease prices stay steady, you may be able to ride out the storm. However, if the real estate market crashes, market rental rates may go down as well. This will significantly decrease your profit margin and cause additional down spirals of the housing market.
The goal is to find your personal balance between leverage and debt tolerance. For one investor, the tolerance might be 5 home mortgages, whereas another investor might be comfortable at 10 mortgages tops. Overall, you must determine what works for you and your financial situation.
Maximize Leveraged Real Estate
Let’s say you’re presented with a good real estate investment opportunity in South Florida, but you don’t have the capital to purchase the property outright. Additionally, you don’t really have the money saved for a downpayment.
In the event you own a property or several properties that are paid off or have substantial equity, you can always refinance one or more of your properties, use that cash for the down payment (typically 20-30%) and closing expenses on a new property, and finance remaining 70-80% to purchase the investment property.
With that being said, there are few other financial investments that you can leverage like you can with real estate. For example, you can’t purchase $100,000 worth of stock in Amazon, with only a few hundred dollars, and agree to pay the rest of the cost monthly for the next 30 years at today’s market price. This is why leverage loans for your real estate investment is typically a winning strategy.