08/24/2021
Real Estate Leverage & Appreciation Explained
New investors may be asking the question, “What do you mean by leverage?” Simply put, leverage is a term used in real estate (or any type of investing) to describe the effect of borrowing money to purchase an asset (i.e. property). It’s the idea that you can buy a $100,000 property by investing only $20,000 of your own money. You are essentially “leveraging” somebody else’s (i.e. the bank’s) capital to buy the property.
When you combine the ability to use leverage in real estate with appreciation, you have an unbelievable money making combination. Let me illustrate with the example below (For the sake of this example, I’m going to leave out any cash flow calculation):
Let’s say you are able to buy an investment property for $100,000. Over the course of 5 years, the property increases at a rate of about 6% per year so that in year 5, the value of the property is worth approximately $134,000. Most people would nod their head and say 6% per year on an investment is fairly respectable.
However, if you are able to buy this property with leverage, your true return actually looks a lot better than 6% annually. Let’s say in this example you put 20% down or $20,000 to buy the property. Your $20,000 investment actually made an additional $34,000 (134K-100K) over the course of just 5 years. That’s approximately a 22% annual return for each of those 5 years! Why? Because while you only had $20,000 invested, you had the benefit of the entire asset increasing in value, not just the dollars you had invested.
(And again, this example doesn’t even include the returns generated by renting the property!)
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