Investing in Real Estate Tip - Leverage

I believe that people have an innate desire to own something solid and substantial that they can actually touch.[.1] Real estate is great for this type of investor.[.2] It is one of a small group of investments where an investor has the potential to impact the profitability through good management, hard work and smart negotiating. As you look at all of the types of real estate available for investment, I believe that Multi-Tenant investment real estate deserves a special look. It has the unique ability of allowing you to leverage a group of tenants with a single transaction. A single apartment complex may contain from as few as 4 units to several hundred apartments. Each one can be purchased with a single contract and is treated as a single transaction.

Leverage, as a term used in real estate investment or in fact any investment, allows you to multiply the return on the money that you have invested to get even greater returns. "Give me a lever and a place to put it, and I can move the world". [.3] A great quote! This is truly the power of using leverage in real estate. You can invest a small amount of capital (say 20% of the total purchase price) and see huge effective returns on that capital on an annual basis. This is what we are talking about when we talk about leverage in a real estate transaction.[see my video below!]

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[.1] There is plenty of competition, be ahead of others by having a good relationship with your local bank and an experienced realtor.

[.2] There are no "no risk" investments, even if you can touch this. Make sure you've done your homework.
[.3]Archimedes of Syracuse

Leveraging Cash in Real Estate Transactions

Leverage is where you buy more property seeking a multiple return on your investment by purchasing more property.

You can't count on the bank to protect you when leveraging cash for a real estate, you must make sure you can pay your debt service (especially if property struggles).

Main question: Can you sustain the mortgage? if not you're putting your equity at risk.

How far can you leverage before you're in trouble:
1) However most banks want to see 10%-20% as a downpayment to protect both you as the investor and them.
2) A good leverage ratio 5 to 1 (if you have a $1MM, you can look into purchasing a property for $5MM)

Watch this video for more information.


Take a moment to offer your comments or questions below.

Cap Rate: What does it really represent?

Hello. I wanted to write a short description on how "Cap Rate" applies to commercial, investment property. I like the cap rate number because it is easily understandable since people are used to paying interest on borrowed money and receiving interest on deposits. Cap rate strives to answer a simple question.

What is the effective interest rate that this investment yields?

I like to use the analogy of deposting money into a bank account. If you were to deposit an amount of money equal to the purchase price, the cap rate would equal the interest rate that the bank is willing to pay on your deposit.

For Example:

If you are purchasing a commercial apartment complex for one million dollars ($1,000,000.) and the listing agent represents that it has a 10% cap rate, then the property should net profit one hundred thousand dollars ($100,000.) annually. Ten percent of one million is one hundred thousand.

Simple, right... Well here is where the problems definitely start to come out in the details.

First: The cap rate is calculated on the net income of the property (IE gross rent, less vacancies, less utilities, property taxes, insurance, maintenance, advertising, management,... etc.). It does not include any debt service. This is as it should be, since a 10% cap rate property should return the same for an all cash buyer as it does for a 90% financed buyer. You do not want to confuse cap rate with cash flow.

Second: The expenses that the current owner is having may be lower or higher than you would experience. If you purchase this property and your expenses increase by sixty thousand dollars ($60,000) annually, then your cap rate is reduced to four percent (4%) and your annual profit would decrease to forty thousand dollars ($40,000.). You may have been better off keeping your money in the bank.

Third: Income is primarily generated from rent collected. If you have a significant increase in vacancies due to a transfer of ownership your cap rate is affected as well. You definately can maximize your profit by keeping a sharp eye on the occupancy. Most of the money that you end up keeping is from the last 15% of apartments and your ability to keep them rented.

Fourth: Your debt service is paid out of the proceeds after all expenses are taken out. You can easily end up with a property that makes money on paper but that you have to come up with money every month to pay the bills and the mortgage. This is what I affectionately call an "Alligator property" because every month it is taking a bite out of your available cash. Ouch.

There are many aspects to commercial investment property that can be a double edged sword to the owner. Each item that affects your "cap rate" can also be used to improve it. The key is to understand the terms that are presented in the property listing and knowing how that applies to your specific investment needs.