One of the key advantages associated with real estate investments is the ability to leverage at least part of your up-front investment amount with a loan. For example, when you buy $50,000 worth of stocks, you will enjoy a return based on that $50,000 investment. On the other hand, if you use your $50,000 as a down payment with a 75 percent loan-to-value real estate loan, you are buying a $200,000 investment. Therefore, with your $50,000 investment, you are taking advantage of growth on $200,000. In addition, you can also deduct taxes, interest, depreciation and other expenses on a real estate investment, and this is not possible with other types of investments. Real estate loans can be used strategically to mitigate risk while maximizing your return.
Determining a Reasonable Leverage Amount
With an investment loan on a tier 1 commercial property, such as a multifamily property, you may be hard-pressed to find a loan-to-value higher than 75 to 80 percent. On other tiers, such as those for office buildings, self-storage buildings and more, the loan-to-value offered by most lenders declines. If your financing is on the higher end of the loan-to-value spectrum, you are being aggressive with your leverage. If your financing is on the lower end of the loan-to-value spectrum, you are being conservative. A savvy investor will analyze his or her risk tolerance level and financial situation as well as market conditions to determine what a reasonable leverage amount is.
Exploring the Benefits of Leveraging Your Investment
Real estate loans are used to leverage your cash position in an investment. This means that you can maximize leverage with a high loan-to-value loan in order to reduce your personal financial exposure. This can mitigate your risk, and it can also enable you to diversify your portfolio across multiple investments to further reduce risk of financial loss. However, just as there are positive aspects associated with leveraging your investment, there are also downsides.
Understanding the Dangers of Over-Leveraging Your Investment
While you may be focused on keeping your up-front down payment amount as low as possible, keep in mind that there are situations when having more skin in the game is advantageous. For example, in the 2008 real estate crisis, property values plummeted sharply, and many investors who had high loan-to-value loans found themselves upside down with their financing. Even those who were at a breakeven point with regards to the loan would have lost money through real estate commissions and other related fees if they sold. Nobody wants to be forced to hang onto an investment longer than planned because of this type of situation or faced with the possibility of losing a substantial amount of money on their investment, and this possible outcome can easily be avoided by making a larger down payment.
Remember that leveraging can also be used strategically when refinancing investments. By refinancing, you can take equity out of the property to reinvest in other areas, but again, you should avoid over-leveraging when refinancing or buying properties.