Real Estate :: Leverage

To the experienced real estate investor, the word Leverage usually means one of 2 things:

  1. The maximum mortgage amount you can put on a property and still receive positive cash flow. It is important to realize that by minimizing the use of your own investment capital, you can maximize your returns through the acquisition of more properties. By putting less money down on one property, you'll have more money available to put towards your next property. As long as each property generates a positive cash flow after all expenses, your investments can appreciate over time without you having to supplement them.
  2. Having a tenant pay off your mortgage for you. Here, the term leverage refers not only to the ability to own a property with as little of your own money as possible, but also having somebody else pay off the loan or mortgage for you. While its true you can usually borrow money to invest in a business or the stock market, how many places can you invest somebody else's money (the bank's) and have a third person (the tenant) actually pay off your loan for you

 

Did You Know?

During recent decades, Canadian businesses increasingly financed themselves by raising their level of debt with respect to assets, commonly referred to as leverage. Between 1961 and 1996, the share of Canadian firms' capital held in debt increased by nearly 50%.1 In the 1990s, the level of aggregate corporate leverage tended to fall slightly, but still remained high by historical standards.

Does this increase in leverage matter? Capital structure theory beginning with Modigliani and Miller (1958) argues that the choice of capital structure does not matter to the net value of the firm or the cost of available capital.

Divergences from this theorem, described by Donaldson (1963), Jensen and Meckling (1976), Myers (1977, 1984), Myers and Majluf (1984), and Fama and French (2002) emphasize the role of informational asymmetries and agency costs which differentiate the cost of external and internal finance, making capital structure choice important for the firm's value and for the cost of capital available to the firm. This has implications for the real side activity of the firm, including employment and investment in inventories.