REAL ESTATE LEVERAGE EXPLAINED

March 5, 2011 by Dave · Leave a Comment

Most people think that if real estate goes up 5% then that is the return on investment – just like a stock. Not quite. If you invest $ 1000. in a stock and it goes up 5% then the return is 5%. However when buying real estate, you do not have to put the full $1000, up, you put 20% down or $200.00 and take out a mortgage of 80% , Now if real estate goes up 5% it has gained $50.00 in value just like the stock but the return on investment is actually 25%. ( 50/200=25%). Not so fast, you say, but you have to pay the mortgage. Yes and No. Yes you make a mortgage payment but you also receive rental income so in fact the tenant is really paying off your mortgage. Assuming the rental income pays all your expenses, you really make more than a 25% return on your investment of $200.00 . Your Mortgage balance has gone down 10.00 so if you add the increased equity to the appreciation you are really making a 30% return (50.00+10.00 / 200 = 30% . When is the last time you made 30% return on any of your other investments? One of our clients explained real estate this way: Where else can you buy something and only put 20% down, someone else puts up the other 80 % and someone else pays off the mortgage for you and at the end of 25 years you own a significantly appreciated , income producing asset. Now does everyone understand why real estate is such a great investment. It is not quick but it is steady and makes a wonderful retirement nest egg.

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