Investing in real estate can be an excellent way for investors to diversify their portfolios and attain long-term wealth. After all, there are several benefits for rental property owners that make investments worth the time and effort. However, it’s not always an easy process. You need a large down payment, you must do adequate research, and it can often take a while for the buying process to close. Luckily, financial strategies like real estate leverage can help. But, what is real estate leverage, and how can it help investors? Keep reading to find out.
What is Real Estate Leverage?
Leverage can help investors increase real estate net worth. But, what is real estate leverage, and how does it work? Investors need to consider every option when it comes to financing a rental property.
Real estate leverage is borrowed capital or other financial instruments used to increase the potential return of a real estate investment. The easiest way to leverage a property is by using a mortgage or with your earnings when it comes to real estate. However, it’s not always that easy.
Leverage techniques are used by people and businesses worldwide to increase the potential for returns. However, while the potential for good returns is likely, it’s not guaranteed. For example, investors can experience more losses than gains if home prices decline.
There are different ways for investors to use leverage to buy real estate. Here are a few different types of real estate leverage to look into if you’re looking for a financing solution for your investment.
Types of Real Estate Leverage
When it comes to the different types of real estate leverage, we’re talking about where you’re borrowing money from. Typically, investors learn toward a mortgage to help gain leverage, since it’s an easy method. So let’s go over a few of the most common types of real estate leverage for investors to explore.
- Home Equity Loans or HELOC
- Business Credit
- Portfolio Loans
- Private Loans
As stated above, mortgages are one of the most common types of real estate leverage. People find this one of the easiest ways to leverage real estate since most people use a mortgage for their primary residence. Additionally, you can get a mortgage from several financial institutions, like a bank, credit union, or even an online mortgage lender.
Home Equity Loans or HELOC
If you already own a property, whether a primary residence or another rental property, a home equity loan or HELOC can help you leverage one investment into more properties. HELOC stands for “home equity line of credit” and works similar to a credit card, except your property is collateral. On the other hand, a home equity loan acts like a “second mortgage” and gives you a fixed sum to repay over time.
Some investors don’t realize it, but they qualify for business credit cards and credit limits. Investors can use business credit to finance new real estate investments. For example, you can use a business credit card to buy a property outright, like a home loan or other financing option. Or you can use it to pay a down payment, pay for repairs, or use it to expand your rental business with marketing or rental property management in Northern Virginia.
Instead of using traditional mortgage lenders, investors can also apply for a mortgage through a portfolio lender. Often, portfolio lenders are smaller financial institutions that aren’t required to meet strict underwriting guidelines. That said, private lenders take on more risk, so they typically charge higher rates. However, they are easier to qualify for and can be more flexible for experienced investors.
If you have good connections with business partners or other people willing to back you up financially, a private loan may benefit investors who want leverage. In this case, you may borrow from a friend, family member, business partner, another real estate investor, etc. As such, it’s crucial to create a professional loan contract to avoid misunderstandings and set boundaries.
How Can Real Estate Leverage Benefit Investors?
Now that we’ve gone over what real estate leverage is, you may be wondering how it can benefit investors. Here are some of the main advantages of leveraging real estate.
- You Can Grow Your Portfolio Quicker
- Earn Additional Rental Income
- Protection Against Inflation
You Can Grow Your Portfolio Quicker
When you use leverage, you can grow your portfolio quicker than you would if you had to save thousands to buy a property outright. Instead, you just need a down payment for your loan of choice. Then, if you can afford the monthly payments, you can potentially own multiple properties using leverage.
Earn Additional Rental Income
Most investors rent out their leveraged properties, which normally covers the cost of the loan plus some profit to keep. For example, use your leveraged property as a vacation rental and rent it out to high-paying tourists. As a result, you can easily cover the costs of a loan while profiting simultaneously.
Protection Against Inflation
Real estate is generally a good hedge against inflation. For example, although prices around you are skyrocketing, the fixed amount won’t change with inflation if you have a mortgage loan. As a result, you’ll owe the same amount on your loan each month, regardless of whether the dollar has lost value.
Risks of Real Estate Leverage
Although there are several advantages of leveraging real estate, there are some risks as well. For instance, you must be able to pay off your loan, or you could lose your leveraged properties. If you want to learn the risks of real estate leveraging, here’s what you need to know.
- Positive Cash Flow Isn’t Guaranteed
- You May Lose Assets If You Can’t Pay
- Property Values Could Decrease
Positive Cash Flow Isn’t Guaranteed
No matter how you finance a rental property, income is never guaranteed. Additionally, you have to think about the risks. For example, what if your property is vacant for several months on end? What if you have to lower rental rates so much that you can’t keep up? There are many factors to consider before purchasing a leveraged property. Investors need to develop a plan and thoroughly research property locations before investing.
You May Lose Assets If You Can’t Pay
You can take significant income losses if you can’t afford to pay for your leveraged property. Or, if you can’t pay at all, your property could be foreclosed. Then, if the property doesn’t sell for total value, lenders can come for your personal assets. Additionally, foreclosure can plummet your credit score and affect your ability to get loans in the future.
Property Values Could Decrease
Finally, just as property values can appreciate, they can also decrease significantly, depending on the housing market. If your property declines in value, it can become challenging to keep up with loan payments. Unfortunately, if you owe more than your property is worth, it can send investors into financial distress.
Tips For Using Real Estate Leverage to Your Advantage
If you plan on using leverage to grow your rental business, there are a few things to keep in mind. After all, moving too quickly on a significant financial decision can hurt your career. So, here are a few tips for using real estate leverage to your advantage.
- Use Cautious Numbers to Calculate Cash Flow- Use more conservative numbers to estimate your cash flow. In other words, assess finances using low rent amounts and high expenses.
- Don’t Try Using No Down Payment- Leveraging real estate without a down payment is risky for you and the lender. Instead, use a down payment to ensure you’re not overleveraging.
- Buy Your First Properties Using Less Leverage- If you’re just starting out with real estate, don’t use as much leverage as you can. Instead, use as little as possible to figure out the fundamentals.
Become Less Stressed With Property Management
When you own a rental business, several aspects need full attention at all times, including property management. Managing several properties while handling finances, new tenants, and lease contracts can be a lot for one landlord to handle.
Luckily, Bay Property Management Group can help. We provide full-service rental property management to landlords that want to maximize their rental portfolios. Contact us today if you need comprehensive management services in Baltimore, Philadelphia, Northern Virginia, or Washington DC.