Why Levergae Real Estate Investment Property?
By: Skyler Moore
“He who holds the gold, makes the rules.” Investors who have cash in today’s distressed real estate market have several avenues to make money, even in today’s real estate market. Investors may choose to purchased distressed residential or commercial assets, passively loan money privately, place options on deals and more. Using cash is the best way to obtain a deal, but once an investor controls a deal, should they leave all their cash in?
A common thread I see with cash investors is leaving all their money into the deal without any debt. While this is a great position to be in, it doesn’t make sense in a lot of cases. If an investor has reserves deep enough that it doesn’t matter to own cash, then great, but very few people are in this position. Instead, most investors have a limited amount of capital to work with and must carefully leverage their position.
For example, suppose you are an investor with $500,000 and want to maximize a fix and flip business. If the average acquisition, rehab and variable costs are $150,000, that would mean the investor could only do 3 properties at once. If the average holding time from start to finish were 120 days, that would turn the money three times a year. If the average net profit was $25,000, the annual net business profit is $225,000. This is a great net ROI of 45%, but lets see what happens when the investor chooses to leverage their position.
Several private money sources will allow investors to leverage a 70% loan to value with the first deed of trust in the private money lenders name. For our example, we’ll use 2 points on the back and 10% interest. Now, the $150,000 is used to purchase the property with 70% being financed by the private money source. This leaves 30% equity into the deal, or $45,000. In this example, that would mean you could now purchase 11 properties at once that were turned 3 times a year.
I want to point out, that this is an example to prove the power and point of using leverage in real estate. A smart investor would not leverage all of their money, but using leverage will great increase the return on investment, while allowing the investor to stay liquid and avoid tying all their funds into a deal.
Leveraging Private Money
The key to leveraging private money
is the cost. In our example, the investor had an average 120 day holding period with a 10% interest and 2 points on the back. That would put the cost of funds at $3,500 for interest and $2,100 in points, which totals to $5,600. That would bring down the net profit per property to $19,400.
The investor would be making less per each investment property, but instead of doing 9 properties per year, the investor could do 33 properties at $19,400. That increases the annual net profit to $640,200. That is an increase of $415,200 annually, or nearly double the net profit. Using private leverage increases the net ROI to 128%.
Investors who use leverage smart and responsibly have a huge advantage over conservative cash investors. Using the correct balance between debt and equity will allow an investor to maximize their net profit, while also mitigating their cash position. My company has been using leverage in the Denver real estate
investment market for this purpose and have successfully established a network of private money lenders that will fund up to 70% on properties that fit their criteria. To learn more about using leverage, contact us today.