There are many people who are looking for different ways to build wealth, and one option is to invest in real estate. Even though it is smart for people to diversify their investments among stocks, bonds, and mutual funds, you should also think outside of the traditional market. Investing in real estate can be a wise move because it provides you with something called leverage. What does leverage mean, and how can it benefit you in real estate investing?
What Does Leverage Mean?
If you listen to people who are experienced real estate investors, you will hear them talk about leverage. Essentially, this means that you are going to use someone else’s money to make money. You probably do not have enough cash to purchase the property outright. Therefore, you will have to borrow money from the bank, so you will be using the bank’s money to make money when the value of your property goes up. Just because the value of your property goes up doesn’t mean you owe more money. As a result, you are gaining capital appreciation from the money that the bank has loaned you.
What Is the Benefit of Leverage?
It might be helpful to take a look at an example of leverage. For instance, you may purchase an investment property for $250,000. You will put down $50,000, meaning that you have to take out a loan for $200,000. Now, let’s say that the property goes up in value by 5 percent during the first year. Now, the property is worth $262,500. The capital appreciation of the property is $12,500. Even though the bank gave you a loan for 80 percent of the value of the property, 100 percent of the capital appreciation goes to you. Therefore, even though the property has only gone up by five percent, it may have made you significantly more money than you would have made in the stock market during the same year.
Real Estate Investing Comes With Risks
Leverage sounds nice, but it also means you are taking on extra risk. You are responsible for the balance of the loan, regardless of how the value of the property changes. Always think carefully before you decide to invest in real estate.
