Let’s start with the discussion of the 2 important factors. I consider them 2 most powerful wealth tools of a landlord’s kitty.
Experience the power of Leverage and Equity Build-up
What is the leverage?
Leverage is generated by using borrowed capital as your funding source when you invest. This allows you to buy a much larger asset by having your money club together with borrowed money and increase the potential return on your investment than you could if you had to pay 100% of the purchase price upfront.
Let’s understand with some example,
- Buy a property worth $100000 paying with your own money. No leverage.
- Purchase a property worth $200000 using $100000 of your own money clubbed together with $100000 borrowed from the bank. This is an example of using 50% financial leverage.
- Acquire two properties worth $250000 each, paying down payment of $50000 + $200000 of the mortgaged loan from the bank for each of the properties. This creates the total financial leverage of 75%. Your future gain and risk will be shared among the 2 properties rather than a single acquisition.
It’s prudent to understand there is a potential to gain(or lose) more because of the financial leverage. When the value of the acquired assets turns negative, you may end up losing more money than in case of no leverage.
It’s the fact that financial leverage is used overwhelmingly as the tool to multiply the wealth by the real estate investors all over the world.
In the above examples,
- If the value of the property increases by 5%, your gain would be $5000. There is no leverage playing out here.
- If the property value increases by 5%, the value would be $210,000, and your gain is $10000.
- In the 3rd instance, if the value appreciates by 5%, the total value of both the properties would be $525,000, Which is the gain of $25000.
So you can see in all the 3 examples, your investment remained the same. However, because of financial leverage, the profit varies.
Many beginners are skeptical or fearful of taking debt. Well, I can’t stress enough how important for a landlord to realize the power of leverage.
By denying to leverage, you may be denying the greatest source available to you to create wealth.
The real estate investor uses the leverage to add another property to his or her portfolio at every possible instance.
From the lender’s point of view, real estate is considered one of the safest assets. Both in the US and Canada, home buyers and residential real estate investors can buy a home with the down payment as little as 20%. So why not take advantage of this favourable lending system.
How to use equity build-up to your advantage
The following table shows the sample detail of one of the landlord’s equity account. Just by sustaining his landlord business, he is accumulating $1866 per month in all of his rental property. Which is about $22000 per year. If he maintains his landlord operation for 10 years, its over $200k increase to his personal wealth. This equity build-up would not be possible in the absence of the leverage.
What I am trying to emphasize to you at the early in your landlord career, Do not underestimate the power of leverage. You should be cautious of high-risk and high-interest debt of credit card, but you should be always open to take the informed and calculated risk of secured low-interest mortgages.
There are many factors affecting your ability to keep purchasing rental properties at the regular interval. From the leverage point of view, there are 4 most important factors.
- Credit – Always be in good standing with your credit. You can still purchase the mortgage without good credit, but that’d be high-interest mortgage and will diminish your power to take maximum benefit of quicker equity accumulation.
- Down Payment – Always be saving money for the down payment of your next rental purchase. Whether you are working your regular full-time job or collecting cash flow from your rent, keep putting down payment money aside regularly. After all, the down payment is the trigger to your further leverage, right?
- Income – Ensure you have enough income year by year to service all your mortgages and always keep an eye on how you’d add addition mortgage for your next rental.
- Don’t mess up with the tax department and keep filing your income tax return regularly. The lenders won’t release the mortgage unless they see you are up-to-date with your taxes.
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