Leverage of Real Estate
Leverage or financial leverage is one of the most important aspects of building wealth through real estate investment. I will try to make my example as simple and understandable as possible.
If you have $100,000 dollars to invest and go out and buy a small home for $100,000 dollars cash. Let us assume the rental income is $800 per month x 12 months = An annual income of $9600. Assume again your property taxes are $900 per year, insurance $700 per year and allow $1,000 for property maintenance and up keep. Total expenses = $2,600. So after expenses your net income is $7,000. We are assuming the tenant will pay all utilities.
Your investment of $100,000 will give you a 7% annual return with out factoring in appreciation. This income will of course be taxable. If real estate were to go up in value at an annual rate of 5% you would make another $5,000 which would be taxed as a capital gain a the time of sale. (applicable at different rates in different countries.) In Canada in some cities just this year real estate values have gone up by 25% or more in the last 12 months. The average home price in Vancouver British Columbia is now in the $1,000,000 range.
Imagine your home (principle residence) making you $250,000 tax free in one year. I would be very tempted to cash out and move to the east coast of Canada where I could possibly buy the same home for $250,000 and retire with $750,000 in the bank. Now that’s a plan.
Now let’s say we take our $100,000 and buy 5 similar homes and put $20,000 down on each. We finance $400,000 and our mortgage payments total $2,000 per month or $24,000 per year. Our income at $7,000 per house is $35,000. After debt service we make $11,000 per year. (over 50% more) but here’s the real bonus. Again assuming 5% appreciation now on $500,000 worth of real estate = $25,000 per year.
That is a 25% return on your $100,000 investment for a total $25,000 + $11,000 = $36,000 = 36% per year. Now that is the power of leverage. Amazing. Yes there is more risk. You have debt. There is more hassle (5 tenants as compared to one.) Is it worth it? Only you can decide. Does it work? ABSOLUTELY. That’s how people become millionaires. Can anyone do it? Absolutely. In my career spanning 35 years I have applied it (I now own $3,000,000 worth of real estate) I have consulted with and helped many of my customers do it. If you have any questions feel free to contact me and thank you for reading my article.