Using Leverage to Build Your Commercial Real Estate Portfolio.
You’ve heard of leverage.
The Greek mathematician Archimedes, who was born in 287 BC, said “Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.”
Today, while leverage is still used to raise and move heavy objects, it’s also used to raise financial fortunes. Employed on both Wall Street and Main Street, it has the potential to create vast fortunes from modest investments.
Commercial real estate purchases are made using leverage every day. The buyer simply makes a down payment with his or her own money, then uses a mortgage loan (other people’s money) to pay the property seller. Of course, the buyer is obligated to make payments on that loan, but as long as those payments are made, the buyer has complete control of the property and ownership of its appreciation.
When the property appreciates – gains in value – the purchaser reaps the benefit of that gain and his or her net worth increases. Here’s how it works:
Let’s say you are purchasing a property for $3,000,000 and have made a 20% down payment from your own funds. You invest $600,000 and a lender grants you a loan for $2,400,000.
Assuming that the property appreciated in value by 5% over the next year, you would have gained $150,000. That’s 5% of the purchase price, but a whopping 25% of your original investment.
If you had only put 5% down. Your out of pocket investment is now $150,000 – and the first year gain is $150,000. That’s a 100% return on investment.
These figures do not include any rents or additional income received from the property and are, of course, approximations and will vary depending upon the interest rate, real estate taxes and any insurance premiums paid.
On the other hand, if you had paid all cash for that $3,000,000 commercial real estate property and it increased in value by 5% over the next year, you’d only have a 5% return on your investment.
Can you buy with no money down?
Of course – but rarely.
Situations do exist in which the borrower uses none of his or her own money, but this is not the norm in spite of what you might hear on late night infomercials. There really aren’t dozens of people in every community who own their property outright and want to hand it over to you at a discount with no money down. There also aren’t many loans that can be assumed with no qualification.
Those folks on TV are usually making their money selling expensive courses to people who want to believe what they say is true.
You might buy a residential home with no money of your own if you’re a Veteran and the seller agrees to pay your closing costs, or if you have parents who “gift” you the down payment. You might also find a seller who is willing to carry back an amount equal to a down payment – so you’ll have two loans (banks do frown on this practice).
“No money down” is a little more common in investment properties, where you might have partners who put up all the cash in return for your legwork. In addition, many investors leverage their equity in one property to fund the down payment on another.
Say you own a building you purchased for $800,000 four years ago. You made a down payment of $160,000 and the building has been appreciating at 5% per year.
After 4 years, the property is valued at $972,405 and you owe something less than $640,000. You’ve gained $172,405 in net worth – which is a 108% gain on your initial $160,000 investment.
You’re now in a position to refinance that building or take out an equity loan to use as the down payment on your next purchase.
I have even known investors who have owned their own home or recreational property for a number of years do the same thing – using the equity from personal property to finance the purchase of commercial investment property.
Again, the figures are approximations and don’t consider interest paid or profits earned through the ownership of income-producing properties.
Now is the time to act…
Right now, with interest rates close to their all-time low, is a very good time to purchase commercial real estate and a very good time to employ leverage in building your fortune with investment real estate.
However, it’s always time to act judiciously.
Real estate investment profits are generally made at the time of purchase, by buying right. As we saw in the buying frenzy and subsequent crash that happened in 2008, paying too much is always a poor idea.
When prices plummeted, sometimes by as much as 50%, homeowners and investors were left owning far more than their properties were worth – and this was after losing 100% of their initial investment. Investors who lost tenants due to job layoffs or their small business closing, found themselves with no cash flow to sustain the properties until prices began rising.
Leverage worked against them – and the result was thousands and thousands of properties in foreclosure all across the country.
We can assist you to avoid mistakes.
As a real estate brokerage and consulting firm dealing in commercial investment properties, we can assist you to analyze a potential investment to see whether the numbers make good sense. We can show you the going rents in an area and/or introduce you to people who can help you determine whether your own business idea is solid. If buildings need rehabilitation and you’re not a builder, we can introduce you to reputable people who will provide estimates on repairs. And of course, we can introduce you to investment bankers.
We can’t guarantee that values will never take another nose-dive, but we can assist you to be in a position to weather the storm if they do.
In short, we can assist you to find and purchase commercial real estate that will let you leverage both your time and money to your best advantage.
Call today at 305.482.1118 (or email) and tell us your goals… We’ll assist you to turn them into reality.
Your Trajan CRE Team – Assisting Commercial Real Estate Owners to Prosper!
