Why Real Estate Investors Use Leverage
In the world of real estate investing, leverage is using borrowed capital to invest in
Typically, real estate investors put down around 20-25% of home value as the down payment for their properties - depending on the investor’s credit score, risk profile and preference, the down payment percentage varies.
It is quite common for real estate investors to use leverage in property deals. So why do real estate investors use leverage? Here are four main ways that investors can reap the benefits of taking out real estate loans.
1. Scale Real Estate Investment Portfolio
First of all, when you use borrowed capital to invest in a property, you free up cash at hand. With extra cash available, you are able to invest in multiple properties at an accelerated timeline and scale your real estate investment portfolio faster.
For many real estate investors, cash is king. With smart real estate financing, investors can grow their real estate portfolio and cash flow exponentially. Saving for a large down payment and buying one property every few years might be very time consuming; you can even miss out on some great deals while waiting. The adequate amount of real estate leverage will help accelerate the investment process and scale your portfolio.
2. Diversify Investment Risk
When you are able to invest in multiple properties with financial leverage, you are also rewarded with the chance to diversify the portfolio by investing in different types of properties or properties in different locations.
With real estate leverage, you can invest in residential, commercial and/or industrial properties. In the case of residential properties, you can further diversify your portfolio by investing in long-term, mid-term and short-term rental properties.
In addition, different geographic markets also represent diversification opportunities. In some markets, a buy-and-hold strategy for home value appreciation is more common. In other markets, a strategy focused on generating cash flow is more prominent. Investing in locations with different market behaviors can help diversify your real estate portfolio and bring you a balanced return.
3. Boost Cash-On-Cash Return
Cash-on-cash (CoC) is an important investment return ratio that calculates the cash income earned on the cash invested in a property. If you put more cash in the deal, the bottom number of the equation will be bigger, resulting in a smaller CoC. But if the monthly mortgage amount is too big, it will also eat away your monthly cash income, resulting in a less than ideal return. So leverage can be a double-edged sword.
With a reasonable leverage ratio, however, real estate financing can help investors get a better CoC return on their investment deals.
4. Enjoy Tax Deduction Benefits
When you take out a real estate loan, the interest on the mortgage is tax-deductible. In addition to mortgage interest, you are also able to deduct expenses such as property taxes, maintenance costs, property insurance etc. from your taxable income, saving tax dollars annually.
Another way you can lower your taxable income is through deducting depreciation. Depreciation is the gradual loss of property value over time. As a real estate investor, you can deduct depreciation as an expense, easing your tax burdens.
There are other benefits associated with using leverage when it comes to real estate investing in addition to the four mentioned above. If used correctly, leverage can help investors scale and take their real estate portfolio to the next level.
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