Why Leverage Benefits Your Investment Returns

Did you know that using some leverage is an advantage you should consider? If you are new to investing, you may not know what this means. We’re offering to shed some light on this benefit. 

This investment tip is critical to help you optimize your equity for better returns. If you’re ready to boost your investment gains, continue reading to learn more about leverage.  

What is Leverage?

When you Google “what is leverage,” the primary explanation is that it uses borrowed funds as part of an investment. You may wonder: How does borrowing money improve your investment portfolio? The short answer is that when used effectively, leverage can maximize your profits. 

Another example, if you bought a home and needed a mortgage to buy it, you’ve already used leverage, though you may not have related the term.

What Are the Investor’s Benefits of Leverage?

There are many benefits to using leverage as part of a sound investment strategy, and here are some simplified examples for discussion sake (omitting standard fees and tax benefits). 

Boosting Your Buying Power

Without leverage, if you have $100,000 cash to invest, you can only acquire $100,000 worth of assets.

But with leverage, that same initial dollar amount could acquire $200,000 worth of assets using only 50% leverage.

When discussing real estate, 75% leverage is not uncommon and would allow an investor with $100,000 to acquire an asset worth $400,000

Boost Your Diversification

Another way to look at leverage using the same $100,000 would allow you to purchase four $100,000 real estate properties, rather than pour all your assets into one investment.   

An excellent solution to diversifying your investments, and if you choose, you could spread your purchases into different geographic areas. 

Stronger Appreciation Investment Returns

If you buy a property, without leverage, for $100,000 that goes up in value by 6%, you make $6,000, a return of 6% on your initial investment. 

But if you use leverage with that same equity to acquire a property worth $400,000 and it also goes up 6%, or $24,000, that would be a return of 24% on your initial investment. Of course, there is a cost for the mortgage interest, but that is considered below.

Greater Cash Flow

Let’s presume you purchase a cash flowing investment property, and it generates more income than it costs to operate, then you receive ongoing revenue with your investment. 

Now assume you purchase a $100,000 rental property, and after expenses, you receive $10,000 in Net Operating Income (NOI) annually.  That would be an additional 10% return on your investment. 

But with leverage, that $400,000 rental property would spin off $40,000 of NOI at that same rate of return.  But with a mortgage expense of $17,185 ($300,000 @ 4% interest), leaves $22,815 for distribution.  22.8% on your initial $100,000 investment.

Leverage Summarized

In the above examples a cash flowing property purchased unleveraged for $100,000, returned $6,000 in appreciation and $10,000 in cash flow netting $16,000 or 16% return on investment.

The same equity invested with leverage in a like-kind $400,000 property returned $24,000 in appreciation and $22,815 in cash flow after interest payments.  Netting $46,815 or 46.8% return on that same $100,000 initial investment. 

Even though your investment contribution stays the same, you are on the receiving end of measurably greater returns when using financing to leverage real estate.  Please keep in mind, the preseeding examples are simplified and serve only to depict the primary benefits of leverage when used in real estate.  

More Tax Advantages

When looking into investment returns, tax advantages are a critical point to consider. Even with leveraged investments in real estate, you still get the full tax benefits. With the use of leveraged financing, you could take 4x the deductions of an unleveraged purchase.

Keep in mind that there are other beneficial deductions, such as writing-off the interest paid for the bank loan.

Investment Tips for Leveraging and Boosting Returns

Investing using leveraged finance isn’t merely for experienced investors. Refuge Investments executive team (with a collective 80+ years of experience) has helped investors participate in professionally managed real estate. If you have questions, we are ready to help. Get in touch today.