Levers and pulleys have been used in construction since before the ancient Egyptians built the Pyramids. They allow force to be multiplied so that, if enough levers are used, a person can move a large, heavy stone. The ancient Greek mathematician Archimedes famously stated “Give me a lever long enough and a fulcrum on which to place it and I can move the world.” Similarly, borrowing, or using leverage as it’s known in the industry, can help multiply your investment efforts as well as your returns, but it also can have dire consequences to your portfolio if things go wrong.
When you borrow, you are using financial leverage. Let’s say that you have $50,000 to invest in property. With that amount of money, you won’t be able to purchase much in the way of a property and you certainly will struggle having the cash you need to rehab the property. Using leverage, however, allow you to purchase much more. For instance, let’s say you find a property that will cost you $100,000 to purchase and will take $25,000 to rehab. You can put down $25,000 on the property, borrow $75,000 and still have enough left over to rehab the property. Leverage can get multiply your buying and allow you to get into the real estate game on a level that will allow you to compete.
Leverage, however, can also eat up any profit that you might have on a deal. In our scenario of borrowing $75,000, if you are borrowing at hard-money rates, say at 10% interest with 2 points, you would be paying $1500 for the points and an additional $625 each month in interest. For rehabs that you turn in 4 or 5 months, this usually isn’t a problem, but if you run into delays of any kind, the financing costs can cause you to lose money.
Using leverage can really help you to take your real estate-related investment business to the next level. You just have to be smart about it.