Leveraging, or using borrowed capital to increase the return on an investment, is an excellent way to maximize your buying power. It’s also a great way for investors to minimize their risk. Check out our real-life example of leveraging in residential real estate Apartments in west Hollywood ca.
I would like to let you in on a little secret. It’s the secret of our success at HIS Real Estate, and it’s the thing that has allowed us to grow our business exponentially. What’s our secret to residential real estate success? It’s all about leveraging.
Leveraging is defined as using borrowed capital to increase the return on an investment. We leverage our investors’ money through private placement funds in order to maximize returns and minimize risk. Leverage is a powerful tool and I’d like to give you an example of how it has worked for us.
Let’s say you have $1 million to invest. If you’re able to buy houses at $200,000, and accounting for closing costs and rehabbing, you could purchase four properties and have maybe $100,000 left over. You’d be using virtually all of your cash instead of leveraging your risk.
On a single $200,000 house, the return is just not that great. Here’s the price breakdown: Acquisition of a $200,000 house costs about $209,000. On the other side, when you sell it, the residential resell is going to give you a net of about $248,000.
Figuring in rehab and construction costs (at roughly $15,000), you’re looking at netting about $21,000. That’s a cash-on-cash return (which is determined by the annual dollar income divided by your total dollar investment) of about 10%, because you would buy $200,000 worth of inventory after your costs of $209,000. So, you dump from your wallet $209,000 and you’re going to get $21,000 back. Honestly, if it were my own money, I wouldn’t think it was worth it. I’d be putting $209,000 at risk to get back $21,000? It’s too risky.
So what we do — we leverage it. Now, when we say leveraging, we’re not talking about leveraging risk like the Wall Street people were doing a few years ago. They were incredibly overleveraged, which led to our economic mess. In fact, we’re talking about risk with a tolerance that is going to protect you in case there is another collapse in the real estate market.
The way that looks is like this: We control the money in our private placement fund and we leverage that money. We want to use the least amount of the capital so that our cash-on-cash return is maximized. We leverage the money with a loan at 65%. So we end up with a loan at around 46% of the actual market value of the property.
At 46 cents on the dollar, your investment is pretty safe. I don’t see the market crashing 50 cents on the dollar in order to lose all of your equity. So by using leveraging in residential real estate, we’re able to turn that $1 million into over $2 million. From these residential flips, the net profit that is generated as you turn over properties is put back into the fund, and the cycle begins again. That’s how we acquire properties.
That’s what we do. We do this throughout the United States. We leverage our money. We maximize our purchasing abilities by extending the amount of purchasing power we have and we lower our risk. We do not want to put all of our eggs in one basket.