Understanding Leverage and Return on Investment (ROI)

Leverage and Return on InvestmentOne of the most common advantages of real estate investing is the financial leverages that can give a return on investment. The sale of investment property is a highly competitive; you have a little product to sale with too many brokers and a good supply of buyers and a few real estate sellers. It is because stakes are high and real estate is a high-performing asset.

The leverage appreciation of the asset value is a great deal of the return on investment which is normally based on income. Leveraging means that the asset being purchased; portion is paid from buyer and the balance comes from a lender. The loan will be repaid by the occupants rental payment to the new buyer therefore it increase the value of the entire asset and it is a real return on the original amount invested. To explain further, the original loan will eventually be paid off by the tenants and the investor will profit in the long run depending on the term of the rental. So basically you will pay the 10% base on equity and the 90% through lending but the idea is you won’t be paying the lending through your own pocket instead the renter will pay it for you and in the right time when the loan is paid. Then you can have the entire asset.

To give you an overview I will give a simple numbers and explain how it works. Suppose you contract to buy a one hundred thousand dollar building and with a 25 percent down payment and another 5 percent in loan points, closing and other costs. Does the maths the buyer normally pay $30,000.00 of his or her own capital? If the property increases in value at 3 percent per year then normally the worth of the property increases by 3 percent. By means of appreciation alone the investor gains a return of investment of 10 percent with just the 3 percent appreciation.

Return on Investment (ROI) = (Appreciated Value – Original Value) ÷ Amount Invested

If we add the appreciated 3 percent of ROI as shown above the cash on cash return on investment is even greater. Since the mortgage is paid from rent collected it is an ROI since the investor sells or refinances through the renter. However, in interest-only loans, which are common in commercial real estate, there is no principle pay-down.

When you plan to buy a real estate make sure you don’t pay it all through your own pocket make sure you only pay part of it the most is 30 percent and the rest through loan. So normally the asset is being paid partially by you and the lending company pays the rest, so its now times to let the property rented. The rent proceeds will be used to pay the mortgage so in due time you will gain a 1,100% return of investment. As show above on the appreciation alone you will gain a 3% increase of your real property value that does not include the entire value on the succeeding years. Normally you only pay a little and the renter will pay almost the whole portion of the amortization. This is a great way to leverage your income and this explains how to leverage and get the return of investment.