Thursday, March 26, 2015

Financial Leverage

Financial leverage is an essential investment tool for the savvy real estate investor. George Antone, author of The Wealthy Code and The Bankers Code, writes about financial leverage, which is, making money off of money. He will be speaking more about this at his presentation to the Real Estate Association of Puget Sound’s April meeting.

The way that most people are familiar with making money off of money is by earning interest on their savings in a bank account. Typical interest earnings on a bank account may be in the range of 0.01-1%, and on a bank certificate of deposit may be  1-2.5%. This is considered to be a fairly “safe” investment, in that it has low risk, and correspondingly low interest earnings.

Higher risk investments generally carry a higher level of interest. Private lenders may earn anywhere from 3-12% on private funds loaned to real estate investors, while hard money lenders may earn anywhere from 10-18%, along with “points.” Points are calculated as 1% of the loan amount and are typically paid by the borrower up front. Most hard money loans will have anywhere from two to five points on the loan. So a hard money loan of $100,000 would be paid to the borrower as $95,000 after paying five points. The interest is typically calculated on the full amount of the loan until repaid.

Sometimes a private money lender will borrow money to make money. For example, someone with good credit and income could take out a home equity line of credit on their house, for say, 4%. He might then lend that money as a private lender to a real estate investor for 10%, making a 6% spread on his money. Otherwise, equity in one’s home just sits there, earning 0% interest.

In sandwich lease options, a real estate investor may negotiate terms with a Seller on an owner-financed mortgage at 4% annual interest; then turn around and charge the end-buyer an interest rate of 6% simple interest, making a 2% spread on the investment.

I financed much of my commercial real estate development using credit cards with 2-4% interest for 12-18 months. I charged my development company 10% for the use of those funds, which will be paid back when the property is sold or syndicated within that time frame. I will be reimbursed with interest as an expense to the company before net profits are split with my partner. Hence, I will earn both interest and profits on my investment.

Not everyone is comfortable with the idea of interest. The east African Oromo cultural group wanted to buy my commercial property on a Seller note, but were culturally precluded from paying any interest. Needless to say, this made any potential sale to them less attractive to me.

But for those willing to learn more about financial leverage, the use of interest and debt to make money is a great option for the real estate investor to employ in his bag of creative investment strategies.

Happy Investing!

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