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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