The use of borrowed
funds to make an investment in real property
in hopes of realizing a profit in addition
to monies necessary to pay for the borrowed
funds. Leverage reduces the owner's risk and
by reducing funds in an initial investment
and permitting the investor to participate
in various projects within defined financial
capabilities (by using the saved funds).
Leverage has the
potential in increasing the owners return in
any given investment. Three types of
leverage can occur.
Positive Leverage
A situation
in which the
yield to an investor exceeds the
over all rate of return that would
have been realized on a property had
no financing been put in place.
Neutral Leverage
Occurs when
no increase or decrease in yield
occurs as a consequence of leverage.
Negative Leverage
Exists when
the use of borrowed funds results in
a lower equity yield then the
overall rate of return that would
have been realized if no financing
had been put in place.
Examples of Leverage
Scenario
1
Cost
of Acquisition
$
200,000
Amount of Mortgage
-100,000
Amount of Downpayment
Required
$100,000
Projected Net Income
$24,000
Cost
of Borrowed Money @ 10%
-10,000
Projected Return to Owner
$14,000
Percentage return on equity
($14,000
÷ $100,000) = 14%
Scenario
2
In scenario 2,
the investor will divide the
downpayment in half to acquire 2
buildings.
Building A
Building B
Cost
of Acquisition
$
200,000
$
200,000
Amount of Mortgage
-150,000
-150,000
Amount of Downpayment
Required
$50,000
$50,000
Projected Net Income
$24,000
$24,000
Cost
of Borrowed Money @ 10%
-15,000
-15,000
Projected Return to Owner
$9,000
$9,000
Percentage return on equity
($9,000
÷ $50,000)
18%
18%
As a result
of a lower downpayment and the
acquisition of two buildings instead
of one, the owner realizes higher
rate of return then would by
acquiring just one building.
The ratio of
the principal amount of a loan or
mortgage to the lending value of the
property. This ratio is one of
several measures used by lending
institutions in determining whether
to grant a loan or a mortgage.
Most lending
institutions will require an LTV of
80% or less, meaning the borrower
will need to provide a
20%-downpayment of the purchase
price.
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