The Power of Debt In Real Estate

Most investments require a substantial cash contribution on behalf of the investor but real estate is one of those rare asset classes that allows you to use a small percentage of your own money and borrow the rest. Some view debt with contempt but those who know how to use it can increase their wealth in a major way.

Because the typical real estate investment can cost, on average, around $200,000 to buy most investors don’t tend to have that kind of capital sitting around in their bank accounts. Therefore, the banking system created a model where the owner/investor brings a percentage of the money to purchase the property and the bank lends the investor the remaining portion. Because the investor doesn’t have to bring the entire $200k, and they get the benefit of using other people’s money, it allows them to take less financial risk.

After the investor has a lender in place the next priority is for them to find a deal. Savvy investors understand that they don’t make money on the sale of a property but rather on the buy. You should never depend on market appreciation to make money. Buying property at a discount is in an investor’s best interest to minimize the risk of losing one’s principle.

But the real fun starts when the property appreciates without the investor having done anything to make it happen. This is called market appreciation. As time goes on, and assuming the market remains healthy, there’s a high probability the property will go up in value, and when it does you just might decide to sell it and move on to the next investment.

So let’s play this out…you buy a property listed at $200,000 for a 10% discount at $180,000. You put in only 20% of the money which cost you $36,000. Let’s just say you decide not to add any extra value to the property by upgrading the kitchen or bathrooms. You just hold the property for the next two years. Let’s also assume that the average annual real estate appreciation rate is approximately 6% (which is not uncommon here in Raleigh-Durham). That’s $24,000 in your pocket that you did nothing to earn! Without including the amount your renter already paid down in your mortgage over the course of those two years, plus the net return you received after all expenses were paid, you’ve made more than $44,000 over an initial investment of only $36,000.

Debt can be a valuable tool when it comes to real estate investing. Not only can one double their initial investment debt also gives them the ability to let the rest of their cash continue to work in other places.

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