However, as I was flipping through his book, I liked the approach the author took in chunking concepts to slowly build an overall understanding. That's a very good way for new investors to become pros in short order while they're making money. For instance, how many of you get glazed over eyes and pretend you know what's being said when the term "leverage" starts getting tossed around? Let's start with the basics.
â—ŹÂ Â Â When the yield of an investment is greater than the cost of an investment, you experience positive leverage. You have X% interest, but get XX% return. Simple.
â—ŹÂ Â Â If the yield of an investment is less than the cost of the investment, you experience negative leverage. You have XX% interest, but get X% return. Simple. (And sad.)
â—ŹÂ Â Â If the yield of an investment is equal to the cost of the investment, you experience neutral leverage. (You break even.) You have X% interest and X% return. (Not great, but better than negative.)
With interest rates as low as they are right now, it's important to consider leveraging in all its aspects. Just because the financing makes sense does not mean the property makes sense.
Yes, cash flow on any property is important, but it does not outweigh potential appreciation.
Basically, real estate investing is more a puzzle than a contest like football. Sure, you want to score a touchdown, which in our world means making money, but you also want to win the overall "game" -- or rather complete the puzzle and achieve the big picture -- by making sure all the pieces actually fit together.
Those pieces -- the ones that create the coherent investing picture -- include:
â—ŹÂ Â Â financing,
â—ŹÂ Â Â leverage vs. cash,
â—ŹÂ Â Â interest rate,
â—ŹÂ Â Â down payment,
â—ŹÂ Â Â return on investment (ROI),
â—ŹÂ Â Â appreciation potential,
â—ŹÂ Â Â tenant base, and
â—ŹÂ Â Â cash flow.
As I told my football confused friend, you start with one concept, get it down, and then add the next concept to it. I think it's most important with the concept of leverage not to make the fundamental mistake most new investors make -- assuming that leverage is all about the down payment and nothing else.
Here's how that really ties together:
â—ŹÂ Â Â Yes, get the lowest down payment you can.
â—ŹÂ Â Â Yes, shoot for the best location possible.
â—ŹÂ Â Â BUT, don't lose sight of working toward the most positive leverage possible, especially as that links to long-term appreciation.
â—ŹÂ Â Â AND remember, when you're looking at the specific pieces for a specific property to determine the quality of that leverage? Look at everything: the neighborhood, the age of the property, the features, the floor plan, the tenant base, the rent potential, and so on.
Real estate is a game in that we want to win, but more over it's a puzzle, a formula where you want the number after the equal sign to be solidly in your favor because you leveraged it in that direction. Posted by Monte Davis on
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