Part I of 2: Leveraging vs. Cash Purchasing

Posted by Monte Davis on Thursday, September 2nd, 2010 at 10:22am

Let's begin with a basic consideration in real estate investing: leveraging.

Leveraging simply means using other people's money to purchase a property. It's a two-edged sword, but one that right now can cut very much in your direction.

Here's the situation you're trying to avoid. -- Falling on your sword. If you go into a purchase without enough down payment, you may not get enough cash flow out of the property to cover issues like:

- vacancies,

- regular maintenance,

- and management expenses.

Word to the wise:

- If you can't afford to actually own the property -- to own the expenses that come with it and to endure periods of vacancy -- don't buy!

And never buy a highly leveraged property unless you are:

- prepared to be a hands-on owner,
- or have sufficient personal income/funds.

With the many variables involved in leveraging and the amount of homework needed to do it correctly, the real issue is finding a good lender and cultivating a positive, long-term relationship.

For all practical purposes, you are married to your lender. We're talking about a 15 to 30 year relationship.

Before marrying, you would do a lot of dating first.You wouldn't walk down the aisle until you knew you were in love and ready to make a commitment.

Choose a lender with the same courtship / commitment mindset. There are, after all, a lot of trust issues with which you'll need to come to terms, most notably:

- Your lender has to trust that you'll have the cash flow and/or reserves to make you payments.

- You need a lender who can provide the "terms" that will let you do that.

How does your realtor figure into all this? As a best man or maid of honor. The one who does the coaching, throws the bachelor party, or helps you pick the "dress."

You realtor will know where to shop and who can deliver what you want. Ultimately though, you are the one who will have to live with your lender after your realtor has gone home.

So, in this economy, is leveraging a good idea? Well, consider some facts about buying power.

- A 1% increase in the interest rate equals a loss of about $25,000 in buying power.

For simplicity sake, look at the scenario this way:

- With 20% down, a $200,000 purchase price at 6% interest has the same payment as a $224,000 purchase at 5%.

Translation?

- For that 1%, you get $24,000 more buying power!

And right there, we have the other side of the leverage sword, the one that will cut through the tangles and get you the best property with the best return on investment.

So why are we emphasizing the need to act now and take advantage of this market?

- Interest rates are at record lows and there's a 7 month supply of inventory, making this market very opportunistic for all types of buyers

- Investor financing is still available for borrowers with good credit, who can put 20% down, and have sufficient reserves.

- Lastly, thanks to tighter mortgage guidelines rental occupancy rates are high.

Now is the time to buy!

(Please join us next week to discuss cash flow vs. appreciation.)

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