The best real estate investments utilize leverage to accelerate financial growth and make money in real estate. Leverage, for the purposes of this discussion, is the use of fixed bank financing to pay for the majority of the property. Current Fannie Mae underwriting criteria for multifamily, requires the owner(s) to put 30% of the purchase price down. The rest can be financed or leveraged.
Why is leverage so important? Leverage is a tool that allows you to get higher returns than you could otherwise get if you paid for the property in full. Of course higher returns mean accelerated wealth and financial growth.
Investors who are accustomed to the lower returns and high volatility of the stock market are often skeptical when I tell them that leverage has allowed me to obtain double-digit overall returns year after year. I am always mystified as to why those same people continue to ride the stock market roller coaster without diversifying some of their portfolio into real estate.
Many of those averse to real estate think that leverage is synonymous with risk. They freely admit that leverage can allow the investor to make money in real estate and exponentially experience financial growth. They know that the wealth accelerating effects of leverage can substantially decrease the amount of time it takes to obtain financial freedom and early retirement. However, they worry about risk.
They correctly point out that leverage is a double edged sword. Just as leveraging positive gains and growth can accelerate your wealth, leveraged losses and declines can accelerate your poverty. The easiest example of this is illustrated by a credit card balance that goes unpaid. Those leveraged losses in the form of interest and penalties compounded over time can take a relatively small negative balance and make it substantial.
What if the investor could take full advantage of the upside of leverage while limiting the downside? The best real estate investments do just that. By combining leverage with non-recourse lending, the investor limits his or her exposure to loss. This would be akin to buying a $5,000 spa on a credit card and preventing the credit card company from charging interest and penalties and compounding those losses. Yes, you owe them the $5,000, but nothing more. Non-recourse loans limit the investor’s risk to their initial capital contribution and nothing more. Leverage makes real estate more lucrative than stock market investing and non-recourse lending makes it much safer.
Non-recourse lending is the industry standard for large commercial multifamily investments. Let’s compare a purchase of $1 million in stock with $1 million in multifamily real estate acquired using 30% down with 70% leverage.
|UNLEVERAGED STOCK / MUTUAL FUNDS||LEVERAGED MULTIFAMILY REAL ESTATE|
|ASSET VALUE||$1,000,000||ASSET VALUE||$1,000,000|
|COST TO INVESTOR||$1,000,000||COST TO INVESTOR||$300,000|
|EXPOSURE TO POTENTIAL LOSS||$1,000,000||EXPOSURE TO POTENTIAL LOSS||$300,000|
|6% ANNUAL RETURN||$60,000||6% ANNUAL RETURN||$60,000|
|RETURN ON INVESTMENT||6%||RETURN ON INVESTMENT||20%|
|LIQUIDITY EVENT||cap gains tax||LIQUIDITY EVENT||tax free refinance|
The above example demonstrates how a $1 million real estate asset can be purchased using leverage at a much lower price than $1 million worth of stock. Due to the lower amount of capital required to purchase the same size asset, leverage allows for higher returns. Non-recourse lending limits the exposure to risk as compared to the stock market and liquidity events are either tax free or tax deferred through a 1031 exchange.
As you can see, in the right hands, multifamily investing can and should be more lucrative than stocks and mutual fund investing at a lower level of risk. Every doctor, dentist, and other busy professionals should consider adding multifamily real estate to their portfolio. If you want to learn how, visit our PASSIVE INVESTORS OPPORTUNITY page.
To Your Wealth!
Dennis Bethel, M.D.
P.S. Leverage combined with non-recourse lending makes the best real estate investments even better so that you can make money in real estate and experience financial growth all at a lower risk profile than the stock market.