Top Four Don’ts in Using Real Estate Leverage

Posted on: August 11th, 2012 by admin No Comments

Used properly, real estate leverage can be an effective tool for real estate investors to increase their return on investment. The key is to avoid making decisions without proper consideration of the areas of risk in leverage.

Avoid these high risk behaviors and you have a far better chance of realizing success in using real estate leverage.

Don't Count on High Levels of Appreciation

Many a real estate investor has gotten into financial trouble by looking at past history, even if recent, and relying on the future to produce the same results.

Even if property has been appreciating at a 12% to 20% rate for a number of years, counting on that rate to continue is an extremely risky proposition. It can cause you to overpay for properties, expecting to realize the difference at sale from appreciation. If it doesn't happen, you're holding a loss or worse.

Don't End up With Too High a Payment

It can seem like a great investment to control a property with a very small down payment. You're looking at the numbers and seeing a really high return on investment due to your low cash outlay.

The problem is the higher payments that come with higher leverage. Should the market soften or your properties experience higher-than-expected vacancy or credit losses, you could find yourself unable to maintain those higher mortgage payments that seemed fine at the beginning.

Don't Let Good Financing Result in a Bad Purchase

Many an investor has overpaid for a property because they found nirvana in a high leverage financing setup. Just because you can get a property with very little cash outlay doesn't mean that it's a good buy. Look at the value of the property in the context of current and expected market trends.

If the property is overpriced, appreciation will be minimal or worse be non-existent. And woe be unto you if the market retraces itself for a while. Your overpriced property will be a significant drag and you'll not be able to unload it without taking a loss.

Don't Forget That Cash Flow is King

If just one of these "don't" behaviors sticks in your mind, this is the one that you should consider carefully. Errors in judgement in one or more of the other items here can be overlooked if you have that one great thing – excellent cash flow.

If your rental income minus your mortgage costs and expenses is putting a nice cash return in your pocket every month, then the fact that the property didn't gain in value this year won't be as worrisome of an event.

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