Abiodun Doherty
| credits: File
Leverage, in simple terms, means to use borrowed capital for an investment whilst expecting the profit the investment will generate to be greater than the interest payable on the loan. Real estate leverage involves the use of borrowed capital to increase the profitability of an investment. The use of leverage is something common in most investments but more so in real estate investment.
When it comes to the subject of debt many people are scared. Debt is a two-edged sword just like fire. It is to an extent neutral. It could be advantageous or dangerous depending on how it is handled. There are good debts and there are bad debts. A good debt is any debt you incur in order to acquire an income generating or appreciating asset. However, a bad debt is a debt you incur in order to spend it on luxury and consumption. A good debt will ultimately make you richer, while a bad debt could impoverish a person except drastic actions are taken.
There is often a huge difference between how a consumer sees their budget and how investors see their budget. The difference is in what they both view as discretionary spending or required spending. Consumers always have money for social spending that increase their value in the eyes of people while depleting their financial resources. While an investor makes investment spending a required expense and really does not waste too much resources on discretionary spending. Eventually, due to the principle of delayed gratification working in favour of the investor, he or she will eventually have more than enough money to use as discretionary spending.
In real estate investment you could borrow (finance) directly or indirectly between 70 to 90 per cent of the value of a property to buy that property or another property. One of the easier expressions of leverage is when you use a mortgage to purchase a property. In effect, what you are using is a debt leverage. You are using your equity contribution of 15 to 30 per cent to secure a property while the appreciation is based on the total value of the property. Your contribution has enabled you to own and control a much larger investment. When you make a profit, it will be on your money and the money you borrowed from the bank or mortgage institution.
Take a look at this example. Assuming you saw a property for sale at N100, 000.00 and you were able to put down a down payment of N20, 000.00. Also you were able to secure a mortgage of N80, 000.00 at 12 per cent per annum. Let?s assume that in a year, after paying the interest on your mortgage and the mortgage you were able to sell the property for over N110, 000.00 and ended up making N10, 000.00. Simply put, you have made a 50 per cent profit on your investment. But if you can afford it and you paid the entire N100, 000 and you made N20, 000.00 profit, the return on your investment is 20 per cent.
In Nigeria, you can indirectly utilise the principle of leverage when dealing with traditional land owners. In most cases, when they decide to sell a parcel of land it is because they need money and when they do they are usually very flexible when it comes to payment. In some cases, you could use a very small deposit to hold on to a property while it steadily increases in value. You do not need to secure a mortgage to implement this strategy but you do need to be sure of the integrity of the land owners you are dealing with to a certain extent.
However, you need to keep in mind that leverage could be dangerous .For instance, missing your mortgage payments could lead to foreclosure or you losing the entire property. Also, when there is economic downturn and property values are reduced your mortgage payment could become an unnecessary burden since you cannot see the equity build up or value appreciation that was once your incentive for leverage. And finally, no matter how skillful you are in the use of leverage, do not over expose yourself. It is better to use leverage cautiously than carelessly.
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Source: http://www.punchng.com/am-business/how-to-use-leverage-in-real-estate/
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