Leverage is one of the key factors that makes real estate investing an appealing option for many investors. Leverage, simply put, is defined as using borrowed capital debt or equity) to purchase an investment. When properly executed, leverage will increase the potential return on your investment.
Unfortunately, there are many risks associated with leverage, many of which are common pitfalls that investors make that lead to a serious loss in equity. Understanding these common pitfalls and devising risk-reducing strategies for leverage investments is critical in making savvy investment choices. Below you will find :
5 Risk-Reducing Strategies for Real Estate Leverage Investing
1. Look for investment opportunities in “Up and Coming” neighborhoods.
Simply put, you want to invest in properties in neighborhoods that could be characterized by the following attributes: healthy rates of growth in development, overall neighborhood improvement through the revitalization of community amenities, and promising comparables (also known as “COMPS”). Although simple in concept, it is often overlooked by many investors which causes high vacancy rates in multifamily buildings, low return on investment, and meager equity gained. Generally, the best investments are found in neighborhoods that have the highest rate of growth.
2. Identify multi-unit buildings with below market rents.
Multi-family buildings with rents below market rents give the investor the opportunity to close the gap, resulting in better cash flow. Additionally, identifying properties with opportunities to do upgrades or remodel to increase rent is also helpful in reducing risks for real estate leverage investing. Better cash flow means more money to invest in other opportunities or to take care of issues that may arise that would otherwise be difficult to cover if lacking liquidity.
3. Find favorable financing that allows increased liquidity.
Understanding the best financing for your particular situation is critical. Increasing your cash outflow by decreasing your monthly loan obligation is helpful. Additionally, lower interest rates and identifying the right type of loan are also essential. For example, if you know that you aren’t planning to keep a property longer than 10 years, an ARM (Adjustable Rate Mortgage) might be a better choice to lower your interest rate, resulting in lower payments and more liquidity when it comes to cash flow.
4. Make a higher down payment. In continuing with the idea of lowering monthly payments and increasing cash flow, simply increasing your down payment can tremendously reduce risk associated with leverage investments. Of course, this is dependent on your ability to be able to produce the additional cash needed to provide the higher down payment. Additionally, this could reduce your return on your investment initially as you have invested more upfront, but reduces your debt, which can make a tremendous difference in situations such as high vacancy rate or credit loss.
5. Pick properties that you can improve while still making a profit.
Simple in concept, but often one of the most difficult for investors to grasp. You want to select a property that needs improvements that will increase the value of the property, which ultimately will increase equity earned, resulting in greater profits. Making the right improvement decisions as well as picking a property in which the needed improvements are proportionate to the return on those investments is going to be critical in ensuring that you have the best chance of receiving the optimum return on investment upon liquidation of the asset. This concept is also applicable with rentals when making improvements to justify a higher rent.
Ultimately as an investor, you want to make savvy decisions that will reduce your risk but increase your return on your investment. Understanding how leverage can maximize your earning potential, but also avoid common risks associated with leverage investments, you can truly master the art of investing wisely and see healthy profits!
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