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Mortgages & Creative Financing

Investing Using Financing: Solid Way to Build Wealth or Imminent Disaster?

Leon Y.
Expertise: Mortgages & Creative Financing, Personal Development, Real Estate News & Commentary, Real Estate Investing Basics
46 Articles Written

Investing in real estate may not be as sexy as the stock market.

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It is a long, grueling process that can take many years before one can realize its true returns. While the return on real estate may ultimately be quite rewarding given the length of time, one is tempted to want the returns now and want the returns high.

That is how I approached real estate investing in Las Vegas from 2012 to 2013. I sought higher returns once the real estate prices in Las Vegas rose, and I was no longer getting high yields in my returns. In the past, I was able to get 10-12% cash on cash returns on my real estate investments, but from 2012-2013 my returns began to fall.

Related: Negotiating Seller Financing: The Definitive Guide

Using Leverage to Earn Higher Returns

Then I began investing in real estate using seller financing. As a new real estate investor I was unable to get a regular mortgage, but I was still able to get loans between 5-7%. Using financing, I was able to achieve higher returns as long as what I paid out in mortgage each month was less than the cash flow I got from tenants.

For example, there is a house that costs $150,000, which after rental expenses can rent out for $900. If I were to buy it with cash, I would achieve a 7.2%.

But if I were to buy it with 20% down ($30,000 investment) with a 5% fixed 30-year mortgage, I would have to pay $644 in mortgage, thereby netting $255 a month, $3,069 a year. If I earn $3,069 a year on a $30,000 investment, I am actually getting a 10.23% investment.

I also set myself up a greater return in future appreciation. If the house were to go up $30,000, I would have doubled my investment return, whereas if I had bought it cash my investment would have only gone up by 20% in value.

The Dangerous Side of Financing

While it almost sounds like we should all leverage our returns whenever possible, getting financing still creates risk for an investor.

Whenever there is a vacancy, a cash buyer only has to worry about paying property taxes and insurance, a small expense. However, with financing in place, the investor has to pay out $644 in principal and interest every month until a new renter comes in.

Related: Unique Strategies to Successfully Obtain Bank Financing

If the investor does not have a large cash reserve, he or she is bound to get into real trouble. Keep in mind, a $644 payment every month is about 2.15% of the investor’s initial investment. When you think of it this way, an investor can be taking a lot of risk with financing.

Creating a Healthy Mixture of Both

I generally prefer to have a mix of both free and clear homes and seller financed homes. As my portfolio grows larger, I am leaning towards owning more free and clear homes. Another side effect of leverage is that the more financed homes I own, the greater the chance is that multiple homes can go vacant at once.

The long tail risk of such an event, while small, can still cause a devastating loss to my reserves and portfolio. So the next time you consider using financing to leverage your investment, understand that you have to prepare for that rainy day, which inevitably will always come.

Do you use financing to leverage your real estate investments?

Join in on the comments below!

By Leon Y.
Leon Yang is an active real estate investor in Las Vegas. He is a buy and hold guy who also likes to flip from time to time. His main passion is to t...
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    Larry Russell
    Replied almost 6 years ago
    Nice points with a very interesting point of view. I wish I was in the position to pay cash for properties without using some sort of borrowed money to do so. Hopefully sometime in the near future.
    Michael Evans
    Replied almost 6 years ago
    You explained the risks and benefits of leverage for buy and hold properties perfectly. So the next question is how to manage the risk associated with leveraging. My company has developed two strategies: 1. Enter into long-term lease-purchase agreements to mitigate the vacancy risk. We enter into 30-year lease-purchase agreements that give the tenant the option (but not the obligation) to purchase the house at a fixed price over the next 30 years. We require a 5% non-refundable deposit that is applied towards the purchase and any major repair required during the time they have to purchase the property. We simultaneously enter into a separate by connected 30-year lease agreement that gives the tenant the option to lease the house for 30-years. They are only obligated to pay the lease for 12 months, after which they can break the lease without penalty, but upon the termination of the lease, the purchase agreement also terminates. The lease agreement is much like a lease for a car; they are paying to use the house. Just like a car, they agree to “normal wear and tear” of the house and are responsible for all minor repairs associated with the house. They have to pay penalty fees for “excessive wear and tear” of the house or they risk their lease being terminated. We provide true “property management” in that our monthly fee covers maintenance of the property (weekly landscape maintenance with also provides weekly external reporting on the property and water usage, and annual maintenance of the houses systems such as the HVAC system, pest control and floor maintenance) and quarterly internal inspections of the property to make sure there isn’t “excessive wear and tear”. We also collect rents are very aggressive in starting the eviction process upon a tenant being delinquent on their lease payment. 2. Don’t put all of your eggs into one basket. This is called “money management”, which generally states that no more than 5% of your investable funds should be in a single position. Therefore we help our clients setup each property independent of the other properties and assets they have. We use land trusts and multiple LLCs to segregate the assets and liabilities of our clients. That way if one property goes under, it doesn’t affect the remaining properties and assets owned by our client. We also use diversification counter-cyclical investment strategies to mitigate the risks inherent with leverage. Leverage is the most powerful tool for increasing wealth (followed next by compound interest). At Help Keep My Money LLC, we pride ourselves in developing investment models that lower risk and produce above-average returns for our clients. God Bless You!
    Michael Evans
    Replied almost 6 years ago
    You explained the risks and benefits of leverage for buy and hold properties perfectly. So the next question is how to manage the risk associated with leveraging. My company has developed two strategies: 1. Enter into long-term lease-purchase agreements to mitigate the vacancy risk. We enter into 30-year lease-purchase agreements that give the tenant the option (but not the obligation) to purchase the house at a fixed price over the next 30 years. We require a 5% non-refundable deposit that is applied towards the purchase and any major repair required during the time they have to purchase the property. We simultaneously enter into a separate by connected 30-year lease agreement that gives the tenant the option to lease the house for 30-years. They are only obligated to pay the lease for 12 months, after which they can break the lease without penalty, but upon the termination of the lease, the purchase agreement also terminates. The lease agreement is much like a lease for a car; they are paying to use the house. Just like a car, they agree to “normal wear and tear” of the house and are responsible for all minor repairs associated with the house. They have to pay penalty fees for “excessive wear and tear” of the house or they risk their lease being terminated. We provide true “property management” in that our monthly fee covers maintenance of the property (weekly landscape maintenance with also provides weekly external reporting on the property and water usage, and annual maintenance of the houses systems such as the HVAC system, pest control and floor maintenance) and quarterly internal inspections of the property to make sure there isn’t “excessive wear and tear”. We also collect rents are very aggressive in starting the eviction process upon a tenant being delinquent on their lease payment. 2. Don’t put all of your eggs into one basket. This is called “money management”, which generally states that no more than 5% of your investable funds should be in a single position. Therefore we help our clients setup each property independent of the other properties and assets they have. We use land trusts and multiple LLCs to segregate the assets and liabilities of our clients. That way if one property goes under, it doesn’t affect the remaining properties and assets owned by our client. We also use diversification counter-cyclical investment strategies to mitigate the risks inherent with leverage. Leverage is the most powerful tool for increasing wealth (followed next by compound interest). At Help Keep My Money LLC, we pride ourselves in developing investment models that lower risk and produce above-average returns for our clients. God Bless You! Reply Report comment

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