leverage

4 Replies

Hi Matthew welcome to BP!!

That's not a stupid question. To me leverage in the context of Buy & Hold is 

1. Using primarily someone else's money (bank loan, seller financing, etc...) to purchase an asset such as a rental property.

2. Using the tenants money (rent) to pay for the loan that purchased the asset.

I hope this helps. 

Welcome @Matthew Holman ! Leverage in general is to 'make use of'/'Take advantage of' and in the context of investing, a phrase you might hear is  "leverage OPM" - means you're leveraging Other People's Money (OPM). i.e: You're taking advantage of funds that are not your own, to work for you.

Interesting question. Leverage means to use something to get better results. Think of the word "lever". 

In real estate investing you can increase your return by leveraging other peoples money.

e.g. If you were to buy a property for $100,000 cash and the property appreciated by $10,000, you realize a 10% return on your investment (ignoring cash on cash return and principal pay down for now). 

You could increase your return by leveraging other people's money (OPM) by borrowing from the bank, for example.

Using the same example, if you only put $20,000 and borrowed $80,000 and the property appreciated by $10,000, your return is now 50% on your investment of only $20,000. In this situation you would be highly leveraged.

The advantages of doing this is you can now invest in 5 highly leveraged properties with the same $100,000 and you will earn a much higher return. 

The problems with this is that you now have borrowing costs that you have to pay so you have to make sure you are still cash flowing.  Also this needs to be calculated in the overall return but generally, your return should be higher even after borrowing costs.