Investing today is the only legit way to expand and increase a portfolio. Many investors and leaders are often in favor of investments in real estate. But buying real estate is no piece of cake. Capital is required to acquire a property and earn a return on it. But what if you were to know that you can buy real estate without dipping your hands too much or only a little of your cash?
You can do it through leveraging. It appears as a key that can be influential and helpful in expanding one’s real estate portfolio without using all, or very little of your cash in hand. So, what is leveraging, and how does it help in buying real estate?
Let’s break down the concept of leveraging and learn everything associated with leveraging/bank loans, its pros, cons, and more.
What Is Leveraging?
Leveraging of bank loans can be termed as financial tools that can help investors and people in buying real estate property without using all their funds. It is borrowed money that is used to expand the portfolio, diversify investments, and essentially earn profit. Leveraging is a technique that is used both on the main street and the wall street.
However, it should be kept in mind that leveraging is a double-edged sword. While it can bring hefty returns and profits, it can also end up in loss. Making real estate investments that will decrease in value can mean loss due to the decline in prices.
What Are The Major Sources Of Accessing Leverage?
There are some tried and tested ways that have been used to get leveraging for real estate investments. We have stated them below.
- Private Money Lender
- Hard Money Lender
- Credit Union
- Banks
These are the lenders that can lend you the money you need to purchase a real estate asset. Many people typically go to banks. However, in case of urgent requirements or short-term payment with an agreement to higher interest rates, people also prefer private money lenders and hard money lenders. One of the most popular private money is ofcourse, Parent’s money!
It is of importance to agree on the interest rates, the return terms, and duration with the lender before you sign the agreement. Typically, the buyer should also foresee how they will make the payments in the future. There are also apps these days that can help facilitate these lending. Be careful to abide by the laws of the land too. It is usually regulated and rightly so too.
What Are The Benefits Of Leveraging In Real Estate?
The most common benefit associated with leveraging in real estate is that it allows the buyer to buy a property without using all their savings or cash. So, it frees you from the obligation to have the cash to invest and earn profit. Moreover, it also allows the unique opportunity to get a maximum return by putting the minimum amount of money into the investments.
Let’s look into an example to illustrate this point further. If the interest you are paying on your loan is less than the return on your investment, you can be in profit due to leveraging. A property that has a 10% rate of return with a 6% interest will be giving you 4% in profit. So, you will be earning the 4% difference from the money you leveraged. There’s another benefit associated with buying property through leveraging/bank loans. Initially, your equity was limited to your minimal cash investment. However, with time through principal payment of the loan, it will increase.
The diagram above shows you a somewhat simplistic model of how your current capital can make up to 23.5%. Yes, there are many other factors to consider, but generally, this is how leverage has been used for generations to create amazing amount of wealth.
The benefits of leveraging can be realized even better in markets that show potential growth of real estate – like The Singapore real estate. Singapore property prices trend indicate that there was an increase of 10.6% in 2021 – it’s the highest since 2010. Singapore real estate has become the rising start in the Asia Pacific Housing Market in the last two decades. The 5 expected trends of the Singapore real estate market further elaborate it in detail.
Does Leveraging Allow For Asset Progression In The Singapore Real Estate Market?
Asset progression means selling one class of assets to move to the next one. It can be understood in the context of climbing the ladder to reach the top. Asset progression allows investors and the public to increase their revenue and the worth of their existing assets. Many Singaporeans are moving from HDB to executive condominiums as a move towards asset progression.
Additionally, it also helps homeowners move from owning one HDB flat toward having multiple properties in their portfolio. It can also pave the way towards an easy and settled retirement life.
An example can be taken to compare the difference between investing money into a fund or using it to buy leverage for a real estate property. If you were to put 100,000$ each into a fixed deposit and real estate in 1998, the outcome of both the investments would be massively different.
Your fixed deposit would be worth $119,800 in 20 years, whereas your real estate investment would be $209.230 as the real estate value grows rapidly and outgrows inflation. Let’s assume that the return was used to buy a 2-bedroom worth $1,050,000 in 2019. An 8-year holding period with an annual 5% property growth rate will make that property worth $1,477,455. The net gain of your 8-year investment would be $508,601.
So, if you’re looking for asset progression, leveraging is the best route and will provide results in a growing market like Singapore’s.
What Are The Cons Of Leveraging In Real Estate?
Previously, we mentioned that leveraging is a double-edged sword. It is so because if not done right, it can cause loss and irreparable damage to the investor. The biggest risk associated with leverage is anticipating the wrong trend or putting all your eggs in one basket. In case of a decrease in property value, the lender will still demand the originally decided payment from you that had to be paid monthly. Additionally, unless you pay off the payment, the lender has a lien on the leverage real estate property. Hence, if you become a defaulter, they have the right to foreclose your property. So, an investor can lose a huge investment in one go when he becomes a defaulter.
So, leveraging keeps the investor directly in the face of changes in the real estate market. A drastic fall in the process is never a good omen for the investors. Moreover, with commercial real estate loans, the return period is often 5 years. A fall in prices during that time can mean no refinancing. Hence, they may have to sell off the whole property to pay off the loans.
However, generally, Real Estate has almost always trended up in the longer term. Unless a fad in Scare Land Singapore, we are going to just assume this trend will continue.
How To Decide Wisely When Leveraging For A Real Estate Loan?
Several factors need to be considered when leveraging for a real estate property. These factors can be different when leveraging for a private property vs. when leveraging for commercial real estate property. However, the bottom line is to introspect, think thoroughly and look at all the factors before finalizing opting for leverage for any property. Let’s look at the important factors.
Interest Rates
Interest rates can vary depending upon several factors like the lender, the kind of property, and the time frame. Some lenders can charge as high as 12% of interest rates. However, these higher interest rates typically come with payments to be made in the short-term, i.e., 12 to 24 months. Hence, it can be safe to say that these higher rates are often associated with leveraging of commercial property.
Private property leveraging will not face such stark interest rates as the loan will have to be paid off in the next 20 or 30 years.
Terms Of Agreement
Real estate business loans can have a payment period of anywhere from 5 years to 20 years or 30 years. So, it makes sense to carefully go through the terms of the agreement and read each clause. IT will keep you up to date on all the necessary information, and you will not find yourself in the dark when it comes to payments, procedures, and clauses.
Penalties For Early Payment
Did you know that your bank or your lender can penalize you if you try to finish payments early and deviate from the agreement? It is true and works badly for the lender as they are not able to earn the pre-decided amount of profit on the loan. So, incorporate that into your cost if you plan to pay off all the loans before the pre-decided date.
Loan Fees
Investors are often caught off-guard when they learn about the actual amount of loan fees and other fees that are part of the loan agreement. Often these are one or two big fees that make the sum. However, at times these can be several small fees that will sum up to a significant amount. So, it is wise to find out in advance about any such kind of fees to be prepared and have everything ready to get the loan going.
Leveraging is a wise and smart tool that, when used correctly, can give the user the required leverage. It has been in use by financial investors, real estate moguls, and conglomerates to build their empires and earn handsome profits. So, the moral is that it’s a tool that works almost perfectly when used wisely.
