By Fred Matera, CIO, Redwood Trust A lack of affordability will lead to near-term weakness,…
While the old adage reminds us, “cash is king”, savvy investors across all asset classes have grown and continue to grow their portfolios using a variety of investment strategies and financial instruments outside the almighty dollar. Cash may be king, but leverage can be applied to build and expand the kingdom. Have you ever wondered how real estate investors seem to keep growing their portfolio property after property without saving up for years to put down a deposit? It’s not magic, it’s using a tactic called leverage – borrowing capital for (an investment), expecting the profits made to be greater than the interest payable.
Some investors want to build a real estate empire while other are just looking to renovate their kitchen. No matter what your cash-out financing needs are, let’s dive into the benefits of using equity in your investments.
Leverage is a dynamic concept. With access to debt, innovative investors can creatively stretch their investment dollars further, taking full advantage of opportunities within the marketplace. From a real estate investment perspective, leverage has become an integral resource for homeowners and portfolio investors alike. Taking out a mortgage to buy a house is a form of leverage.
Equity within investment portfolios (residential real estate portfolios, for example) is a resource which can be used—via financing—to grow one’s investment footprint. In a vibrant marketplace of endless investment opportunities, it is important to fully explore and leverage the equity within existing investments to recognize the greatest returns.
Here’s a simple example. You buy an asset worth $100,000, putting a 20% deposit ($20,000) and borrowing the remaining 80% ($80,000). Overtime, the property’s value increases by $25,000. The 80% mortgage would now be 64% of the property value – or less if you’re paying off the principal as well as the interest. You refinance (utilizing Corevest’s bridge program), increasing your mortgage up to 80 per cent of $125,000. You then create a fund with $20,000 which can be used in a variety of investments. Utilizing leverage, the investors pocket book is magnified, providing greater “buying power.”
Your Personal Blueprint
No two investors are the same. It’s hard to generalize when it comes to productive investment strategies. Much can be learned from the performance of our peers and the market, but ultimately, each investor’s investment strategy is unique. It’s essential to plan ahead, considering all your options and opportunities, before delving into the debt world. Leverage, when used strategically, can significantly amplify an investor’s opportunities and returns.
Jane Slack-Smith, the Director of her own award-winning, Australian-wide mortgage brokerage, Investors Choice Mortgages, says “It’s important to have a clear initial plan of how you’re going to set out your finances. If you plan to buy two properties, ensure you have enough equity to cover the deposit, stamp duty and buyer’s agent fees for both purchases.”
The primary distinction between an amateur investor and a seasoned veteran is their understanding and expectations of portfolio performance now, in the near future, and in the long term. Smart decisions—big and small—make all the difference when building or growing investment portfolios. Equity is more than static capital but a source of expansion when leveraged strategically, and should be used for needs rather than wants in most cases. Houses, fixtures, appliances or other durables rather than exotic vacations and lavish weddings.
With all investments, there are risks. There is a direct correlation between risk and returns. When applying leverage, it is important to remain cognizant of one’s risk tolerance. It is important to balance the utilization of financial resources.
As Jay Voorhees, broker and owner of JVM Lending, a mortgage company in Walnut Creek, California, says, “It all comes down to responsible borrowing.”
Some Benefits of Equity from Leverage
Leverage provides a great opportunity for investors whose home has risen in value to access a larger equity cushion.
- First, equity can be used to invest for a higher return as long as interest rates remain low. (NOTE: This is only true when used efficiently!) It’s inexpensive cash. If you can borrow at 4% and turn around and make an investment in the stock market and yield 8%, you made an extra 4% on your money.
- Second, equity could also be a good source of funds to start a business or further your education because you would be putting that money in human capital to increase your earnings in the future. In these cases, an objective adviser is recommended to make sure your investment is solid.
- Third, a very popular option would be to use your equity to put it towards home improvements. This ranges from an addition, cosmetic changes, kitchen and bathroom updates, finishing a basement or building a garage.
Overall, leveraging equity in your investments could be a great way to build your portfolio if you do your research and plan accordingly. In the words of Allan F. Mogenson, “work smarter…not harder!”
CoreVest is a leading provider of financing solutions to residential real estate investors. We provide attractive long-term debt products for stabilized rental portfolios as well as credit lines for new acquisitions. For more information about how CoreVest can help grow your rental and rehab business, please call 844.223.2231 or submit our contact form.