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Increasing Real Estate Return on Investment

Gaston Reboredo • Sep 25, 2021

Using Positive Leverage, other people's money to increase returns

How to increase return on investment in residential real estate by using debt financing


I see many small residential real estate investors buying properties cash. To obtain the maximum possible return of a real estate investment an investor needs to review that he/she is renting the property at the maximum possible market rent, has a comprehensive maintenance program with cost reduction strategies and uses debt under a positive leverage situation. 


The use of debt, such as mortgage financing, is a perfect way to maximize returns on real estate investments. The only way for this to work is in positive leverage situations. 


Positive leverage is when a business or individual borrows funds and then invests the funds at an interest rate higher than the rate at which they were borrowed. 


For example, if your total investment in a rental single family home is $200,000.00 and your net total income for that property a year is $10,000.00 then the yearly Return of this investment is 5%. This is the unlevered cash on cash return of the investment, also known as the Capitalization Rate ( Cap Rate). 


If you are able to obtain a mortgage loan for the property with an interest rate below 5% this is call positive leverage and will increase the return on the investment but if the market interest rate is more than 5% this is negative leverage and will lower the return on the investment because the borrowed funds are costing more than what the investment is producing. 


In other words the positive leverage calculation requires that you know the loan constant, which is the total annual loan payment (loan principal and interest) divided by the total loan.


 The calculation is:

Loan constant = [annual loan payment] / [total loan amount]

If the loan constant is greater than the cap rate, it is positive leverage. If it is lower than the cap rate, it is negative leverage.

As an example calculation, assume a property is acquired for $200,000 and generates a net operating income (NOI) of $10,000 resulting in a 5.0% unlevered cash-on-cash return prior to using any debt. In this case, the cap rate is also 5.0% as explained above. Let’s assume we are obtaining an interest only loan.


If you as an investor are able to secure a 60% loan-to-value mortgage with an interest rate of 4.0% (interest-only), then total debt service payments would be $4,800 ($200,000 value times 60% LTV times 4.0%) and cash flow after debt service would be $5,200 ($10,000 NOI (net operating income) less $4,800 (debt service). Using debt, the investor would have contributed $80,000 of equity ($200,000 purchase price less $120,000 mortgage loan at interest only) which results in increasing the cash-on-cash return to 6.5% ($5,200 cash flow after debt service divided by $80,000 equity). This 6.5% is higher than the 5.0% cap rate and results in positive leverage.


The levered scenario obviously has a better return than the unlevered scenario. But is there a point at which using leverage is no longer a viable option? Yes — a higher interest rate can create a negative leverage situation. As an example, an interest rate of 5.2% would create an annual debt payment of ($120,000 times 5.2%) $6,240. $10,000 NOI less $6,240 debt service is $3,760. Then $3,760 divided by $80,000 is 4.70%, which is less than the 5.0% cap rate, creating negative leverage.


The use of leverage (financing) not only increases the return on the investment but also allows the investor in buying more properties because instead of putting the $200,000 as in our example above in one property, the investor can put 40% down payment which is $80,000 for a $200,000 purchase price and buy one property and be left with an extra $120,000 in hand to buy one or two more properties. This will not only dilute risk because now we have the funds invested in three properties maybe in three locations rather than all the funds in one property in one location but one of the great aspects of real estate investment is appreciation, values increase over time and are a great head against inflation and an excellent way to create wealth. For example if we use our total funds of $200,000 to buy two properties valued at $200,000 using 60% loan to value loans as in the example above, we are buying each property for $200,000 but with a down payment of $80,000 each and we still have $40,000 to buy a third property, let’s say valued at $100,000 using also financing on a 60% LTV, now we will own three properties, two valued at $200,000 and one at $100,000 so with the same $200,000 in cash, using leverage we now control $500,000 in real estate and if the appreciation rate is let’s say only 2% (usually is more than the inflation since there are many factors that influence property appreciation and not only inflation) we will be increasing our wealth by $10,000 every year since the value of all the properties ($500,000) will increase at 2%, rather than only the value of one property of $200,000 increasing at 2% which will create a wealth accumulation of only $4,000 a year instead of $10,000. 



To calculate real returns of real estate investment we perform deeper analysis than the simple one here, taking into account the property appreciation over time as explained herein, then the return is composed of the yearly return after financing plus what the increase in value of the asset. This is the calculator of an Internal Rate of Return.


So in our example if we have a total return on our $200,000 investment in three properties would be the our 6.5% yearly cash on cash return plus the property appreciation ($10,000 increase in value, which is the 2% appreciation rate times the value of the three assets totaling $500,000,  over our $200,000 total investment in the three assets) which is an additional 5%, so in a simple calculation we would make in one year a return of 11.5% over on our investment (6.5% plus 5%). Of course the portion of return allocated to the appreciation in value is not realized until we sell the property and we will have to take into account the selling costs and the time period from acquisition to the sale, which is what we obtain when we perform an Internal Rate of Return analysis. We will discuss Internal Rate of Return and Net Present Value and other topics of Financial Analysis in future blogs but the intent here is to illustrate how to increase returns on investment using real estate financing with positive leverage. 


Gaston Reboredo CCIM CPM


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Introduction: Rent control, often touted as a solution to housing affordability, has been a contentious topic in policy debates for decades. The premise seems simple: cap rents to make housing more affordable for low-income individuals and families. However, the reality is far more complex. While the intentions behind rent control are noble, its implementation often leads to unintended consequences, exacerbating housing shortages, disincentivizing investment in housing, and ultimately failing to achieve its intended goals. Market Distortions: One of the fundamental flaws of rent control is its tendency to distort market dynamics. By artificially capping rents below market rates, it creates a mismatch between supply and demand. Landlords may find it unprofitable to maintain or invest in rental properties, leading to a decrease in the quality and quantity of available housing. Moreover, rent control discourages new construction, as developers are hesitant to invest in markets where their potential returns are limited by regulations. Allocation Inefficiency: Rent control often results in misallocation of housing units. Because tenants in rent-controlled units have little incentive to move, even when their housing needs change, they may occupy larger units than necessary or stay in prime locations longer than they otherwise would. This reduces mobility in the housing market, making it harder for new renters to find suitable accommodation, especially in high-demand areas. Disincentive to Investment: Another critical issue with rent control is its adverse impact on property investment. Landlords facing rent control regulations may be less inclined to maintain or upgrade their properties, as they cannot fully recoup their investments through higher rents. This leads to a decline in the overall quality of rental housing stock and can exacerbate issues such as poor maintenance and inadequate living conditions. Shortage of Rental Units: Rent control can contribute to housing shortages by reducing the incentive to build new rental units. Developers may choose to invest in other types of real estate or in regions without rent control regulations, further exacerbating housing affordability challenges. Additionally, some landlords may convert rental properties into condominiums or other forms of housing that are exempt from rent control, shrinking the supply of affordable rental units even further. Black Market and Informal Economy: In markets with strict rent control measures, a black market for housing often emerges, where landlords and tenants engage in illegal rent agreements outside of the regulated system. This undermines the intended goals of rent control while exposing tenants to exploitation and landlords to legal risks. Moreover, the informal economy may lead to a lack of transparency and accountability in rental transactions, making it difficult to address issues such as tenant rights and housing standards. Alternative Solutions: While rent control may seem like a quick fix to address housing affordability, alternative approaches offer more sustainable and effective solutions. One such approach is increasing the supply of affordable housing through incentives for developers, streamlined zoning regulations, and public-private partnerships. By encouraging the construction of new rental units and expanding affordable housing options, policymakers can address housing shortages without distorting market dynamics. Housing Subsidies and Vouchers: Another alternative to rent control is providing direct housing subsidies or vouchers to low-income individuals and families. These subsidies can be targeted to those most in need, allowing recipients to afford housing at market rates while maintaining the flexibility and efficiency of the rental market. Additionally, housing vouchers empower tenants to choose their housing according to their preferences and needs, promoting mobility and choice in the housing market. Tenant Protections and Regulations: While rent control may not be the most effective solution, tenant protections and regulations are still essential to ensure fair and equitable housing practices. Measures such as rent stabilization, eviction protections, and housing quality standards can help safeguard tenants' rights while maintaining a healthy and competitive rental market. By striking a balance between tenant protections and market incentives, policymakers can address housing affordability without the unintended consequences of rent control.  Rent control, despite its good intentions, ultimately fails to address the root causes of housing affordability and often exacerbates existing problems in the rental market. By distorting market dynamics, discouraging investment, and contributing to housing shortages, rent control hinders rather than helps in the quest for affordable housing. Instead, policymakers should focus on alternative solutions such as increasing the supply of affordable housing, providing direct subsidies to those in need, and implementing tenant protections and regulations that promote fairness and efficiency in the rental market. By taking a comprehensive and balanced approach, we can create a housing system that works for everyone.
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