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Using Leverage in Real Estate

Archimedes made the comment, “Give me a lever long enough and a fulcrum strong enough, and I can move the world.”  Leverage is a method that allows you to control properties with little cash.

Below are examples of leverage connected with compounding.  We take a $100,000 property and assume a 6.0% inflation rate.  The return of initial cash is expressed as a percent of the amount borrowed.

Property Value After Amount Borrowed
Nothing 50% 75% 90%
1 Year $106,000 6% 12% 24% 60%
5 Years $133,820 79% 68% 135% 338%
10 Years $179,000 79% 158% 316% 791%

To take advantage of this leverage, you do not have to have a high income or assets.  You just need enough credit and the ability to correctly evaluate risks.

The economist David Baxter sets out a distinct advantage of investment real estate:

“Monopolistic or oligopolistic power does not exist within real property markets. Property ownership and especially home ownership is widely distributed.  So is the demand for ownership.  While much has been made of the concentration of the developable land, and the supposed monopoly profits it entails, new building accounts for less than 3% of the total.”

For real estate, the small investor is on even footing with the larger investors.  Real estate wealth based on capital appreciation is likely to continue because investors are allowed to use and profit from the continuing availability of leverage.

Let’s look at a real estate investment with only a 2.5% rate of inflation compounded yearly.  We will see that it is still a good investment when used with leverage.

Property Value After Amount Borrowed
Nothing 50% 75% 90%
1 Year $102,500 2.5% 5% 10% 25%
5 Years $110,381 10% 21% 42% 104%
10 Years $124,886 25% 50% 100% 249%

Some of North America’s greatest fortunes have been built from real estate.  Properly selected, real estate is one of the safest investments you can make.  It is the single biggest investment for most people.

Inflation Can Help Real Estate Appreciate

The federal government is running on an annual deficit.  The government has no politically acceptable alternatives other than to “print” new currency into existence.  While that happens inflation will creep into the general economy in the form of price inflation.  And one day, maybe in the not too distant future, we may likely see a rapid flare up with hyperinflation.

The bottom line is: As long as the dollar’s value continues to go down, people will continue to resort to real estate as a hedge against inflation.  Moreover, this will contribute significantly to the future demand for real estate. T hus creating an increase in real estate property values.

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