Self Help

The operative word in earning the big bucks in real estate is “leverage”. While most people have heard that real estate offers enormous financial leverage, few really understand how it works.

Leverage basically means that you buy property with other people’s money. You put in little of your own. Indeed, a basic tenet of real estate investing is that the less of your money you can put into the deal, the greater your chances for profit.

Perhaps you’ve seen this sort of thing in operation with stocks. You want to buy a hot stock that you think will soon go up in price. It costs $20 a share and you have $2000 to invest. That means that you can buy 100 shares. It’s quite easy to see that if you buy 100 shares at $20 and the stock goes to $40 a share, you’ve doubled your money to $4000.

However, what if you could buy twice as many shares for the same $2000? You may very well be able to do just that by buying on margin. Here you might put down only 50 percent of the price of the stock and, for a fee, a brokerage company might put up the other 50 percent. In other words, you’ve leveraged half the value of the stock. You only put up $10 for each $20 share of stock you bought. With your $2000 you now control 200 shares instead of 100 shares.

Now if the stock goes up to $40 a share, you’ve quadrupled your money. Because you have twice as many shares, your original $2000 jumps to $8000. Further, to double your money, the stock no longer has to double. With only a 50 percent increase in share price, you can double your investment; it only has to go up by half. You get much more bang for the buck because you control twice as many shares with the same investment cash. That’s called leveraging your investment, and savvy stock investors do it all the time.

Of course, stocks are far more volatile than real estate. And there is always the chance that your stock might go down as well as go up. With a 50 percent leverage position, when the stock goes down you’d lose money twice as fast as you would by buying the stock outright at 100 percent a share. If the stock fell to $10 a share, all of your money would be lost. That’s the risk with stocks.

Real estate leveraging works in a similar way, only a whole lot better. One of the big differences between the stock market and real estate is volatility. Stocks are highly volatile. Real estate is relatively low in volatility. While stock and bond prices bounce up and down on a daily basis, real estate prices move glacially. If real estate prices go up by 10 percent in a single year, it’s considered an enormous increase. Most investors in real estate are very happy if prices just go up by 5 percent a year on average.