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Real Estate Leverage and How it Works

by Guest on Jul 7, 2012 General Property 1000 Views

I would like to explain how leverage can be the essential ingredient to creating wealth. We all understand there are many types of property to consider when buying real estate as an investment. Each property is unique and can be bought with various goals in mind for ROI (return on investment) . Income producing real estate is bought with the emphasis on the cash flow it produces while land might be purchased with hopes of appreciation over time. The average person with $100,000 who buys a $100,000 property. Who pays cash and then sells it for $125,000 thinks he has made 25% on his $100,000 investment. An astute real estate investor will take that $100,000 cash and perhaps buy 10 properties at $100,000 each putting $10,000 down on each and mortgaging the other $90,000. This investor now owns $1,000,000 worth of real estate.

Now I realize I am skirting details like closing costs,cash flow etc but an astute investor would be sure of things like debt service and money for closing costs. An astute investor might even get the seller to pay the closing costs. An astute investor would leverage that $100,000 into $1,000,000 worth of real estate.  Let us assume it took the average person 5 years to cash out for the $125,000 and make his $25,000, and let us assume the same results for our astute investor.  That 25% return (say 5% per year not compounded = $25,000 on the average persons property purchased for $100,000. our astute investor cashes out for $1,250,000.00 . His profit is $250,000, yet both had $100,000 to invest. The average person made 25% or $25,000, but the astute investor made 250% or $250,000 with the same amount to invest over the same amount of time.  The astute investor made 1000% more than the average person, that is the power of leverage in relation to real estate. Did the astute investor have more risk and hassle? Of course. Was it worth it?  I believe so.

I realize this may seem far fetched to some people especially in these economic times.  I have helped my customers do this time after time over my 35 year career as a real estate broker, mortgage broker and appraiser.  This is my third recession in my 35 years and I have made more money by investing in real estate than I have working in real estate.  I have a saying, "The money is made in the buying."  The three most important qualities of a good real estate investment are of course location, location and location.  I have another saying "It is not what you make but what you keep that counts."  What you net after taxes is the money that you get to keep and spend.  Astute real estate investors maximizes leverage and minimize tax, that is how true wealth is created.

In my 35 years of listing and selling real estate I have learned that structuring the sale to minimize tax for the owner can make or break a deal.  In many cases you can save the purchaser interest and the seller tax.  This type of transaction actualy saves both buyer and seller money and enhances your reputation as a competant negotiator.

Whether you are a real estate broker, accountant, lawyer or mortgage broker you can enhance and improve the value that you bring to the table by understanding how you can help your customers to minimize tax by structuring the terms of any sale to take advantage of legal tax regulations.  For example in Canada there is a $750,000 tax exemption if you sell shares in a Canadian company.  Does your customers business qualify?  If it doesn't can it be restructured to qualify?  This is an individual exemption, so each family member has the $750,000 exemption.  It is important how shares held.

You can see how the planning and structuring before listing a business,corporation or real estate can be so important when it comes to what the owner will net after taxes. This all needs to done before a transaction is entered into. This can sometimes take up to two or three years especialy for an operating business. The whole operation in regards to preparing tax returns and share structure.Organization of employees and sub-contracters may all have to be addressed before the owners are able to qualify for any tax exemptions.

I have only scratched the surface of how leverage and real estate work to create wealth.  I have also given you an indication of how important the tax issues are, and I want to thank you for reading my article and I wish you well with all your real estate related endeavours.

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