Why Real Estate? The Leverage

Why Real Estate? The Leverage

Do you like to buy things? Even if you don’t, imagine for a moment, that you do, or at least for the moment that you’ve found something that would be very valuable to you that is for sale at an unbelievable bargain. Maybe it’s a more fuel efficient car, or that coin that’s missing from your collection, or a work of art. Whatever it is, you check your wallet and your bank account and you don’t have enough to pay for it. What do you do?

For many cautious and responsible people the answer would be to go home, save their dollars until they can pay for all of it themselves, all at once, then go back and hope it’s still there for the same price. Many of these people are my friends, and for many types of purchases I would do exactly the same thing. When I’m drooling over a new kitchen appliance to further fill my already overstuffed kitchen with devices of convenience that protect me from the dreadful horror of having an imperfectly crisped grilled cheese sandwich or waiting an extra 20 minutes for my soup to be cooked… I fully agree, it’s either cash, or nothing, no matter what kind of bargain the thing is being sold for.

But when a thing is on sale and that thing actually would make me money if it were in my hands… that’s a different story entirely. Maybe the thing is a 100g coin of pure gold at an estate sale for $1,000. Well the current price of gold is $42.38 per gram, so even if the coin is a waste of a stamp, then the gold itself is worth $4,238! If I don’t have the money in my pocket, maybe someone else does! I’ll call a friend, and get them to bring the money, then once they’ve bought it for me, I’ll get it appraised and resold and my friend and I will split the profits in a way that seems fair. If I had waited, someone else would have bought the coin, or the coin would have changed price, or the price of gold would have changed, or the seller would have lost the coin… or SOMETHING would have happened to stop the deal.

Believe it or not, a clever person who’s looking will frequently find bargains that when bought, will make their buyer more money. Once you can see those bargains you’ll still need a moneyed friend, but for a whole different reason: the time that you might think about saving money could instead be spent finding and executing more deals that make way more money than you can save!

Here’s what’s so great about real estate: there is no other asset class in which it is so conventional, common, and so widely accepted to buy the asset using mostly or sometimes even entirely someone else’s money. It’s practically assumed that if you own real estate, you also have a mortgage. While to the debt averse or to the financially illiterate that may seem like a bad thing, it’s actually a very good thing because most real estate either is or could be income producing.

Suppose a property produces $1,000 per month and costs $100,000. Let’s say that you can save $2,000 per month. Would you rather wait 50 months and hope that the property will still be available at the same price, or buy the property now and give $500 per month to your lender? In the latter case it will only take you 40 months to save $100,000, and if after saving however much you borrowed, you want to pay off the property you know the opportunity will still be available!

Now it’s more complicated than that. Lenders have a wide array of tools that they use to ensure that their real estate investing borrowers stay honest, safe, and responsible with their money, but by and large it is a very successful partnership between real estate investors and lenders. There are many companies, individuals, and financial institutions that are only too happy to lend against real estate and eagerly await the next deal a real estate investor will bring them.

Here are some of the advantages they’re seeing:

  1. Real estate cannot be stolen or lost, so a lender doesn’t have to worry about their borrower losing their collateral.
  2. Real estate interests are recorded with the county, so a lender can be sure that the borrower does actually own the collateral. The lender can also be sure that their interest is not disputed by recording it with the county.
  3. Real estate holds value well, so a lender doesn’t have to worry about their loan becoming under collateralized.
  4. Real estate is a VERY old and well proven business model that most people understand, so a lender can be confident that there is some profitable use for the property.
  5. Real estate is easy to insure, and there are many businesses that make it easy and convenient for a lender to be confident that a borrower is protecting the financial interest in the property.
  6. Real estate loans are very common, so the lender can often sell a real estate backed loan to get their money back whenever they want.

If you had a few spare hundred thousand dollars wouldn’t you want to lend against something that could keep your hard-earned money safe for you like that?

If you’re interested in lending, give me call, but let’s assume for the moment that you want to stay on the equity side of the real estate business for the moment and dig a little deeper. What if you DO have the cash to pay for the income producing thing you want to buy? What value does the incredible lendability of real estate have for you?

Even if I had WAY more than enough cash to do it, I would not pay for a piece of real estate using mostly my own money and if I owned free and clear properties I would refinance them. It would be worth it, and there are several reasons why.

The first reason is that my personal finances are limited and for the same $100k of my own money I’d rather own three properties producing $500 of extra cash flow per month each for $1,500 per month total than just one producing just $1,000. I can always find additional uses for the cash that will pay at least as much as a conventional mortgage, so at least for my properties that I own long term, I always know I can make more money by having more money available.

The second reason is that I don’t want to be a target. Real estate records are public and anyone who wants to know can find out if a property is free and clear. For an aggressive attorney, “free and clear” is equivalent to “juicy target”, and if they can find a cause to force the sale of that property that is convincing to a judge they can get a nice payday. If that property has a mortgage on it that same attorney will know that if they do get a judge to force the sale a mortgagee will very quickly show up saying “Hello, Mr. Judge, that money is legally owed to me.” and the attorney will have to satisfy himself with whatever small amount of value I leave between the forced sale value of the property and the mortgage value.

The third reason is that I have a team of lenders and I need to keep that team rolling, even if the additional money isn’t particularly valuable to me at the time. I borrow money from people I trust and like, and I do it often because I want to maintain those relationships and I respect the value they’re bringing when they lend to me. This is in particular important for lending relationships. In most other industries if you are desperate they don’t really care and will be happy to help you. Are you starving? Pick any grocery store and they’ll sell you some food, whether they know you or not. Are you injured? The ambulance driver doesn’t care who you are, they’ll help you anyway. Not so, lenders. If you are insolvent, an estranged lender will not help you. They’ll stand by and watch you go bankrupt; not because they’re cold-hearted, but because it’s better than them taking the chance both of you go bankrupt! So I go to my lenders when I don’t need them and they help me to make sure I never do.

You can tell by now that I am a fan of debt. I love debt like a carpenter loves a hammer. Just like a hammer though, debt can be used poorly and improperly; indeed, it often is. Many people hurt themselves financially by failing to understand and improperly using debt that they are able to get. So many in fact that some financial advisors give up on teaching people how to use debt and recommend that individuals not use debt at all for anything. As long as capitalism exists, however, debt will remain a powerful tool for creating wealth, which will go to those who understand how it is safely used and that tool shines nowhere better than in the field of real estate investment, and an investor who masters its use will be well and handsomely rewarded!

Leave a Reply

Your email address will not be published. Required fields are marked *