Leverage
Using borrowed capital (debt) to increase the potential return on an investment.
Definition
Leverage is the use of borrowed money to increase the potential return on an investment. In real estate, this means using a mortgage to control an asset worth far more than the cash you put in. A 20% down payment gives you 5-to-1 leverage.
Leverage amplifies both gains and losses. If a $200,000 property appreciates 10% ($20,000), an all-cash buyer sees a 10% return on their $200,000. A leveraged buyer who put in $40,000 (20% down) sees a 50% return on their cash invested — the power of leverage. However, if the property declines 10%, the leveraged buyer loses 50% of their invested capital.
The key to prudent leverage: ensure the property's income can service the debt across various scenarios (vacancy, expense increases, rate changes). Over-leveraging — taking on too much debt relative to income — is the primary cause of investor foreclosures during market downturns.
Related Terms
Loan-to-Value (LTV)
The ratio of a loan's balance to the property's appraised value, expressed as a percentage.
Debt Service
The total cash required to cover loan payments — both principal and interest — over a given period.
Cash-on-Cash Return
Annual pre-tax cash flow divided by total cash invested, expressed as a percentage.
Equity
The difference between a property's market value and the outstanding balance of all loans against it.
BRRRR Method
Buy, Rehab, Rent, Refinance, Repeat — a strategy to recycle capital into multiple rental properties.
Amortization
The process of paying off a loan through regular scheduled payments of principal and interest.