Lease Purchase 1

Nothing down

How to use leverage to buy property

Wednesday, July 19, 2000 By Robert J. Bruss

I had a real estate nightmare recently. I dreamed my second home-vacation condo burned to the ground. Not only did I lose its nice furnishings, I lost my about $100,000 equity.

Thankfully, it was just a bad dream. When I visited my condo a few weeks ago, everything was fine. But that nightmare brought home to me the advantages of leverage and the reasons for not tying up too much equity in one property.

(First in an eight-part series. See part 2)

Yes, if there really had been a fire, the condo homeowner’s association would have a legal obligation to either rebuild the structure or distribute the building’s fire insurance proceeds to the condo owners.

But I would have, at least temporarily, lost my $100,000 equity. As a result of that nightmare, I’m now shopping for a home equity loan for that condo (since I don’t want to disturb its low balance first mortgage at a low interest rate).

The point of telling about my nightmare is to show that without real estate leverage, in the event of a fire or other disaster loss, any real estate owner with a large equity can suffer a significant financial setback that could be avoided by using leverage.

In other words, just as it’s smart not to own more than 5% of your stock market portfolio in one stock investment, it’s wise not to put all your eggs in one real estate basket.

What is real estate leverage?

Real estate leverage means controlling all of a property’s benefits with only the small cash amount of the down payment.

When I began investing in real estate, it was standard to make a 20% or 25% cash down payment and obtain a 75% or 80% home mortgage. Occasionally, highly motivated sellers would carry back a second mortgage of 10% or even 15% of the sales price.

I remember paying a now-astronomical 20% down payment on my first home—actually, as long-time subscribers know, it was a triplex with a house in front and two rental apartments at the back by the alley. I bought my current residence the same way with a 20% cash down payment.

Today, real estate high-leverage opportunities are much easier. Countrywide Mortgage offers 100% home financing if you have good income and good credit. Fannie Mae and Freddie Mac heavily advertise their 97% mortgages. They don’t even care if the 3% "down payment" is borrowed on your credit cards or from a bank loan.

The most important leverage benefit is controlling the entire property with little or now cash. Yes, there are monthly mortgage payments to make. But those payments are usually about the equivalent of rent for a similar quality rental, after considering the income tax savings from the mortgage interest and property tax deductions.

Please remember that once you control the property as its owner, thanks to the "magic" of leverage, your receive 100% of its market value appreciation—even if you made a zero cash down payment.

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