Have you decided to invest in housing? You can do it in two ways: by requesting financing for the operation or not. In this post, we tell you what leverage is in a real estate purchase and how the profitability of a leveraged real estate transaction is calculated.
What is real estate profitability?
When a person makes a real estate investment they want to make a profit. In this sense we understand the concept of return on investment (ROI). There are several ways to calculate the profitability of a real estate investment. The final result is the money obtained after deducting expenses. Therefore, the lower the expenses, the higher the profitability.
Many buyers consider the possibility of investing by purchasing a home to rent or renovate and obtain a return. In fact, the operation can be done in several ways:
– Using own funds for 100% of the operation, which assumes more risks.
– Using a portion of your own funds to pay the price of the home (50% of the purchase price can be covered, for example). Meanwhile, request bank financing for the other party.
– Financing 100% of the purchase and sale without using your own funds.
Financial leverage occurs in the second case, as we will see below. It is because a part of the investment is “leveraged” with financing from a bank.
What is leverage in a real estate transaction?
Leverage in the purchase of a property consists of using financing to carry out the operation.
In addition, real estate leverage provides various advantages such as the following:
– The risk decreases. Because the buyer does not use all his savings to purchase.
– Financial profitability increases.
– The possibility of conserving capital for other projects.
– The realization of the investment for which we do not have 100% of the capital.
What types of leverage exist?
We can distinguish three types of leverage in a real estate investment operation:
– Positive leverage. In this case the profitability of the operation is higher than the interest on the mortgage loan that has been requested. Therefore, the operation is profitable for the investor.
– Neutral leverage. The profitability obtained from the investment is very similar to the amount of interest that has been paid on the mortgage loan. In this way, the investor neither loses nor gains money.
– Negative leverage. In this case, the profitability obtained from the investment is lower than the interest paid on the loan. Thus, the investment is not profitable.
What to take into account so that the profitability of a leveraged real estate transaction is positive?
There are various factors that will influence the final profitability of a leveraged real estate transaction, which are the following:
– Purchase price of the home. The price of the home that the investor buys will be influenced by aspects such as the location, condition, quality of the construction materials, the services available, the time it has been on the market and the urgency that the seller has to carry out. the operation. Thus, it is important to check that it is a price in line with the market and that it is not inflated.
– Operation costs. Another essential factor is the costs of the operation. For example, the taxes on the sale, interest on the mortgage, the renovation that must be carried out on the apartment, the fees of the notary, property registrar and lawyer involved in the operation or the costs of an appraisal.
Rent
If you buy the property already rented, it is important that you carefully analyze the content of the rental contract. Specifically, you should study several aspects that will influence the profitability of the investment:
– Annual rent paid by the tenant.
– Duration period of the contract and whether there is a mandatory deadline. The objective is that the rent paid by the tenant covers the interest on the loan you request to finance the operation.
– Expenses and taxes that are passed on to the tenant. In the rental contract it can be agreed that certain expenses and taxes will be passed on to the tenant. For example, the Real Estate Tax. In that case, it will be a cost that the investor will not have to assume for the duration of the lease.
– Situation of the residential market. A very relevant aspect that will influence the profitability of the leveraged real estate operation is the situation of the residential market. Therefore, it is advisable to analyze the trends to verify if the prices of homes similar to the one you want to buy are rising or falling. Furthermore, the market situation will also influence whether the home is rented. It may happen that demand or supply varies, that regulations are approved that limit prices and that, as a consequence, prices go down or up.
For this analysis, you can consult with an expert real estate advisor who knows the market in depth and knows how to detect trends for the future.
– Financing. It is also very important that you properly calculate the amount of financing you need, since if you request financing and later costs appear that you have not considered, the profitability of the operation could be affected.
– Speed with which the sale is made. When you calculate the profitability of a real estate transaction, you consider a specific period of time. Therefore, time is a factor that also influences the transaction. After having made the investment, renovated the house and put it up for sale, if you take a while to find a buyer and close the transaction, profitability will suffer. Because you will assume more maintenance costs, community fees and taxes. In this sense, in our post Real estate tricks to sell your apartment quickly, we give you several tips so that the sale does not take longer and profitability is not affected.
Example of how profitability is calculated in a leveraged real estate transaction
To understand how profitability is calculated in a leveraged real estate transaction, let’s start with an example:
Juan buys a home in Barcelona for an amount of 200,000 euros. To buy it, he uses 100,000 euros of his savings and asks the bank for another 100,000 euros with a mortgage, which charges him total interest of 10,000 euros. He decides to renovate the house and invests 30,000 euros. Then he sells it again for 270,000 euros. Therefore, the profit obtained is 30,000 euros.
Therefore:
Concept Amounts
Purchase price of the home 200,000 euros
Savings used in the purchase 100,000 euros
Mortgage -100,000 euros
Total interest -10,000 euros
Housing renovation -30,000 euros
Sale price of the house 270,000 euros
Benefit 30,000 euros
Profit percentage 30%
In this case, the profitability of the leveraged real estate operation is positive. However, as we have seen, it can be neutral or negative, depending on the costs that arise. That is why it is important to do the accounts very well and have the help of an expert real estate consultant.
In short, knowing how the profitability of a leveraged real estate transaction is calculated is the first step in making an investment when buying a home, either to resell it later or to rent it for a while.
What is needed for the mortgage
in a second home?
