3 Benefits of Leverage in Real Estate

Post by 
Dan Croce

Most real estate investment strategies allow the use of leverage through borrowing — earning returns while using someone else’s money.

The simple definition of leverage is “using debt to increase your returns.” Borrowing money to finance projects enables investors to acquire more assets than they could otherwise afford, and to earn outsized returns proportional to equity invested. 

The name is pretty self-explanatory: leverage is a force multiplier that can substantially improve investor returns.

Let’s explore just a few of the basic benefits that leverage provides to real estate investors.

1. Enhanced Cash Yield

Investors can generate better cash flow via someone else’s money. 

Assume an investor has $200,000 to invest into a real estate project. If a $1 million property is purchased at an 80% loan-to-value ratio, the investor puts $200,000 down and finances the rest at a 3.5% interest rate on a 30-year mortgage. 

Suppose that property produces annual net operating income of $65,000. 

The investor will be on the hook for loan payments of $43,000 per year ($800,000 loan amount, 3.5% interest rate, 30-year mortgage), leaving them with total cash flow of $22,000 ($65,000 in net operating income minus loan payments of $43,000). 

This results in a cash-on-cash return of 11% ($22,000 in cash flow divided by $200,000 of invested capital). 

If the investor had to come up with a full $1 million to purchase the property unleveraged, the cash-on-cash return would have only been 6.5% ($65,000 in net operating income divided by $1 million in invested capital). 

The additional return is the borrower’s reward for taking on the risk of debt. 

80% Leveraged Investor 100% Equity Investor
Invested Capital $200,000 $1,000,000
Cash Flow $22,000 $65,000
Cash Yield 11% 6.5%

2. Better Return on Equity 

Leveraged real estate investors can use debt to amplify the returns from appreciation and debt paydown. 

In our example above, if the property appreciates by 3% from $1,000,000 to $1,030,000, the unlevered investor earns a 3% return from appreciation ($30,000 in appreciation divided by $1 million of invested capital). 

However, the investor that borrows 80% of the purchase price earns a 15% return from appreciation ($30,000 in appreciation divided by $200,000 of invested capital). 

Additionally, of the leveraged investor’s $43,000 in loan payments, $28,000 will have gone towards interest, but the other $15,000 will have gone towards principal in the first year. This $15,000 in equity from loan payments goes to the pocket of the leveraged investor. 

So, the leveraged investor made $45,000 in year one from appreciation and loan payments, while the unleveraged investor made only $30,000 from only appreciation.

80% Leveraged Investor 100% Equity Investor
Invested Capital $200,000 $1,000,000
Investment Value After Year 1 $245,000 $1,030,000
Return on Equity 22.5% 3%

3. More Favorable Tax Treatment

Leveraged investors can depreciate the entire value of the property, despite the fact that they financed most of it — which can result in very sizable tax deductions. 

If the investor purchases the $1 million property in 100% equity and depreciates the property over 27.5 years, the investor will be able to recognize depreciation expense equal to 3.6% of its invested capital ($36,000 in depreciation divided by $1 million in invested capital). 

If the investor finances 80% of the purchase price, that investor will still be able to recognize $36,000 of depreciation expense; for this investor, though, this amount is equal to 18% of its invested capital in a given year. 

The leveraged investor will be able to deduct $28,000 in interest expense on the mortgage, for an additional 14% of invested capital being expensed. 

In total, the leveraged investor will have deductible expenses of 32% of invested capital, while the 100% equity investor will have deductible expenses of only 3.6% of invested capital. 

This is a humongous difference, and investors are wise not to overlook it.


To recap, in our illustration of the leveraged investor vs. the unleveraged investor, here are the differences in outcomes:

80% Leveraged Investor 100% Equity Investor
Cash Yield 11% 6.5%
Return on Equity 22.5% 3%
Tax Deduction 32% 3.6%

There’s just one problem with leverage: it comes with  risk. Taking on debt demands heightened research and analysis to ensure investors find a loan that meets their needs and doesn’t expose their financials to an unhealthy level of risk. 

Many loans require personal guarantees from principals or have onerous hidden covenants that can put too much power in the hands of a lender. There’s no substitute for shopping around, and one investor’s ideal loan may look very different from another’s, but there’s still a few common attributes to look for. 

Prudent real estate investors should think long and hard about their risk tolerance before utilizing leverage -- but, when properly utilized, debt can produce compelling outcomes. 

Keep Up With Birgo

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
THere's More

Posts You Might Also Like

Birgo Capital

Investing in the Crazy Real Estate Market with a Small Amount of Money

Today’s housing market is not exactly friendly to the new real estate investor. Unless you have enough money to put a significant amount down on physical property, you may want to consider other avenues of real estate investment. Fortunately, opportunities still exist in this crazy real estate market to make profitable investments with a small amount of money. Continue reading to learn more about other real estate investing options.
Birgo Capital

r/realestateinvesting, Part the Second

Last time we talked about Reddit, you guys went wild for it. We continue to think Reddit is pretty great so we aren’t surprised that yinz are back for more. We don’t want to keep you waiting, so here it is: another dive into r/realestateinvesting.
Birgo Capital

Gifts for the Personal Finance Person in Your Life

Find yourself struggling to get the perfect gift for the finance person in your life? Look no further! We’ve compiled a list of some of the best ideas to give the financial person for any occasion.
Birgo Capital

How Do You Win at Monopoly? A Real Estate Investor's Thoughts

We were today years old when we realized there’s statisticians who analyze Monopoly. We're putting our real life real estate investing knowledge to the test to determine how you can increase your chances at winning the longest lasting board game on the planet.
Birgo Capital

What is Upland? An Intro to the World of Virtual Real Estate

Upland is a virtual game that exists in the metaverse. Players can buy, sell, and trade virtual real estate assets on a map that replicates real life cities. What are the implications of real estate in the metaverse for the future?