Leveraging Real Estate To Build Wealth

by : Bruce Swedal

Most people have realized that the prices of real estate have stopped rising and in most parts of the country have began to fall. Home owners consider this bad news if they were counting on their values rising quickly. The fall in prices has signaled to investors that it is an excellent time for investing in real estate.

Over the next few years there are going to be many people making money in real estate who are buying now during the downturn. Everyone has heard that the key to turning profits is to buy low and sell high. The problem for most people is recognizing the buying opportunities. In real estate that time is now!

So let's take a minute to try and understand the principals behind making money in real estate. The most important thing to grasp is something called the rule of 72.

Basically what the rule of 72 deals with is the compounding of interest on investments. If you take the interest percent that is returned on your investment and divide it into 72 it will give you the number of years it takes for your money to double. Put $5000 in the bank at 4% interest and how long will it take for your money to double. Seventy two divided by four is 18 years.

So when investing for the long term, if you put $5000 in the bank for 36 years you could expect to get $20,000 back.

When it comes to real estate investing the historical average runs at about a conservative 6% return. Markets change from year to year though and there are some years where you can see a 20% or 30% increase depending on your location. Historically real estate has been cyclical just like most other forms of investment. Cyclical markets are conditions where the market will fluctuate down at times and then move back up.

Now lets take our 6% appreciation in homes and use the rule of 72 to see how long it will take for the price to double. 72 divided by 6 is 12 years. This means one could reasonably expect the value of a home that is worth $200,000 today to be worth $400,000 in 12 years.

Now let's talk about the best part of real estate investing, leverage.

Since doubling your money every 12 years is not fast enough lets factor in the leverage that can be used when purchasing real estate. Leverage allows you access to much more capital with only a small personal investment.

Let's take that $200,000 home again. To purchase it you intend to put a 20% down payment or $40,000. Now the rule of 72 says that the price will double in 12 years and the property will be worth $400,000. During those 12 years you rented out the property and the rent provided by the tenants covered all of your mortgage payment over those 12 years. That means after those 12 years are up you will have made $200,000 from an initial investment of $40,000.

In a bank it would have taken 18 years to double your investment of $40,000. By investing in real estate with leverage and the rule of 72 you made $200,000 over 12 years from an initial investment of $40,000. You just multiplied your initial investment by 5. The best part is that this does not factor in hot markets in a rebound.

What's next? More leverage. Take the $240,000 you received from this home and use it to fund down payments on 5 more. Then watch leverage really go to work. It does not take long for someone to accumulate wealth using this formula.

You're next question, is it realistic? It is very realistic and probably leans more to the conservative side. The hardest part for most people is finding that first down payment, which can be done if you know how. Applying this concept may be possible even if you may not have 20% to put down.

If you're interested, we should talk.