Investing in real estate brings incredible and unique opportunities by using leveraged cash and bank financing to own and control far more real estate than the initial cash investment. AND, we are rewarded as investors beyond our initial investment of cash with deprecation, potential appreciation from the market, cash flow, and the tenant paying down our property through their rent. Real estate is an incredible asset, and one that the wealthiest of investors in the world have used to build, grow, and sustain their wealth through generations.

The first challenge in scaling using leverage is to understand the upside and downside of using leverage. There is not a right or wrong answer, but it’s good to understand the principles and make a conscience decision of how you want to build your portfolio.  

Leverage as a tool.

The higher the leverage, the higher the inherent risk in the deal but also the larger the potential returns on your investment, since you have less of your own cash in the deal. Then, as you put more cash and use less leverage you have lower risk, but also a lower return on your cash since you have used less financing.

Let’s use a $100k property as the example with a 30 year mortgage. If you put $20,000 down on the property it took 20% of the value of the property to control and buy it. Versus, you put $35k down on the property, which is lower leverage and a lower mortgage payment. However, you took $15k more cash to control the same property. The latter example shows the example of a lower risk, and lower cash on cash return.

Many investors want to use as little of their own cash, and put down the 20% or 25% required by the bank to acquire the number of properties they want to. Then they worry about paying the mortgage down, managing the cash flow of their properties. They also think about how long they want to hold those properties. Do they want to hold them for 5 years, 10 years, 20 years? And, what is the exit strategy beyond that? Will they refinance the debt and take some cash tax free? Or sell them through a 1031 exchange from more or bigger properties? These are both great options (that also don’t have a tax bill attached to them!)

Create the end goal for your portfolio now.

How big do you want to grow? Do you want 5 properties, 10 properties, 40 properties, or maybe even 100?  If you are looking to scale up to say 5 properties, and your goal is to have all 5 properties paid off in a few years and be debt free, then we’d suggest you pay a little more down on the properties and or consider doing a 15 or 20 year mortgage. Putting more down on the properties does take more cash but if you want them paid off in a few years anyway, you are starting with less debt to pay down.  By using a 15 or 20 year mortgage, this also takes less time to pay the mortgage down completely, costs you less in interest, but will have a higher mortgage payment since its based on 20 years of payments instead of 30.

If you say you want to grow your portfolio to 30 properties over 10 years, then you have to figure out both the cash down as well as the financing for those properties. From a leverage perspective, in order to acquire those properties you will need a significant amount of cash to buy them, so the less you have to put down the more properties you can purchase with the same amount of cash. Let’s review the same example of a property as we did earlier. if you average the same $100k house, with 30 houses, you would need $600k total cash down with 20% down, and $1.05 million at 35% down. That’s a more than $400k difference!

As far as the actual financing, you want to first look at the Fannie Mae mortgages. They are the easiest to get, and you can have the lowest available interest rates as well as 30-year amortization. But, you aren’t stuck at just 10 properties. From here, you can speak with your bank about using commercial mortgages or portfolio loans from your local bank.

There are many different types and variations of these loans, and we aren’t trying to cover all of them here. But, the loan products are out there for you to scale your portfolio as big as you want to.

Final Thoughts

First, think about the way you want to use leverage, and the percentage you want to put down on each of your properties. It’s your philosophy of investing. It can definitely change over time, but thinking this through ensures you’ve given it the thought it requires and made a conscience decision on how you want to proceed.

Second, have a clear plan on how many properties you want to own. Do you want them paid off, or continue to use the leverage long term? Are you holding the properties “forever” or are you going to hold them for 10 years and then 1031 exchange them into something else? Your plans can definitely change or grow over time, but have one from the beginning so you are making decisions based on what your goals are.

Regarding financing, spend the time making relationships with your local community banks, if you want to scale well beyond 10 properties. Working with these types of banks helps with scaling and growing because you get to work with the bankers and teams who are making the decisions on your loans.

And finally, no matter where you are on your investing journey, take action. Don’t wait. Save your money. Create a plan. Find the property you want to invest in, and start changing your life through real estate today.