- Leverage is the use of debt to increase the potential return on an investment. Mortgages are the most straightforward example of this.
- With leverage you can often increase your % return without putting up the entirety of a purchase price
- In the event of a real estate market downturn, leverage can be a double edged sword as the magnifying effect on the positive return is mirrored in a negative return environment
- As a Lotly investor, you benefit from the magnifying power of leverage without taking on the mortgage yourself
What is leverage?
Wondering why so much wealth is created in real estate? The answer is leverage.
Leverage is the use of debt, or money borrowed from banks, to increase the potential return of an investment. Mortgages are the most common and straightforward example of leverage.
Instead of paying the full price when buying a property in Ontario, investors are allowed to borrow up to 80% of the home value from a bank in the form of a mortgage. This means that for every $1 an investor puts in, the bank puts in another $4. Leverage helps us purchase assets we otherwise could not afford.
How does leverage increase returns?
Let’s consider the following scenarios. Assume you want to purchase a $1M home. Without a mortgage, you have to pay $1M out of pocket. With a mortgage, you only have to cover the down payment, which is $200K (20%) for investors.
Now, say the property goes up $100K (10%) in value, and it's now worth $1.1M
In the case of no mortgage, the math is quite simple: your return on investment is 10% ($100,000 of net return divided by the cost of investment of $1,000,000).
When a mortgage is involved, you need to first pay back the bank the $800K you borrowed, and then you are left with $100K in profit. Since you only put down $200K as the initial investment, your return on investment is now 50% ($100,000 / $200,000)! That is a 5X increase, thanks to the use of leverage.
What happens if the housing market goes down?
While leverage helps investors get higher returns when assets appreciate, it can be a double-edged sword. This is because the magnifying effect goes both ways. If the property loses 2% of its value, the investments would be worth 10% less. With a mortgage, your downside is capped at your initial investment. Unlike some other types of leverage that can make you lose more than what you invested, your loss in real estate is capped at your down payment.
Do I get leverage with Lotly?
As a Lotly investor, you can benefit from the magnifying effect of leverage without taking on a mortgage yourself. Our properties have a down payment of 20% with the other 80% being covered by a mortgage. This mortgage is held by the homeowner and you are not involved. You will not be required to apply for the mortgage or make any payments.
Real estate is such a great investment partly because mortgages provide leverage, and investors can use less out of pocket money. At Lotly, by becoming co-owners through down payment assistance to acquire shared equity, you get the benefits of a mortgage without taking on a mortgage. If you are interested in this new way of real estate investing, sign up today!