Real Estate Financing

The viability of real estate finance depends upon numerous variables and vicissitudes in the market. If you wish to finance a real estate you need to consider several factors, not the least important of which are the leverage and interest rates. Since the opportunity costs have far reaching effect on the present cost of an investment, the interest rates on the value of investment can never be ignored especially in real estate.

Using Leverage in Real Estate Finance

Several investors use leverage in buying real estate primarily for two reasons. The first reason is the affordability. Real estate requires huge investments of millions of dollars and most investors do not have that much cash to invest without leverage.
The second reason for using leverage is the yield enhancement. Leverage can enhance returns on any investment if the cost of leverage is lower than the yield returned on the investment. Therefore the type and the amount of leverage deployed will make deep effect on the risk level and the potential rate of interest on any investment.

Take for example the case of an investor who gets a chance to buy a property worth one million dollars. He leases the property for 100,000 a year to a tenant who agrees to bear all the expenses. Lease payments will increase, say at the rate of 6% per annum for the next ten years. The investor can sell off the property at the beginning of the 6th year for the same rent multiple that is 10 x at which it was purchased.

Considering the before-the-tax cash flows, the rent at the beginning of the 6th year would escalate to $133,823 and the anticipated sale price would be $133,229. Discounting the tax effects and costs of the sales the internal rate of return on the investment of one million dollars would come to be around 16 percent.
Suppose the investor has borrowed 800,000 dollars @ 10% for thirty years. After discounting the debt service amount of $ 84,247 and mortgage expenses from the sale price of @1,338,229, the investor is left with a net of $ 565,631 which comes to an internal rate of return at 32% on the initial investment of $200,000. The income obviously is double the amount of actual investment.