Leverage in Financing Commercial Property Investment

While in an ideal world you'd have the cash to buy your property without the need for borrowing, let's be realistic.

Commercial Proeprty LeverageMost people will need to borrow money to develop their commercial property investment portfolio. So understanding what leverage is, is essential if you want to be able to dictate your profits.

Leverage refers to the balance of debt you have to incur against the the equity you have. So for example, if you have to borrow much of the projected value of the investment, you are highly leveraged. By borrowing money, you are using someone else's capital to increase your investment, the more you need to borrow, the less your return and profit.

It's best to be wise before the event, and use any borrowed capital wisely. It's impossible for most people to fund a large commercial property investment on their own (unless you have decided to invest in small commercial properties). The key to success here is quite simple and logical. Only get involved in deals with the absolute best guarantee of a high return. Sound simple doesn't it? But too many investors invest with their heart and not their calculator.

For instance, you find a property that after all expenses is projected to make you nine percent a year. You find a lender who is prepared to invest seventy-five percent of the purchase price, with you funding the remaining twenty-five percent. They are going to charge you an annual interest rate of six percent.

So, for twenty-five percent of the total price, you are going to earn nine percent of the total investment. However, you are only paying the lender six percent. This means that you are three percent on seventy-five percent of the the property, and nine percent on the twenty-five percent that you invested in. Okay, three percent may not seem a great deal, but three percent of a six figure sum isn't to be sniffed at.

Problems arise though should interest rates change, lenders sell on their loans, or something happens to reduce your nine percent return. If your tenant suddenly goes bust, it's more than your nine percent that's gone - you are now liable for maintenance. When things are working out, it's great, but it can only take one simple thing to go wrong and ...

Be prepared to for the worst. Just as you have that contingency in your refurbishment budget, have one in your income budget. Budget in no tenants, and having to rent at a lower rate to keep the tenants in. If times are hard for your tenants, and they've generally been reliable, best to help them out rather than have an empty building.

Remember, if you fail to plan, you are planning to fail.

 

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