The leverage effect of a rental investment , what is it? A magic power or a Pokémon? Not quite…
In fact, leverage is a financial notion . You are disappointed? Rest assured, you will not be when you understand how it enriches you with money from the bank . This is called real magic!
If you have decided to invest in a property , you will sooner or later ask the question of its financing. So you have two options: tap into your savings or borrow from the bank.
Your first intuition may be to say, “Youpi, my savings are enough to buy this house! Not to use the loan will save me money. Fault ! This thought is natural but misleading! Borrowing from the bank allows you to operate this famous leverage that alleviates the burden on your shoulders and increases the profitability of the rental investment.
To understand, let’s start from the beginning.
1. Saving or borrowing is the question
Very often, you do not have enough savings to buy the property you dreamed of. In this case, two choices are available to you: give up your wish or borrow what you miss. The last mechanism is called leverage: it allows you to buy a property above your means by the debt. And as a bonus, the profitability of your investment will be boosted!
Be careful because there is a golden rule , a prerequisite for this effect to work righteously. Make sure that the cost of your loan (including borrower insurance ) is lower than the return on your investment.
In other words, the debt should not cost more than what it brings you.
Jacques wants to take out a mortgage of 500 000 €. His bank offers him a real estate rate of 1.50% over 25 years. The borrower insurance amounts to 0.50%. The cost of his credit is therefore 2%.
When he looks at the property income and rents that this new house will bring him, he finds a profitability of 4%.
The answer is obvious: Jacques’ cost of credit is well below his future profits. If he accepts the proposal of his bank, the leverage will lavish his good works.
2. Leverage: how does it work?
As a lever helps you lift a heavy mass, the bank supports you in your investment. The longer it is, the easier the load is to move: the more important your personal contribution is, the more advantageous the borrowing conditions will be.
You do not have to finance alone, with the strength of your arms, your property. Banks lend easily, even if your contribution is low , and ensures you in the event of death or any other unforeseen (which is not the case of financing by savings). In addition, the rents received on this investment will allow you to repay the credit : your cash remains untouched!
An alpine chalet is 750 000 € but your savings are not enough to cover the costs in one go. Your bank offers you a mortgage at 1.74% over 20 years in return for a contribution of 75 000 €, or 10% of the investment.
Calculation of leverage: (Amount of investment) / (Personal Contribution) = (750,000) / (75,000) = 10
You plan to rent this cottage which will ensure a yield of 6% per year. Thus, your contribution of departure, 75000 €, brings you back: 10 x 6% = 60%. Only the real estate market allows such returns, we should not miss!
3. With leverage, you are always winners!
Take an example over several years and follow the evolution of your income on a Paris apartment, one of your rental investments financed by the loan. You bought it € 100,000 with a personal contribution of € 15,000 and a loan of € 85,000 at 2% per year over 15 years.
You decide to rent this nice apartment at 800 € per month (9 600 € per year) knowing that you will have to pay charges of 2500 € per year.
To be sure to always win, let’s imagine a case where real estate prices fall by 2% per year and rents and expenses by 1.5% per year.
|Year||Property income||loads||Refund your loan||Your Cash Flow|
|1||€ 9,600||€ 2,500||$ 5,581||$ 1,519|
|2||$ 9,408||$ 2,463||$ 5,581||€ 1,365|
|3||€ 9,220||$ 2,426||$ 5,581||$ 1,213|
|4||€ 9,035||$ 2,389||$ 5,581||$ 1,065|
|5||€ 8,855||$ 2,353||$ 5,581||$ 920|
|6||€ 8,678||€ 2,318||$ 5,581||$ 779|
|7||$ 8,504||$ 2,283||$ 5,581||$ 640|
|8||€ 8,334||$ 2,249||$ 5,581||$ 504|
|9||$ 8,167||$ 2,215||$ 5,581||$ 371|
|10||€ 8,004||€ 2,182||$ 5,581||$ 241|
|11||$ 7,844||$ 2,149||$ 5,581||$ 114|
|12||€ 7,687||$ 2,117||$ 5,581||– € 11|
|13||€ 7,533||€ 2,085||$ 5,581||– € 133|
|14||$ 7,383||€ 2,054||$ 5,581||– € 252|
|15||€ 7,235||€ 2,023||$ 5,581||– € 369|
|16||€ 7,090||€ 1,993||$ 5,581||– € 484|
|17||$ 6,948||€ 1,963||$ 5,581||– € 596|
|18||$ 6,809||€ 1,934||$ 5,581||– € 705|
|19||€ 6,673||€ 1,905||$ 5,581||– € 812|
|20||€ 6,540||€ 1,876||$ 5,581||– € 917|
The result ? Your cash flow is positive ! Finally, the loan did not encroach on your cash and you could even get rich with the money from the bank. This, you have understood, thanks to the action of leverage, which no longer has any secrets for you now.
Leverage allows you to invest with money you do not have while enriching you!
A golden rule: cost of borrowing and profitability of your investment!
The loan is even often strongly advised, you will be winners!