They always say leverage is the key to massive profits. And it is true as you can see here. However, it is not always true.
Here’s the fine print they don’t tell you about…
Leverage cuts both ways.
Let’s go back to that first example where you actually bought a house putting $10,000 down… this time, let’s say the property declined 7% the first year.
Now it’s worth only $93,000 – you’ve lost almost your entire $10,000 in 12 short months.
If it declines 7% again the next year, it gets real ugly…
… because now, you’re underwater. You owe $90,000 on a property worth only $86,490.
You’ve lost your entire investment.
Unless you’ve got spare cash to cover your shortfall, and your closing costs – you’re totally up the creek without a paddle… you’re stuck and out of exit options because you couldn’t sell it even if you did have a buyer.
All you can do now is ‘HOPE’ and ‘PRAY’ the market bounces back quickly – but it rarely does; that’s not how local cycles work. Everyone and their brother are in the same boat… and no one’s got a paddle. Some markets take decades to rebound. Houston, Texas is a great example. Thirty years after its big crash, and real home values are still way below their peak… they’ve not even kept up with inflation.
The only good solution is to avoid getting into that mess in the first place because real estate is just too illiquid. Once market psychology takes over, everyone starts running for the exit doors and you can’t get out even if you want too.
The bottom line is this…
Leverage multiplies the effects of appreciation (or decline)… it does not, by itself, create any wealth.
Let me say that again…
Leverage does not create wealth.
If the property value declines, leverage multiplies that pain the same way it multiplies wealth on the upside.
Most real estate education products out there teach you a particular spin on how to get properties with little or no money – leverage. That’s just a small part of the equation, and it’s NOT the important part.
What you should be focusing on is the second part of that equation… the part that actually creates the wealth – APPRECIATION.
The key to leverage is making sure your use of it matches where your local market is in its cycle. Otherwise, leverage is just another form of Russian Roulette… it’s irresponsible to use leverage – or for that matter – to even do a deal – unless you know where you’re at in the local cycle.
Appreciation, not leverage,
is what makes you money.
It’s a simple concept, but as a real estate investor, nothing’s more important to you.
If you get nothing else, then please lock this into your permanent memory:
Appreciation, not leverage, is what makes you money.
When will your market appreciate? Are the home prices in your area about to soar or fall off the face of the earth?