Leverage, Leverage, Leverage

Recently I had a discussion with a friend about differences of investing in stock market versus real estate. Buck for buck historically stock market wins, but there is a really big but. That big rear end is called leverage. Leveraged real estate outperforms any other kind of investment hands down.

Leverage is ability to use OPM – other people’s money. You can put 10% down on a house and borrow 90% of the purchase price to buy a house. Try going to the bank and borrowing some money to invest into stocks. I have not met anyone who has succeeded.

So lets look at a simple example. I have $100k in and John has $100k. I go out and buy 10 houses worth 100k putting 10% down on each. Now I have 10 houses worth 1 million. John goes out and buys $100k worth of stocks.

Lets say that John’s stock portfolio earns him a whopping 20% return on investment and after a year he has $120k. My real estate portfolio on other hand is not doing so well, it is growing at a pathetic 5% rate, but because of leverage my portfolio now is worth 1,050,000. So John made 20k and I have made 50k. But that is not the end of the story. My 10 houses have tenants in them, I am making modest positive cash flow every month of $50/mo times 10 houses = $500 per month, plus my tenants are paying down my mortgages and I am depreciating the properties to create a loss to lower my tax basis.

The moral of the story is that if you use OPM you create leverage to increase your gains.

Remember real estate created the most millionaires then any other investment strategy.