I thought I’d share a fairly detailed, yet admittedly simplified explanation of something that we at MCC hold dear and attempt to communicate with small business owners daily: the leverage power of real estate. Right after owning your own business, investing in real estate gives you the highest potential return on investment (ROI). Using leverage power is the primary reason you can get such high returns on real estate. In the scenario of most of our borrowers, their business has to have a place/facility of business, so investing in their own commercial property enables them to pay themselves the rent their business would have paid their landlord.
When you invest in real estate, you essentially are in the business of finding other investors to back your “projects.” Those investors typically are lending institutions (like us) or private lenders, and they receive interest payments and loan fees (initially) from you to do so. The profits on your real estate investments, however, are yours to keep. This is what is called “positive leverage.” Basically, you are borrowing most of the money you need and can ratchet up your profits by using other people’s money (OPM) to control an appreciating asset. This is one of the great advantages that real estate has over the stock market and other asset classes. Yes, you can get a margin loan on stocks or buy/sell options too, but there are inherently more complexities and risks (and often costs) involved with both of those than I have space here to properly discuss.
In a typical leveraged (i.e., mortgaged) real estate deal, you can invest $20,000 (or 10% equity down) to buy a $200,000 property (our minimum deal size). If that property appreciates just 4% (or $8,000), then the ROI you achieve is not 4% but 40%. Our typical 90% mortgage gives you a 10-to-1 leverage advantage. If you put 20% (or $40,000) down in this example, as required by most ordinary lenders, and you still get a 4% appreciation (which is just about the historical average for commercial real estate), then your ROI is 20% – not bad, just not quite what it could be. The side benefit of putting the least amount of equity into a commercial real estate transaction in order to maximize positive leverage, is that the “equity savings” (the difference between what you would have had to put down with another lender versus us) can immediately be reinvested back into your business at hopefully, equally high or higher returns. Using the leverage power of real estate is one of the best and easiest ways to accelerate your personal path to financial independence.