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Wealth Creation the Real Estate way


Wealth Creation the Real Estate way

Last updated: May 28 2007
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  • Wealth Creation the Real Estate way

    Use OPM to Get Rich! The Power of Leverage!

    When people ask me “why property?” There has to be only one answer.. “Leverage”. In my opinion leverage makes property the best assets class of all! For this reason property out performs other assets classes in the long term growth category!

    So what is leverage?

    It’s just like the word says “leverage” means using a “lever” and in the case of property that’s Other People’s Money (or OPM as it’s commonly called)… The other people in this case are the banks. You see the great thing about property investing is that banks are falling over themselves to lend you money to buy property… this just doesn’t happen on other asset classes! Can you imagine going to your bank manager and asking for a Rs. 80 lakh loan to buy Rs. 1 crore of shares! I think he would chase you out of his office... So, why does the bank lend money to buy property? Well banks always avoid, or at least try and avoid, risk. And property is regarded as safe. YOU have heard the expression “safe as houses” haven’t you…It was probably written by a banker!

    Let’s just look at an example. Suppose that the stock market grows at 20% a year, and the property Market grows at 10% a year… which will provide you better returns? Well if you’re like most investors – you will say stocks! Why? Because the growth is better! Or is it? The biggest mistake is not taking into account the power of leverage.

    How does leverage work?

    So, using the above example lets say that you had Rs. 10,00,000 to invest and let’s look at a 2 year time frame. So, if you bought stocks – your investment (at the end of two years) would be Rs. 14,40,000 or have grown by 44% - Not bad! (Especially if you can pick stocks that grow by 20% a year!) .

    Ok so now lets take that same money and buy a property. So how much property can you buy for Rs. 10 lakhs? Well, most banks will lend you 80% LTV (loan to value), so that would mean you could buy a Rs. 50 lakh property! (of course you would have to pay back the bank their money eventually – but with a tenant in the property they can do it for you!).

    So after 2 years with a 10% growth – your house would be worth Rs 60,50,000! The exciting thing here is that the asset has only grown 21% in value, but your money has grown by a lot more… You see the Rs 10 lakh of your own money you used to buy the house has more than doubled! - Your Return on Investment (ROI) is a whopping 105%

    Can you see the power of leverage?

    Taking it a step further, if the property market grew at 20% per annum your (ROI) goes up to 220%! WOW.

    Many savvy investors use leverage to buy more property and get solid equity growth. But leverage comes with a health warning…it is… A two edged sword!

    Leverage does work both ways. In our simple example above, if the stock market drops by 20%!

    How much have you lost? Only 2 lakhs – but if the property market drops by 20% and you bought a property for Rs 50 lakhs how much have you lost? A whooping 10 lakhs – your complete investment! So leverage does have it’s risks!

    But the reason why banks lend money on property rather than stocks and shares is that property is a much safer asset – It’s less volatile and besides, when have you ever heard of a property’s value going to zero? Never

    The perils of focusing on leverage

    Leverage can make you immense returns by multiplying the power of your money many times over… but it is NOT the “be all and end all”. In fact 99% of property investors focus too much on capital growth - sometimes willing to lose money each month by “funding” a property. (As the rent is not enough for the EMI, they dip into their own pockets to make up the shortfall). According to me that is foolish! We all know that markets go up and down, and it amazes me that many investors think that the property market will just keep on rising. This is NOT true, at some point the property market will crash! But the key thing is no one knows when! (and to be prepared for it when it does!)

    My final advice

    So if you do use leverage (and I would highly recommend that you do) remember to tread carefully… Don’t sacrifice monthly cash flow for equity growth, do your research, follow a system and let Other People’s Money make you rich!

    Good luck with your investments!
    Just make sure that you time it right with the right location
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