You want to start investing but you don't have much funds and you are worried that your choices will be limited.
Understanding the leverage effect allows you to earn high returns even if your own capital is low.
This time, we will explain in detail the leverage effect, merits, and risks of real estate investment.

What is the leverage effect of real estate investing?

Many people are familiar with words like FX, stock trading, and investment.
But what exactly does leverage mean with regards to real estate investing?
Leverage is easier to understand when we describe it in terms of the principle of leverage.
A lever can move big things with small force.
In other words, leverage in real estate means "making a large profit from a small investment."
Making a big profit with little money is the basis of investment, and ideal.
Now, let's explain in detail the leverage effect of real estate.

What is the leverage effect of real estate investment?

In an easy-to-understand explanation by FX, trading foreign currencies five to twenty times as large as offering a margin of 0.1 million yen is called the leverage effect.
With regard to stocks and FX, there are fewer investors who invest by lending money from financial institutions, and most of them invest with their own funds.
In order to get a leverage effect in real estate, financing from financial institutions is very important.
The more favorable the terms of loans from financial institutions, the more the leverage effect is gained.
Therefore, it is important for real estate investments to cultivate borrowers.
Leverage increases with less equity.
Thus, by managing high-priced properties, we will have a higher leverage effect.

Leverage Effectiveness Mechanism

Consider a simulation with no leverage and leverage when your own capital is 10 million yen.
If you invest in real estate only with your own funds, the maximum amount of properties you can purchase is 10 million yen. (no leverage)
With an investment yield of 10%, the annual rent income is 1 million yen at 10 million yen × 10%.
Next, suppose you invest in real estate by borrowing 50 million yen from a bank to augment your own funds of 10 million yen. (Leveraged)
The property that can be purchased is 60 million yen.
Assuming the yield is 10%, the annual rental income will be 60 million yen × 10%, which is 6 million yen.
In addition, if the annual interest is set at 3%, the amount of interest to be paid in the first year is 1.5 million yen at 50 million yen × 3%.
When interest of 1.5 million yen is subtracted from rent income of 6 million yen, the actual profit is 4.5 million yen per year.
Compared to investing in real estate using only one's own funds, we can earn an annual income of 3.5 million yen as much as we would if we had invested in real estate.
From the above case, it can be seen that leveraging can generate higher earnings.

What is the advantage of leverage in real estate investment?

Now let's look at the specific benefits of leveraging in real estate investing.

Can invest in high-priced properties that cannot be purchased with their own funds

The first advantage of levereage in real estate investing is that we can invest in high-priced properties.
If we invest in real estate solely with our own funds without receiving loans, there is no risk, but we do cannot expect high returns.
Since the revenues generated by high-priced properties are large, it can be said that it is more profitable to leverage them as a result.
When borrowing, it is possible to increase profits by borrowing with low interest rates.
This is precisely the situation in which the leverage effect is exerted to the fullest extent.

Make other investments with your own capital

When investing in real estate, you can use your own funds to invest in other investments.
In addition, we can leave some of our own funds on standby to have a reserve.
For example, by having a reserve, you can respond to changes in interest rates or rent reductions due to vacancy measures.
You can also use your own funds for early repayment of the loan.

Will become your asset once loan is repaid

The attraction of real estate investment is that rent income is generated.
The larger the loan amount, the greater the leverage effect and the higher the profit.br> After the loan is repaid, it becomes your property and generates additional income, making it the epitome of passive income.
Real estate investment is also an effective way to fund your retirement.

What are the risks associated with leverage in real estate investment?

What are the risks associated with leverage in real estate investment?

Risks Associated with Rising Interest Rates

When making real estate investments, we must keep in mind the risk of rising interest rates.
Let's assume in advance how we will respond in the event of a rise in interest rates.
Ideally, we will invest with leeway so that we can also respond to the increase in the amount of repayment.
Another way to avoid the risk of rising interest rates is to use fixed-rate loans.

Vacancy risk

The real estate property we have invested in may not always be fully occupied.
There is a risk that rental income will decrease due to vacancy if location, age of the property, etc. are not considered sufficiently.
There may also be a risk that if more rooms become vacant or rent reductions increase, the repayment of the loan will become harder.
When investing in real estate, select a property that is as favorable as possible and whose value will not decline even after the age of construction.

Risk of reverse leverage

When investing in real estate, there is usually no problem with the leverage effect. However, if interest rates rise as described above or the yield on vacancies become low, the leverage effect will work in reverse.
We must always keep in mind that there is a risk of reverse leverage when we make real estate investments with loans.
To cope with reverse leverage, it is effective to keep some amount of your own money on hand and to hedge against risk by focusing on other investments.
Care is required because the higher the leverage effect, the higher the risk of reverse leverage.

Risk of disasters

Real estate investment carries the risk of disasters.
Natural disasters in particular are unpredictable, and they cannot be prevented from occurring.
Reinforced Concrete and Steel Reinforced Concrete products are more suitable for reducing damage caused by natural disasters than wooden real estate.
When investing in real estate, keep in mind the risks that may arise in the event of a disaster.
In addition, checking the hazard map in advance also leads to avoiding risks.
It is desirable to select a building with a firm ground and a strong earthquake-resistant design.
You also need to make sure that you have adequate insurance coverage in case of a disaster.
It is not uncommon to find out that you do not have earthquake insurance when an earthquake strikes.
Earthquake insurance is not included in most standard fire insurance policies, so make sure you have it.

In Conclusion

In this article, we explained the leverage effect of real estate investment.
There are many advantages to leveraged real estate.
However, please remember that there is always risk involved.
When investing in real estate, it is important to simulate the risks that may occur and to consider countermeasures in advance.