46 - Borrowing to Invest in Real Estate? Here is What You Need to Know
In this episode of Get Real Wealthy Season 2, Quentin talks about five things you should know when borrowing to invest in real estate.
Quentin says that these invaluable strategies are mentioned in detail in the book The Ultimate Wealth Strategies. He says that the first thing to keep in mind is that you can’t save yourself to financial freedom. Budgeting is important to learn so that you don’t overspend your income. While it's important to save some on the side, to help you to invest especially at the beginning, but if you want financial freedom, just putting money in the bank isn't going to do it. You will have to understand the power of leverage. He adds “Well, let's say you are going to invest in something... So are you going to get an annual rate of return on that asset, when you invest in it, I'll give you an example. I buy a rental property, and I buy it for $500,000. I have a mortgage on it for $420,000, I have $80,000 invested in that property, that property, remember is leveraged.”
What usually happens in real estate is that property goes up 5% to 20% or even more in a year. So that 5% is what you have made on the property through appreciation. Now, on top of that, your mortgage went down. If you improve the property in some way, you are adding additional equity and that increases the rate of return. So you need to understand that rate of return. He adds “if you are working with an accountant, and I suggest you do, you can also reduce any income that you get from your rental properties by using capital cost allowance. So it's a way to reduce your taxes.” It is something to keep in mind when you are starting your real estate investing journey.
Secondly, Quentin says that you need to think about when borrowing to invest in real estate is the interest rate. Are you getting a fixed rate or a variable rate? What is the term? What are the type of terms that you are getting within your mortgage, and what are the penalties? Are you able to put a second behind the first mortgage? What kind of flexibility do you have on it to refinance? All of those aspects need to be considered. Thirdly, how long are you going to hold on to the asset? If you need the money, be careful, because that may force you to sell an asset that you don't necessarily want to sell. So make sure that you understand when you're buying an asset and how long you plan to hold that asset. Be careful not to over-leverage yourself into a position where you're forced to sell that asset.
Next, does the property itself support the payments or do you have to come out of pocket to pay that loan or mortgage? It's really important when you're thinking about leverage, and when you're borrowing to invest in real estate. Lastly, it's the mindset – are you able to tolerate the ups and downs when it comes to the residential market? He adds “you're going to recover in the future as long as your payments are fixed, and you're not in a variable rate product, or you're in a product that is going to get you into trouble, that you're comfortable with that. So just make sure that whatever your mortgage payments are, they're able to cover it.”
In conclusion, he says that it's important to have the right mindset. By these tips in mind, you can navigate the roller coaster ride of real estate investing.
Important Links and Resources
• The Ultimate Wealth Strategy Book