Rob Diodato is the president of York Commercial Finance,
a commercial mortgage advisory company with offices in
Dallas and New York. Diodato arranges financing for commercial real estate transactions nationwide for all property
types and is an expert in Small Business Administration 504
and 7(a) loans. Diodato has more than 26 years of experience
in the commercial and residential mortgage industries. Reach
him at (214) 561-8671 or firstname.lastname@example.org.
Leverage Can Amplify
Return on Investment
Maximizing debt financing for the right properties
helps investors get more bang for the buck
By Rob Diodato
Commercial mortgage brokers, for the most part, would agree that leverage in a financ- ing package is a useful and necessary tool for any of their real estate investor clients.
Leverage, or the ratio of debt to value, can influence the
risk and reward of real estate transactions. The benefits
include, among other things, reducing the initial investment required to close the deal, as well as potential tax
write-offs on the interest paid on the resulting debt.
Real estate owners and developers rely on leverage
in order to maximize their return on investment (ROI).
The use of leverage can increase ROI because the cost
of financing is usually cheaper than the unleveraged
returns a property can generate.
Compare three commercial real estate investors, for
example, all with $1 million to invest. One investor utilizes
no leverage to buy a $1 million property, another uses
50 percent leverage to buy a $2 million property and
the other uses 75 percent leverage to buy a $4 million
property. Then, assume 10 percent price appreciation
on the property after purchase.
In such a scenario, the second investor with 50 percent
leverage would realize a gross ROI double that of
the first investor with no leverage. The third investor
would realize a gross ROI quadruple that of the all-cash investor and double the gross ROI realized by the
second investor. Investors simply get more bang for
their buck by utilizing leverage and are able to create
additional returns as a result.
Given the potential to expand ROI using leverage, one
would think it would be used in most, if not all, real
estate transactions. All-cash transactions, however,
still account for a large segment of the real estate purchase market.
For the most part, leverage is utilized by most first-time homebuyers in the residential sector. Investors in
the residential sector, who are able to finance purchases
with commercial loan products, utilize leverage far more
frequently, but still not as much as might be expected,
given the potential advantages for ROI.
The fix-and-flip market offers a window into the use
of leverage in commercial real estate transactions.
In that market, investors buy homes, rehab them as
fast as possible and then resell the houses, hoping
to make a profit on the increase in market value. In
second-quarter 2017, only 35 percent of homes flipped
nationwide were acquired by flippers using financing,
although this percentage was a nearly nine-year high
and up from 33.2 percent the prior quarter, according
to a report by Attom Data Solutions.
When an investor uses all cash, assuming they have
the financial viability to do so, the resulting lack of
liquidity can stand in the way of additional opportunities.
Leverage can take the form of a mortgage on a single
commercial property, a blanket lien on multiple properties or a line of credit that can be utilized repeatedly for
fix-and-flip residential transactions. It allows real estate
investors to diversify and exponentially multiply their
ROI. The rise of commercial lenders in the fix-and-flip
and buy-and-hold rental segments of the real estate
market has expanded financing options for investors.