Using Structured Leverage

Editor’s Note: This article first appeared in the April 1972 issue of the Real Estate News Observer.

The word “leverage” ap­pears to be the historical concept of estate building. It is from this basic historical concept of leverage that the Estate Building Broker might find “opportunity” using the historical ap­proach and adding a few ideas.

Historical leverage is, and forgive us for reducing the definition to this basic concept, “using other people’s money,” and less of your money in a real estate venture. On improved property, the idea is to borrow mortgage money to help finance the real estate at a lower rate of return than the property produces. On land transac­tions, the idea would be to borrow money to help finance the property at an interest rate less than the anti­cipated growth rates.

If any property earns 10% and you can borrow (for instance) 75% of the total price of your property and only have to pay 6%, this would normally make good business sense. The investor has leveraged into the real estate with only 25% of his capital.

The investor has many “gravy” reasons for leveraging into real estate:

  1. He can make other investments and, thus, have diversification;
  2. He believes in amortization and likes the idea of “renters” retiring his loan;
  3. By not having his eggs all in one basket, he can acquire other build­ings and secure greater tax benefits; and
  4. He likes the basic idea of borrowing at 6% and earning at 10%.

The conservative investor who does not leverage property can normally ride the crest in times of recession and depression. He normally doesn’t have problems when units are overbuilt as he doesn’t have to make payments on the loans. His investment is rather liquid, too. By being free and clear of encumbrances, he can raise money for emergencies by financing the prop­erty. The use of leverage has, most of the time, one overlooked and seldom dis­cussed factor — time. Historically, an owner will borrow for a specified period of time at a fixed repayment schedule.

A typical example of historical lever­age might be when an owner puts $25,000 down on a property and borrows the $75,000 balance from a lender over a 24-year period at a fixed monthly payment including interest. The owner has leveraged his property for 75% and this percentage will reduce “a tad” as he repays the capital bor­rowed (other people’s money).

The “structured leverage concept” is used by talented individuals desiring to accelerate their own portfolios using TIME as a key factor in structuring transactions.

Broker Reynolds wanted to acquire ten 8-unit apartments from Builder Howard. The builder was open-minded to a transaction for the following reasons:

  1. He would not have to develop a sales program to “unload” the buildings.
  2. He would be free of a $100,000 loan on each building (10 buildings X $100,000 = $1,000,000).
  3. By reducing one million dollars of debt from his statement, he could borrow substantial amounts for a new project.
  4. He loved the idea of “clipping coupons” — a paper transaction would be great.

Broker Reynolds offered Builder How­ard his real estate fee as a down pay­ment, a note secured by a 2nd mortgage back on each building in the amount of $15,000 each.

The buildings were appraised at $135,000, but Builder Howard dis­counted his price as Broker Reynolds was buying wholesale (all of the build­ings).

Broker Reynolds, in structuring the 2nd mortgages, offered to start the payments eight months from close of escrow. Reynolds understood TIME and LEVERAGE. He needed enough time to be able to merchandise the properties. He saw no reason to burden his own cash position by making pay­ments on the structured 2nd mortgages.

This “saved” money that normally would have been used to make pay­ments on the 2nd mortgages would best serve himself (and Builder How­ard) by being used to promote the project.

Thus, the Estate Building Broker should note the value of structuring TIME properly in his investment inventory property transactions.

Clifford P. Weaver taught “Broker Estate Building Techniques” for the Richard R. Reno Educational Founda­tion. Mr. Weaver was Secretary-Treasurer of the Society of Exchange Counselors. He taught “Broker Estate Building and Administration Techni­ques” for the Richard R. Reno Educa­tional Foundation. Specializing in real estate problem solving, he conducted his practice in the San Jose, California, area.

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