Think about the words you use when it comes to investing, or your retirement, or real estate in general. So many people use words which sometimes fail to impart exactly what they’re trying to say. Ever been in a conversation that seems to go around and around, getting nowhere in record time? That can happen for lots of reasons. My experience says more likely than not, the words are not doin’ the job each speaker has employed them to do.
Words mean things. To the real estate investor the word leverage connotes a specific concept. Most would say it means — to control real estate with a relatively small amount of capital.
First of all, what’s small? Then, what’s relatively small? Then there’s the question being begged — is your meaning for leverage the same as the other guy’s?
With apologies, most investors would be incorrect. Sure, using a small down payment to control real estate is one form of leverage, or rather, one meaning. But that definition is simplistic at best, and potentially ruinous at worst.
Ideas, principles, and concepts are defined by words. If the wrong words are used for this purpose, the entity defined is rendered worthless. Following worthless, incorrect ideas, principles, and/or concepts is never part of anyone’s plan, right?
For example, what if you looked at a map thinking west was north? You’d always end up at the wrong point B. You’d never have a chance for success. West means something totally different than north. Surely, that’s an extreme example, but it clearly illustrates my point here.
Words mean things. Those understanding the value of correctly used words, don’t often fall victim to misunderstood ideas. Here’s an example of one of the most understood concepts in all of investment real estate.
It’s leverage. Worst thing? Folks use the ‘small down payment’ definition, succeed wildly, then conclude they understand the word, and therefore the concept itself. That’s akin to runnin’ a 10K in a really good time, then concluding that success means you’re ready to run a marathon. The problem there, among others, is the misunderstanding of adequate training. Training is a word. Adequate training can be an idea, principle, or concept. Learned that one the hard way. Inadequate training for long distance running is a cruel mentor. 
So, what is leverage?
Primarily, leverage is the ability to borrow money at a cost (interest rate) lower than the return on the property in which you’ve invested. If for example, your return is 8%, and the borrowed money costs 7%, you have what’s known as ‘positive leverage’. Whether you put 1% down, or 99% down is irrelevant to that definition.
The other side of the leverage coin is ugly. That example has you earning 5% return on your property while paying 7% interest on your borrowed money. That’s ‘negative leverage’ and the investor is doomed.
BawldGuy Axiom: Exactly as the laws of physics, for example, gravity, works every time, the Physics of Economics will not be mocked.
Uh, wait just a doggone minute some are sayin’ about now. If I put a larger down payment I could conceivably increase the return of a property via the resulting increase in, or creation of cash flow. If that return then became larger than your cost of borrowed money? Bingo! Instant positive leverage.
But wait another dang minute! Did he just say increasing a down payment can increase positive leverage? Huh? What?
Yes, he did.
So if an investor doesn’t understand what the primary meaning and real life relevance of leverage is? He’ll realize what the banker realized when he borrowed money at 5% and lent it out at 4% — which is the answer to a question I’ve always loved.
How do ya make a small fortune? It’s simple — Start out with a huge fortune and religiously employ negative leverage.
See what I mean? Words mean things. Ideas, principles, and concepts matter.
Down payments can make huge differences in the growth rate of your invested capital. They don’t, however, supersede the primary principle of leverage as applied to investing. When real estate investors, however well meaning, violate this concept, the penalty is guaranteed. Just as gravity is brutally objective in its predicability, so too is the principle of leverage.
Wanna get together and figure out a Purposeful Plan for your circumstances? It’s as simple as sendin’ me a quick note, or callin’ me at 619 889-7100. Before ya know it we’ll be talking about the retirement for which you’ve been workin’ so hard. Have a good one.
Related posts:
- Words Mean Things — Ideas Principles And Concepts MATTER
- Taking Control Of Your Retirement — Words — They Mean Things
- Listening To What We Think The Market Should Be Saying Is No Laughing Matter
- Real Estate Investors — The Little Things Count — Big Time
- An Example Of Grandpa Economics’ Principles At Work
About BawldGuy
Another great post. You add in the other leverage processes [value leverage & labor leverage] and you got yourself one fine way to create wealth.