Benefit of Leveraging Invested Capital

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>Benefit of Leveraging Invested Capital
Posted by: MG90 Aug 15 2004, 07:24 AM
This is probably a basic question, but it would be helpful to know so that I can have the proper perspective. I am interested in creating passive income. Obviously there are several types of investments I could utilize (CD’s to income properties to bonds, etc). My question is would I get better leverage of my invested capital and generate more income for every $ of invested capital in an income property, lets an apartment complex vs. other investments like a bond fund.

Given the financing parameters for income properties of 25% down and NOI must be 1.2x or more relative to debt service, it appears I could produce more absolute dollars of net income because of the leverage, but I was hoping someone could confirm or negate this with an example.

Thanks in advance.
Posted by: loanuniverse Aug 15 2004, 11:18 AM
You are right, investing in income producing property can produce a better return than CDs or bonds. However, you can not really compare passive income from rental properties to that provided from a portfolio on financial instruments.

There is a relationship between risk and reward and that holds true. Let me use the three examples that you brought up.

Certificate of Deposit: As long as you go with an FDIC secured institution there is next to no chance that you will lose your principal. {there are certain limitations in coverage and if you have a multi-year CD your rate might be adjusted in case of Government takeover, but you are safe}

Government Bond: If it is federal Uncle Sam has to go out of business, and if that is the case we have bigger problems than getting our interest back.

Rental property: You are at the mercy of tenants {getting them, getting them to pay & getting them to stay} as well as being subject to other things that can come up in the way of expenses. In addition the word “passive” does not necessarily means that you won’t have to be involved with the investment. There has to be a premium for the hassle. I haven’t even touched on the fact that you might have to use leverage for the investment. Borrowing money increases the risk.

As you can see the potential is higher, but so is the downside.
Author: Commercial Loan Underwriter