Key Takeaways
- Leverage amplifies returns proportional to the leverage ratio: at 5:1 leverage, a 10% gain produces a 50% return on equity.
- Leverage equally amplifies losses: at 5:1, a 10% decline causes a 50% equity loss. At 10:1, a 10% decline wipes out all equity.
- Real estate is the most leveraged asset class available to individuals — FHA loans allow 28:1 leverage (3.5% down).
- During the housing crisis, 23% of U.S. mortgages were underwater at the Q1 2012 trough.
- Responsible leverage requires DSCR ≥ 1.25x, 6+ months cash reserves, fixed-rate financing, and total debt-to-assets below 50%.
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Test Your Knowledge
1.An investor buys a $200,000 property with 20% down ($40,000). If the property appreciates 15%, what is the return on equity?
2.What is the minimum recommended debt-service coverage ratio (DSCR) for investment properties?
3.What percentage of U.S. mortgages were underwater at the housing crisis trough (Q1 2012)?