LeverageLeverage in real estate: how debt raises returns, and risk.

What leverage in real estate means

Leverage is the use of debt alongside your own cash to buy or improve real estate. Almost every apartment purchase uses some, because a loan lets the same equity control a larger property.

When a property earns more than the cost of the loan, leverage lifts the return on the cash you invested. When income falls short, the loan payment still comes due, and the same debt that boosted returns can strain cash flow.

How leverage is measured

Loan-to-value (LTV) = loan amount / property value

A $7,000,000 loan on a $10,000,000 property is 70 percent LTV. Lenders also limit leverage with the debt service coverage ratio, which caps the loan at what the building's income can carry.

A worked leverage example

Illustrative figures, not from a real property

A building costs $5,000,000 and produces $300,000 of NOI, a 6 percent cap rate. Bought with all cash, the yearly return on your money is 6 percent.

Now buy it with a $3,500,000 loan whose yearly payments are $230,000. You put in $1,500,000 and keep $70,000 after the loan, a 4.7 percent cash-on-cash return. Here the loan costs more than the building earns, so leverage lowers the yearly return. If NOI rises to $350,000, the cash after the loan becomes $120,000, or 8 percent on your cash: the same debt now works in your favor.

When leverage helps and when it hurts

Leverage helps when the property's yield is above the loan's yearly cost and when value grows, because gains on the whole building accrue to a smaller slice of equity. That shows up in IRR in real estate and in the equity multiple.

It hurts when rates rise, rents soften or a refinance comes due in a weak market. Owners balance the upside of a higher loan against the safety of a lower one, especially when interest rates or rents are uncertain.