The risk-return trade-off of leverage


The risk-return trade-off of leverage

In the preceding videos, you learned that using borrowed money to finance a real estate investment creates leverage, as it enables investors to buy properties that cost more than the money currently available to them. Suppose you want to buy an investment property that costs $1 million and will provide a steady cash flow, but you only have $500,000. Would you find an equity joint-venture partner to provide the other $500,000, or would you take out a loan for the money you need?

Consider the following questions when formulating your discussion:

  • Would you feel comfortable sharing management and control with an equity partner?
  • Would you be content with the risk and return presented by the property asset itself, or would you want to pursue a higher return even though it will mean taking on more risk?
  • Would you be willing (and able) to give up a part of the cash flow of the property to prioritize servicing the loan?
  • What would the interest rate and terms of the loan be in relation to the cash flow yield rate and total return expectation for the property?

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