What is Leverage

Leverage is a really cool concept to use with your investments, and it’s an important concept that can be used to help change your business. Understanding where your cash flow comes in is quite important, so understanding this is definitely a big part of leverage.

There are three key pieces of data to consider here. First, you’ve got the cap rate of investment, which is 10% generally.  Then, you want to look at the loan constant, which is the ratio in finance to signify the relationship between the loan and loan payments. Before calculators and computers, this was a constant that was used to determine the monthly payments for loadns.it was used to take the total loan payments and dividing it by the principal balance on there.  You should from here use this to determine leverage.

Leverage is used to indicate the return that you’re getting or losing out on on the capital that you’re borrowing for the loan. Leverage is defined as your cap rate minus the loan constant.

With this, you can essentially determine the cash flow of any situation, and if you need this for learning about any property or loan, this is something that you should consider learning.

So let’s take for example that you want to get a property with no loan, and you can use the cap rate to determine the NOI, which is the same as the cash flow if there is no loan. Which is essentially the price times the cap rate.so, if you’re getting a property for say 900,000 dollars, and the cap rate is 10$, then the NOI is going to be 90 grand essentially.

But what if you don’t realize that the cap rate applies to any cash you contribute, even if it’s not the full, the same rules apply.  Essentially, what this means is that if you put down say 500 grand on a property, not the full 900, and you then use the cap rate, then you’ll get the 50,000 on that as the cash flow.

Leverage also applies to borrowed funds, and they are either working for you or against you. When borrowed, it’s called positive leverage if it generates extra cash. With positive, borrowing money increases returns, whereas when it doesn’t create cash flow, it’s negative leverage, and decreases returns. So how do you know? Well, you can calculate the leverage value at this point. =if the value is positive, you’ll get positive leverage, if it’s negative, you’ve got leverage.

The cap rate tells you how much it’s earning, the loan constant tells you how much borrowed funds are, and how much it’s generating for the lender.  If the cap rate is higher than the loan constant, the lender isn’t taking all the returns, and essentially, the extra is what you get from this.  you’ll notice this, so you want to make sure that you look at the leverage of this before you begin. it’s important and can determine a lot of loan values.