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Leverage

Leverage is the use of various financial instruments or borrowed capital to purchase and/or increase the potential return of investment. Assume a buyer puts 20% down on a $5M property. Essentially, they paid $1M to own something worth $5M. Assuming the property appreciates at 5% per year, the sponsor’s net worth would grow to $5,250,000 in a year. Had they instead paid $1M for a $1M property, and not taken out a loan or raised the remaining $4M from other investors to buy the more expensive property, the buyer’s net worth would only increase $50,000 over the first year, versus $250,000 for the more expensive property. Better leverage enables a buyer to increase their overall net worth significantly over time.