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Positive and Negative Leverage

Blog by Andrew Reid | February 3rd, 2021

Positive and negative leverage. 

“Real estate is nothing more than a positive spread investing game” (Sam Zell, Bergsman)

Positive and negative leverage are two sides of the same coin, with positive leverage occurring when the investment property’s yield is higher than the mortgage which increases the investor return.  Conversely, negative lavage is exactly the opposite, where the loan amount is higher than the property yield-reducing the investor's return.  If the property return and the cost of capital are the same, you have neutral leverage where the investor's return is not impacted.   That said, in order to get an accurate picture of the merits of a particular investment it is important to factor in both the income and growth component of the investment when calculating the effect of leverage on the total return since factoring in income only can produce neutral leverage or negative leverage when the property is actually producing positive leverage when growth and income are factored into the equation.  The effects of leverage can be determined using the weighted average cost of capital (WACC) formula “calculated by multiplying the coast of each capital sources (debt and equity) by its relevant weight, and then adding the products together to determine the WACC value”(Investopedia)