Ask a group of real estate investors their opinion on the best way to make money with real property, and each one will probably give you a different answer. Some would argue that you should always invest for cash flow, while others use a home's potential appreciation as the primary consideration in their investing decision. Still others would claim it is all a matter of geography, market timing, or sometimes just plain dumb luck (these people tend to be the ones who don't do well in the market over the long term). There would be one theme, however, that every successful real estate investor can agree upon as to why real estate has created more millionaires (and subsequent billionaires) than any other form of investing in the world. More than the stock market, commodities, or patents, real estate dwarfs them all. It is directly attributable to the power of leverage.

But what do real estate investors mean when they attribute their success to leverage? Imagine that you purchase an investment property for $100,000 with 10% down ($10,000). Ideally (read: always) you are going to want to invest for positive cash flow from your rental units. In other words, the rent you charge your tenant should be higher than your mortgage payment. To keep this example simple, let's imagine that the rent payments just barely cover your mortgage payment. This is offset by the fact that you are able to keep the property continually rented while you own it. Assuming a 6.5% mortgage rate and only making your mortgage payments, at the end of 5 years, you will owe approx $82,859 on the home. Furthermore, at a very modest annual appreciation rate of 5%, the home will now be worth $114,865 on the open market. If you sell after five years, you have effectively made $22,006 (equity plus appreciation). Instinctively, most people would think that they roughly made a 20% return on investment on their initial $100,000. Remember, however, that only 10% down truly came out of your pocket. The remaining $90,000 was leveraged with what those in the industry refer to as OPM (other people's money). In light of your $10,000 investment, you have effectively made a 120% profit.

This is all very academic of course. In the real world, you have to shell out money to fix broken toilets, and most landlords only dream of having 100% occupancy on all of their units for years on end. This example also does not account for real estate agent fees or closing costs, but nor does it account for positive rental cash flow or more advanced tax deduction concepts like rental depreciation, etc. And to be fair, when most people talk about their return on investment in regards to the stock market, they are glossing over broker fees, management fees, etc. as well and are talking about what amounts to nothing more than theoretical approximations.

All different types of investments have their advantages and disadvantages. Stocks are much more liquid than your average parcel of real property, for example, and just as many people have bankrupted themselves with the siren song of OPM as have become millionaires. Leverage can never replace a sound investment strategy and an emphasis on maintaining a healthy debt ratio, good credit, and risk mitigation in your real estate investments. Understanding the concept of leverage, however, is the key to making serious money in real estate. The trick is changing the way that you think about money, cash flow, profit margins, and your investment strategy. Educating yourself about what successful investors mean when they speak of leverage is the tentative first step. Congratulations on beginning your journey.