Leveraging real estate is a term that should illustrate how to build and expand real estate assets as efficiently and quickly as possible. To illustrate such a process, in this article we present a model with which one acquires up to 17 properties within less than ten years with a modest original equity.

1. Leveraging Real Estate – Introduction

For a long time, the view was that real estate can slowly but steadily build up assets. What you had to consider, however, was that with a debt financing, as was usual in the past, you often waited a long time until you could invest in the acquisition of new real estate. That it also works differently, we want to show in this article with an example. One of our keys to this goal is our knowledge of how tax law supports leveraging with real estate.

2. Foundations of real estate tax law

In order to create the basis for understanding an essential factor of leveraging real estate, we need to briefly enter into tax law. More specifically, we are looking at the taxation of income related to the private management of real estate.

On the one hand, the acquisition of real estate acquisition tax is incurred. Since the federal states collect the tax, they also determine the amount of the tax rate. In North Rhine-Westphalia it is currently 6%.

Furthermore, a taxation of rental income is to be expected. Because the properties that we want to leverage here should be rented. According to § 21 EStG income tax and possibly church tax and/or solidarity surcharge is incurred. However, when renting real estate, a depreciation of 2 % of the acquisition costs is usually added. It reduces the rental income over a period of 50 years, thus also lowering the income tax. For us, however, the approach to financing costs will be more decisive, because these are also tax deductible.

On the other hand, we also have to take into account the fact that a subsequent sale of the properties may be taxable. However, if one observes the current ten-year speculative period, the profit can even be tax-free. However, in this post we have no primary intention of selling real estate. Therefore, we essentially only list this income taxation to list all the important aspects regarding real estate taxation.

3. Real estate leverage – this is what our plan looks like

3.1. The starting position

Let’s say we have equity of EUR 50,000 at our disposal and want to invest this in the acquisition of real estate. Let us also assume that a bank grants us a real estate loan with an equity ratio of 10%, which is remunerated at 4% annually. We also agreed with the bank to repay 1.4% per year. Furthermore, we want to assume that the increase in the value of the property we choose is 2.5% annually. At the same time, we can expect a rental yield of 5%. What, then, is the development of our wealth?

Development of the model in the first three years

If you count exactly, you find out that in the end there is no profit left that you would have to tax. Because the financing costs ensure that only 1% of the rental income is subject to taxation – and that is just EUR 5,000. This income is far below the basic allowance, so it is tax-free. To simplify matters, we have even ignored the regular depreciation of 2%.

After three years, we have already repaid EUR 20,250 of the original loan of EUR 450,000. However, we took EUR 75,000 in the same period. Of these, we transferred another EUR 54,000 to interest from the bank. So hardly anything remains on the credit side. How can we then dare to say that we can build up real estate assets within ten years? Wait and see.

3.3. Real estate leverage for the first time after only three years

Because of the repayment, our equity share increased to EUR 111,000, which corresponds to a ratio of 22.2%. At the same time, the property value has risen to EUR 540,000. This added asset enables us to renegotiate loans with a bank in order to obtain external capital to buy another property. So we leverage our new property. This works because the increase in value on the one hand and the repayment of the previous loan on the other hand allow us to access a grown asset.

Those who are now once again able to contribute part of the equity to the purchase of two comparable properties from private assets should also receive the necessary debt for the remaining purchase price. After three years, we already have three properties in our assets through leverage.

3.4. Other ways to leverage real estate

And so the plan continues. After another three years you can then renegotiate with the bank. This time there are even enough own funds to acquire four new properties. There have been no changes to the external conditions. Only in the case of income tax, one now comes into the area that actually becomes tax relevant. But overall, this leverage effect through debt financing makes sense.

Finally, let’s take it to the top: After another three years – we are now already in the ninth year after the first acquisition – we can celebrate the increase in our real estate stock to a total of 17 units!

4. Leveraging real estate: influence of taxes

Let’s take a closer look at the influence of taxes. In doing so, we can see that they only become relevant when the income, after deducting the financing costs, exceeds the threshold of 2% of the property value. In fact, this condition can happen at some point, but depending on how much you increase rents, it takes a very long time to get from a balanced liquidity inflow into the area of taxable income. A period of ten years after the acquisition of the first property is realistic. To avoid this income tax, you can now make the sale of the first purchased property. After all, this is tax-free after the speculative period has expired. However, after offsetting the profit with the remaining debt usually only a relatively small profit remains. But at least you can then invest in the purchase and leverage of new properties.

5. Real estate leverage – conclusion

If one pursues the goal of building real estate assets quickly and consistently, leveraging real estate can be very efficient. However, this also includes excellent planning and structure. In addition, good negotiating skills are required in contact with the banks, which in turn is associated with a corresponding credit rating. Finally, our design for leveraging real estate stands or falls with the acquisition of new loans to finance further real estate. Tax factors, on the other hand, are less relevant in this context because the positive income from the rental is often neutralised by the financing costs and by the depreciation. Only later in the model period can there be a noticeable increase in income tax. So if a conclusion is general validity at this point, then it is that leveraging with real estate is quite worthwhile.