Leverage in Multifamily Investments: Unlocking Bigger Returns with Smart Borrowing
Leverage is one of the most powerful tools available to real estate investors, especially in multifamily investments. By using borrowed capital to purchase and control properties, investors can magnify their returns, increase buying power, and achieve long-term wealth-building goals. However, while leverage can unlock significant opportunities, it must be used wisely to avoid unnecessary risks.
In this article, we’ll explore what leverage is, how it works in multifamily real estate, its benefits and risks, and tips for using leverage effectively in your investment strategy.
What Is Leverage in Real Estate?
In real estate, leverage refers to the use of borrowed capital (debt) to finance the purchase of a property. Instead of paying for the entire property in cash, investors use loans to cover a portion of the purchase price. This allows them to control a larger asset with a smaller upfront investment.
For example:
A $5 million multifamily property with an 65% loan-to-value (LTV) ratio would require $1.75 million in equity (investor funds) and $3.25 million in debt.
By leveraging $3.25 million, the investor gains control of the entire property while committing only 35% of the total cost.
The Benefits of Leverage in Multifamily Investments
Amplified Returns (Equity Growth)
Leverage allows investors to earn returns on the total value of the property, not just the amount they invested. As the property appreciates or generates income, the gains are calculated on the full value of the property, while the loan amount remains fixed.
Example:
Assume a $5 million property appreciates by 10% ($500,000).
If the investor used 80% leverage, they only invested $1 million of their own money.
That $500,000 gain represents a 50% return on their initial equity investment of $1 million.
If the investor had purchased the property outright using $5 million of their own money, the $500,000 gain would represent only a 10% return on total equity.
Increased Buying Power
Leverage allows investors to acquire larger or more properties than they could with cash alone. This diversification reduces risk by spreading investments across multiple properties or markets.
Example:
With $7 million in cash, an investor could purchase a $7 million property outright.
Alternatively, by leveraging 65% LTV, they could acquire control of $20 million worth of properties using the same $7 million in equity.
Tax Advantages
The interest paid on real estate loans is often tax-deductible, reducing the investor’s taxable income. Additionally, depreciation—a non-cash expense—can further offset income, enhancing the overall tax benefits of leveraged investments.
Preserving Liquidity
Using leverage allows investors to keep a portion of their capital available for other opportunities, such as additional acquisitions or emergency reserves. This flexibility can lead to greater overall portfolio growth.
The Risks of Leverage in Multifamily Investments
While leverage is a powerful tool, it comes with risks that must be managed carefully.
Debt Service Risk
Loan payments (debt service) are a fixed expense that must be covered, regardless of the property’s performance. If the property’s income declines due to vacancies, market conditions, or unexpected repairs, covering debt service can strain cash flow.
Interest Rate Risk
Rising interest rates can increase borrowing costs for variable-rate loans or make refinancing more expensive, reducing cash flow and investor returns.
Mitigation: Use fixed-rate loans or purchase interest rate caps for variable-rate loans to limit exposure to rising rates.
Overleveraging
Overleveraging occurs when an investor takes on too much debt relative to the property’s income, leaving little room for error. This can lead to default if income declines or operating costs increase.
Mitigation: Maintain a healthy loan-to-value (LTV) ratio and focus on properties with strong cash flow.
Refinancing Risk
Loans with short terms may require refinancing at maturity. If market conditions or interest rates have changed unfavorably, refinancing could become difficult or costly.
Mitigation: Match the loan term to the investment’s business plan and build in contingency reserves to cover unexpected refinancing challenges.
How Multifamily Investors Use Leverage
Multifamily investors strategically use leverage to maximize returns while managing risk. Here are some common scenarios:
Value-Add Investments
In value-add strategies, investors use leverage to acquire properties with the potential for rent increases and operational improvements. The added income (through renovations or management efficiencies) increases the property’s NOI, boosting its value and enabling the investor to refinance or sell at a profit.
Example:
An investor acquires a multifamily property for $5 million and implements a value-add strategy to increase the NOI by $100,000 annually. This NOI increase raises the property’s value by $2 million at a 5% cap rate ($100,000 ÷ 0.05). Let’s compare the returns with and without leverage:
With 65% Leverage:
The investor uses a loan for 65% of the purchase price ($3.25 million) and contributes 35% equity ($1.75 million). After the value-add strategy, the $2 million increase in value translates to a 114% return on equity ($2 million ÷ $1.75 million).Without Leverage:
If the investor purchases the property outright using $5 million in equity, the $2 million value increase results in only a 40% return on equity ($2 million ÷ $5 million).
Stabilized Properties
For stabilized properties with steady cash flow, leverage can enhance returns while maintaining relatively low risk. These deals often use conservative LTV ratios and fixed-rate loans for predictable payments.
Opportunistic Deals
In opportunistic investments, investors may use higher leverage to acquire distressed or underperforming assets. These deals carry more risk but can yield outsized returns if executed successfully.
Evaluating Leverage: Key Metrics
Loan-to-Value (LTV) Ratio
The LTV ratio measures the proportion of the property’s value financed with debt. Lower LTV ratios reduce risk but require more equity, while higher LTV ratios increase potential returns but carry greater risk.
Target: 65%–75% for most multifamily deals.
Debt Service Coverage Ratio (DSCR)
The DSCR measures the property’s ability to cover debt payments with its NOI. A DSCR of 1.25 or higher is considered healthy, providing a buffer against income fluctuations.
Formula: DSCR = NOI ÷ Debt Service
Interest Rate Terms
Understanding whether the loan is fixed-rate or variable-rate is crucial. Fixed rates provide stability, while variable rates can offer initial cost savings but come with greater risk.
Best Practices for Using Leverage in Multifamily Investments
Align Leverage with the Business Plan: Match the loan structure to the property’s strategy. For example, use short-term loans for value-add projects and long-term loans for stabilized assets.
Maintain Conservative LTV Ratios: Avoid overleveraging, especially in volatile markets.
Stress-Test Financial Models: Assess how the property would perform under worst-case scenarios, such as increased vacancies or rising interest rates.
Build Reserves: Set aside contingency funds to cover unexpected expenses or temporary cash flow disruptions.
Partner with Experienced Sponsors: If investing passively in a syndication, ensure the sponsor has a track record of managing leverage successfully.
Closing Thoughts
Leverage is one of the most powerful tools in multifamily investing, enabling investors to amplify returns, preserve capital, and scale their portfolios. However, it must be used responsibly to manage risks such as debt service, interest rate fluctuations, and market volatility.
By understanding the mechanics of leverage and applying it strategically, investors can unlock the full potential of multifamily real estate. Whether you’re an active investor or a passive participant in syndications, leveraging wisely can be the key to achieving long-term financial success.
About Brookeast Capital:
Brookeast Capital is a multifamily investment firm dedicated to helping investors grow and protect their wealth while achieving passive cash flow. With a focus on strategic acquisitions and value-add strategies, Brookeast Capital delivers exceptional returns by acquiring, repositioning, and managing multifamily apartment properties.
Our team combines in-depth market research with proven expertise to identify lucrative opportunities, maximize asset value, and return capital to our investors upon executing our business plans. We pride ourselves on creating long-term partnerships with our investors, ensuring transparency and trust throughout the investment process.
Join Brookeast Capital in building a stronger financial future. Explore how you can benefit from the dynamic multifamily market by scheduling your personalized consultation today. Let us help you take the next step toward achieving your investment goals.
