Question

Why will most real estate investors choose the scenario with a mortgage? vs without one

Answer 1

Real Estate means physical/real property, such as house, flats, shops, agriculture/industrial land, warehouses etc. further it also includes air rights above land and underground rights.

Real estate can be classified as:

1. Residential (house, flats),

2. Commercial (shops, open space in malls etc.)

3. Industrial (industrial (Open) land, factory, warehouse, Mines)

4. Vacant piece of land (Agriculture farms)

Underground rights: rights to exploit minerals/ water underneath the land. (this part is extra, can be ignored)

Air rights above land: developing buildings above land, this meaning has changed over time, since literal meaning of air rights would also include flyover rights. (this part is extra, can be ignored)

Following are benefits of having real estate investment with mortgage over without mortgage.

1. Higher leverage: investing in a real estate with mortgage leads to lower upfront investment in the form of down payment, in this way you are leveraging of a property of say $40000 with down payment of just $4000 (assuming DP of 10% of total value). Lower DP would leave more funds for meeting other expenses such as developing property, maintenance expenses, insurance exp. and for investing in other assets.

2. Tax Savings: generally, interest paid on mortgage is a tax deductible item and therefore it leads to lower tax expenses, further debt is a cheaper source of finance than equity/own capital.

3. Banks generally allow facility like moratorium period on loans, step-up/step-down payments, ballooning payments. These types of facilities allow investor to defer its repayments till the property is developed and start reaping benefits, for example if Mr.X buys a ware house with mortgage and bank allows for moratorium of 6 months to Mr.X on loan taken for ware house then Mr.X has 6 months to make necessary changes and lease the ware house and start receiving rent.

4. When a property is purchased on mortgage and given on rent, then such rent helps in repaying the instalments to certain extent.

5. if you are buying a property whcih already has mortgage in it, then you can have upper hand while negotiating with the seller for the property, if he/she is selling the property because he/she is not able to pay installments.

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5. If the investor has purchased a residential property (2 floor house) for on mortgage, then he/she can save the rent expenses by utilizing some part of it for own use (and save rent) and let out the remaining part.