Leverage is using borrowed money to control a larger asset than cash alone would buy. It multiplies outcomes in both directions: when the property's return beats the loan's cost, equity returns rise; when it doesn't, losses concentrate on the smaller equity slice. Debt never improves a building, it only decides who feels its results, and how hard.
Return on equity (ROE)=Unlevered return + (Unlevered return − Cost of debt) × DebtEquity
- Unlevered return
- The property's return with no debt: net operating income over the price paid.
- Cost of debt
- The loan's annual interest rate.
- Debt, Equity
- The loan balance and the cash invested behind it.
- A multiplier, not an improvement. It changes who feels the result and how hard, never what the building earns.
- Blind to timing. A spread can stay positive for years and turn negative at the one moment a refinance comes due.
- Positive leverage needs the property's return to beat the cost of debt. When that spread is thin, small errors get amplified.
- The higher the debt-to-equity ratio, the less room a wrong assumption has before it becomes a loss.
The same building bought at $1.60M, with the $1,012,000 loan at 6.5%.
Borrowing lowered the return. When the spread runs the wrong way, leverage is not aggressive, it is only expensive. One caution on the 5.1%: it prices the loan at its interest cost alone. Repaying principal takes another $10,978 out of the year, so the cash that reaches the account is the 3.3% under cash-on-cash. That difference is not lost, it is the balance coming down.
Related terms
All termsDSCR (Debt Service Coverage Ratio)
The debt service coverage ratio is net operating income divided by the annual loan payment.
FinanceLTV (Loan-to-Value)
Loan-to-value is the loan amount divided by the property's value.
FinanceCash Flow
Cash flow is what actually lands in the owner's pocket in a period: net operating income minus the mortgage payment and minus the capital dollars the building consumed.
Terms arrive with the writing.
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