Using Financial Leverage in Purchasing Commercial Real Estate

Therefore, if two commercial properties with comparable equity investments earn the exact same percentage return on total capital, the higher financially leveraged house will have greater earnings than will the lower leveraged firm. To earn this kind of a return, however, it's required that the revenue rate over a borrowed capital exceed the commercial real estate investor's pre-borrowing price from the capital (Dilmore and Wilson 537).

There are both advantages and disadvantages to high financial leverage in commercial real estate investing. A main advantage, of course, is that high financial leverage permits a commercial real estate investor, so to speak, to operate on somebody else's money. In finance, the process is called trading over a equity (Hudson-Wilson and Elbaum 94-95).

Financial leverage can be severely detrimental to a commercial real estate investor inside a case in which cash flow or profitability over a commercial property, for whatever reason, deteriorates. At noted earlier, financial leverage is based on fixed-interest debt. Fixed-interest debt carries with it fixed-interest charges. Although the level of income flow or profits on a commercial residence might deteriorate, the fixed-interest debt charges do not. Depending on the severity of a dollars flow or profit deterioration, a very financially leveraged position in a commercial household may well trigger a commercial true estate investor being illiquid (or at least illiquid in relation to a particular commercial property). A second disadvantage of high financial leverage is that such a position may perhaps bring about bankers along with other potential sources of income to perceive a higher risk associated with the investor's assets. Ought to such a perception come to be broadly accepted, (a) the commercial actual estate investor will normally be needed to pay a greater rate of interest on any new debt (Ciochetti, Deng, Gao, and Yao 602) and (b) the industry importance in the investor's equity in a commercial home may possibly deteriorate.

In a single sense, risk is regarded to be a measure of uncertainty. In this broad context, everything that may be done by a commercial actual estate investor involves risk. This notion is valid, and, certainly, risk in whatever operation needs to be minimized by investors. The concept of risk is narrowed somewhat by the definition holding that risk will be the possibility of an damaging outcome to an event. This definition places the concept of risk a lot more closely inside context of the risks that a commercial true estate investor will attempt to avoid in relation to financial leverage (Schneyer 429-430). In the context of events, however, this definition of risk remains very broad.

 

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