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Is Negative Leverage Negative?

March 28, 2008 – 4:02 pm

Earning interest at the rate of 3% on your savings and carrying credit card debt at 19% seems to indicate a financial disconnect. If this were to happen for a month or 2 it may have some rationale, but certainly not long term.

The same reasoning can be applied to buying a property using what is known as negative leverage. That is, buying a property at a 5 cap rate and financing it at 7% interest. It’s going to be real tough to make a return on investment until the net operating income grows substantially.

Buyers are suddenly reacquainting themselves with the concept of cash flow. It’s been a few years since that has dawned on them. Frankly, I’m not sure why that concept seemed to vaporize around 2002 or 2003 but it did.

I know, I know property values shot up faster than a rocket and one only had to buy and sell a property in the space of a few months to realize their gain. But still, why did we collectively lose our basic principles when dealing with hard assets such as real estate.

Why did losing money become fashionable? Why did it take the tanking of the entire mortgage market and eventually the credit market to wake us up?

Won’t it be nice when Sellers all wake up too?

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