Financing a land deal: when leverage works in your favour

Many of our clients express concern when it comes to financing their real estate investments with loans. This is understandable, given the conservative attitudes many of us hold towards borrowing. However, taking out a loan for a real estate transaction can actually be a smart move when it is done correctly. It can significantly increase profitability, improve a person’s financial well-being during the transaction, and even make it possible to carry out several transactions at once. This technique is known as leverage, and it is a tool that large companies and businesses use to maximise profits in today’s economic climate. Join us to learn how to do more with less and achieve greater success in your real estate investments.

How can you leverage real estate?

In the field of real estate, leverage is a term used to describe the use of borrowed capital to invest in an asset. In essence, leverage allows an investor to acquire a larger asset with less capital by borrowing funds from a lender. This can increase the profit potential should the asset appreciate in value, but it also carries a higher level of risk, due to the possibility of interest-rate fluctuations and a more significant debt.

Leverage refers to using the initial equity to secure a loan or financing from a bank or another lender. This results in an increase in the percentage of profit from the transaction. In essence, leverage means that a significant portion of the funds used in the real estate transaction do not come from equity. Instead, the loan costs are balanced against the profit of the transaction, ultimately leading to a more worthwhile financial outcome. To illustrate this point, imagine a real estate transaction with and without the use of leverage.

For the purposes of this example, let us assume that the transaction costs ₪100,000 and that the market value of the property is ₪150,000.

• A transaction carried out without the use of any form of leverage – if you have a budget of ₪100,000 and you decide to use the entire budget to purchase a property priced at ₪100,000 but valued at ₪150,000, you are making a wise investment choice.

When it comes to calculating the return on a transaction, the process is simple. Let us assume you invested ₪100,000 and now have an asset worth ₪150,000. This means you have made ₪50,000. Your return is therefore 50:100, which translates into a 50% return on your investment.

• A transaction carried out with the use of some form of leverage – leverage is a central concept in many financial transactions. It allows individuals and organisations to use borrowed funds to invest in assets with the potential to yield returns that exceed the cost of the borrowed money. This form of leverage can increase both profits and losses, and it requires careful consideration of the risks and rewards.

By investing just ₪50,000, the bank will grant you an additional ₪50,000. This loan, however, comes with an interest payment of ₪5,000. It is important to note that the value of the property you will purchase with this loan is ₪150,000.

On completion of the transaction, the return can be determined by carefully calculating the profit that remains after repaying the loan and paying the interest. In this particular case, you can expect a profit of ₪45,000 against an initial investment of ₪50,000. The return can be calculated by dividing the profit by the investment, which gives a return of 90%.

By obtaining the right loan, you can invest a significantly smaller initial sum and still receive a much greater return.

What types of loan exist in the market for financing real estate transactions?

When it comes to financing real estate transactions, it is essential to be aware of the different types of loan available. What are some of the loans worth knowing in the field of financing?

• A loan obtained from a provident fund, a pension fund or a study fund (keren hishtalmut) – if you need financial assistance, you may be able to obtain a loan ranging from 60% to 70% of the value of your fund. The terms of this loan are usually favourable, provided that you pledge the funds in your account as collateral. When taking a loan of this kind, your money remains in the account and continues to accrue interest in line with the fund’s performance, at least until the loan is repaid in full. This allows you to enjoy a worthwhile loan while maintaining the growth of your investment.
• Balloon (grace) loans – grace periods are a common feature of balloon loans. These loans, also known as balloon loans, require borrowers to make low monthly payments for a period fixed in advance. At the end of this period, a large payment, or “balloon payment”, must be made. With a grace period, borrowers are given additional time to make the balloon payment without incurring late fees or other penalties.

A balloon loan is a financial instrument that serves as a kind of “bridge loan” and can be obtained from various financial institutions, such as banks. Its purpose is to provide a convenient means of financing over the short term – a period during which a significant sum of money is expected to become available, such as the profit from a transaction. This type of loan, also known as a “bolt loan” or “grace loan”, differs from a typical loan in that it is repaid in a single payment, or a small number of payments, at the end of the loan period. While interest payments may be made on a monthly basis during the loan period, the principal is repaid only at the end of the period. Although the interest rates on balloon loans are generally higher, they can be a smart financing solution for real estate transactions if used wisely.

When you take out a loan, you can also receive a discount on betterment tax (mas shevach) at the time of sale, by offsetting the financing costs. When carrying out a real estate transaction, you must be aware of betterment tax. This tax depends on the profit made from the transaction. Related expenses, such as the interest paid on loans used to finance the transaction, can be offset against the profit when the time comes to pay betterment tax. As such, when paying betterment tax, you may deduct from the sale price both the purchase price of the property and the real interest paid on the loan. This deduction constitutes a form of discount on betterment tax, available only to those who took out a loan. In certain cases, this discount may make taking out a loan worthwhile. It is therefore important to take into account the potential advantages of taking out a loan when carrying out a real estate transaction.

If you are considering purchasing real estate, why not turn to us for our professional advice? We are here to help you! Our team is here to provide professional guidance and to assist you in making informed decisions. If you need further information, the experts at Connection Group will be glad to help you!