As a commercial real estate investor, you can increase your profits and pocket tax-free cash by using leverage and refinancing (also known as “Other People’s Money”). This benefit is just one reason why investing in commercial real estate often stands out when measured against other forms of investment.

Leverage is the use of borrowed funds to complete an investment transaction. The higher the proportion of borrowed funds used to make the investment, the higher the leverage and therefore the lower the amount of capital required.

Here are some examples of how leverage works for you:

Increase your gains in price with leverage

Suppose you purchase a $100,000 property. Borrow $80,000 and deposit $20,000. Over the next 5 years, the CPI increases by 50 percent, however, your property lagged the CPI increasing by only 25 percent. Your actual wealth went down, right? No, it increased. The $100,000 property is now worth $125,000, so your net worth wealth (your initial initial $20,000) has increased to $45,000. You have more than doubled your money, while inflation has only increased your $20,000 to $30,000. Investing in real estate builds wealth because it produces acorns (small down payments) on free, clear properties that are worth many multiples of the original amount of cash invested.

Increase cash flow returns with leverage

Traditionally, investors not only magnify their capital gains from leverage, but also magnify their rates of return from cash flows. You pay $1,000,000 in cash for an apartment building that generates net income (after all operating expenses) of 7.5 percent with no financing. Nothing bad. But if you finance $800,000 of that $1,000,000 purchase price for, say, 30 years, 5.75 percent interest, you invest only $200,000 in cash. Your net income equals $75,000 (7.5% X $1,000,000) and your annual mortgage payments (debt service) will total about $56,000. You pocket $19,000 ($75,000 minus $56,000). You have increased your return on cash flow (called the cash-on-cash return) from 7.5 percent to 9.5 percent ($19,000 divided by $200,000).

Refinance to Pocket Cash without paying taxes

Refinancing occurs when a commercial real estate investor replaces their existing financing with new financing.

Let’s say that after 10 years your $1,000,000 property is now worth $1,500,000. You have paid off your loan balance at $650,000. Your capital has increased from $200,000 to $850,000 ($1,500,000 to $650,000). You take out a new 80 percent loan-to-value (LTV) mortgage of $1,200,000. You pocket $550,000 tax-free. However, I suggest you don’t spend that money. I suggest you reinvest it. Buy another income property. Yes, you now owe higher monthly mortgage payments on your first property, and your cash flows from that property will decrease. But with the additional cash flows from your second property, your total cash flows will increase.

As a commercial real estate investor, that’s called having your cake and eating it too!