Borrowing money can make a good deal better or a good deal dangerous. The difference has a name. It is called positive leverage, and right now it is getting rare.
Here is the idea in plain English. Positive leverage is when the cost of your debt is lower than the yield the property generates. When that is true, every dollar you borrow lifts your return instead of dragging it down.
Walk through it with a real deal.
Earlier this year we acquired an IOS site in Clovis, California, fully leased to AT&T at a cap rate 150 bps higher than the interest rate. Because we are borrowing at less than the asset earns, the spread between the two does not go to the bank. It flows to our equity. The asset is working for us from day one.
That is positive leverage. The debt is accretive.
Negative leverage is the mirror image. When you buy at a 5% cap rate but your debt costs 6.5%, borrowing actually lowers your return. You are paying the bank more than the building earns, and you are betting entirely on rent growth or a future sale to bail you out. That may be okay when we look at value add but is dangerous when we think about core deals where we can't pull levers to increase NOI.
One warning. Positive leverage is only as durable as the income underneath it. Leverage magnifies whatever is there. If the cash flow is solid, like a credit tenant who has been on the site for 20 years, leverage amplifies a good outcome. If the income is shaky, leverage amplifies the loss just as fast.
The cheapest debt in the world does not save a bad deal. It just makes a good one better.
Are you seeing positive or negative leverage in the deals crossing your desk right now?
Wednesday Real Estate 101: Positive leverage
