Accretive Leverage | Conatus Real Estate Inc.

Accretive Leverage describes a scenario where the use of leverage increases current cash flow returns. With recent interest rate drops, investing with accretive leverage may be possible.

Accretive Leverage is the icing on the cake of real estate investing. The concept combines “accretive” (to increase something by gradual addition) with “leverage” (using borrowed capital as a source when making an investment). Together, accretive leverage means that as we increase our loan, the returns from the investment also increase — we’re using leverage to achieve higher performance on our investment.

Why Is It Important?

There are many different things in real estate investing that we can control and some that we can’t. Investment attributes like rent amount and purchase price are largely dictated by the market. Rehabilitation costs are dictated by property condition. These things have low volatility. Interest rates, on the other hand, are a high-volatility item — changing constantly, sometimes daily. The one thing we have full control over is the amount of debt we use when buying a property.

Three Scenarios

Using a six cap rate property in San Antonio with $1,400 rent as an example:

Current Rates (4.73%) — Limited Negative Accretion. At a conservative 50% LTV, the cap rate drops slightly from 6% to about 5.91%. At 70% LTV, we lose about 17 basis points total. This is essentially a point of indifference.
Five-Year High Rate (5.61%) — Non-Accretive Leverage. At 50% LTV, the rate drops from 6% to 5.38%. At 70% LTV, the levered yield falls to 4.64%. By increasing leverage, we lose almost three quarters of a point in return. In this scenario, minimizing leverage is preferable.
Five-Year Low Rate (just above 4%) — Accretive Leverage. At 50% LTV, levered yield rises to 6.28%. At 70% LTV, it reaches 6.52% — about a quarter point benefit from using leverage.

The Indifference Point

Something happens between the five-year low and high rate: we cross over a line where the use of leverage becomes beneficial. This indifference point — the accretion line — sits at 4.47% in this scenario. Below this threshold, increasing debt improves returns. Above it, additional borrowing reduces performance.

Conclusions

Debt should always be used with tact
Increasing debt doesn’t always make for a better investment
Know your numbers and make smart choices
In today’s market and interest rate environment, you may find opportunities to invest with accretive leverage