Should One Use Leverage in a Private Equity Real Estate Portfolio?

Abstract

Whenever interest rates fall and positive leverage conditions hold, the subject of the use of leverage in a portfolio of real estate inevitably comes up. When the cost of debt falls below the income yield on an asset or portfolio of assets, there is positive leverage and it can be used to raise the return on the asset(s). While using leverage seems trivial (how can positive leverage be a “bad” thing?), it is, in fact, quite complex and raises some philosophical and operational issues for the investor. In this article the authors discuss the many aspects of the leverage decision and offer a recommendation. Throughout the discussion they assume that leverage can be applied, creating a positive spread, at least initially. They do not discuss the use of very aggressive leverage as an opportunistic strategy; leverage is considered only in the context of a base real estate portfolio strategy.