Asking the question of why buyers should never pay more than appraised value on leveraged property may seem complicated to some, but the answer boils down to simple economics. When investing in a property with leverage, the goal is to maximize return on investment (ROI). Let’s take an example to illustrate this point.
Suppose a buyer offers to purchase a property with a purchase price of $250,000. They plan to invest $50,000 in it and borrow $200,000 from a lender. If they hold on to the property and sell it for $400,000, their total gain would be $350,000, which is a impressive 700% ROI on their invested amount of $50,000.
However, if the appraised value of the property is $12,500 less than the offer price, the lender may not cover the difference, forcing the buyer to make up the shortfall themselves. In such a case, investing the additional funds into the property would not increase their ROI and would lead to a decrease in return due to opportunity costs. They could have invested that $12,500 in an alternative investment that produced the same return, allowing it to grow to $87,500.
Suppose the buyer puts in $62,500 as the deposit instead of $50,000 and invests the additional funds in an alternative investment that yields the same return. If they sell the property for $400,000, the total gain would be 540%. This is clearly a lower ROI than the 700% they would have received in Example 1.
Another example would be of a buyer who invests $62,500 in a property and borrows $200,000 from a lender. Suppose they sell this investment years later for $500,000, their ROI would be $437,500; much higher than the ROI they would receive in Example 1.
To summarize, investors must be mindful of the opportunity costs associated with paying