I bet most people would be surprised to hear that they can use their brokerage account to buy a rental property, but it's true.
You may use funds borrowed from a margin account to purchase real estate. But there are risks involved in using margin accounts for this purpose, including the possibility of a margin call if the value of the investments securing the margin loan decreases.
Let's explore this little known strategy for investing in real estate.
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The information contained in this post is for informational purposes only. It is not a recommendation to buy or invest, and it is not financial, investment, legal, or tax advice. You should seek the advice of a qualified professional before making any investment or other decisions relating to the topics covered by this article.
What is a Margin Account?
The basic brokerage account only allows you to buy investments up to the amount of cash you have in the account.
But if you apply (and are approved) for an upgrade of that account to a margin account, then you gain access to what is essentially a line of credit from the broker that can be used to buy additional securities.
You can typically borrow up to half of the total purchase price of the investments in your account (as long as those investments are eligible for margin). Source: Schwab.com
Eligible investments normally include stocks, bonds, ETFs, and mutual funds.
How Does a Margin Account Work?
A classic example of how someone uses a margin account is as follows.
You have $10,000 in cash, but want to buy $15,000 in stock with a $500 share price. Using margin, you buy 30 shares equal to $15,000, instead of 20 shares equal to $10,000.
If the stock rises to $1,000 per share, you have made $20,000 off your $10,000 investment. If you had not used margin, your profit would have only been $10,000.
But margin can cut the other way.
Let’s use the same example, but in this case, the stock price drops to $250. Now your loss is much greater than it would have been if you did not use margin.
Instead of losing $5,000, you have lost your entire $10,000 because the value of your stock is only $5,000 and you still owe the broker $5,000 (plus any interest that has accrued on the loan amount).
This is a simple example to illustrate the point about how leverage can cut both ways. The actual mechanics of how this would play out in real life is likely to be different.
This is because there are certain “maintenance margins” that must be satisfied and they kick in well before your stock drops by 50%.
If your stock price declines too much, your broker will issue a “margin call” where you have to deposit more money to satisfy the maintenance margin. If you don't, the broker can sell some or all of your stock to pay down your loan.
An Unfortunate Lesson For Me
That happened to me during the 2008 financial crisis when I was heavily invested in individual stocks of banks that I purchased on margin.
I learned the hard way that in a rapid decline, you may not get the chance to deposit additional funds. The broker may simply sell your holdings to protect against their future potential losses.
A more prudent use of margin would have been to purchase investments that don’t have that kind of volatility.
Also, just use a fraction of the margin available to you. Most articles I saw on the topic recommend using only 10% of your available margin, with a cap of 30%.
The bottom line is that if you are not a sophisticated investor or you can’t tolerate the risk of loss, you should not be using margin for investment purposes.
So that’s the good and the bad. If you are an experienced investor and can accept the risks associated with investing on margin, let’s see how we can use your margin account to purchase real estate.
Can I Buy Real Estate with Margin?
As I mentioned at the beginning, yes.
You can use margin to buy real estate. Many brokerages allow you to withdraw money from your margin account for any purpose, including real estate investing, essentially transforming your margin account into a line of credit. The money from your margin account may be used to fund a down payment or purchase your property outright.
On top of this, there are no monthly payments required on margin account balances. The interest on those balances will just accrue. Of course, you will have to pay it off eventually, but in the short term, your cash flow will not suffer.
As of this writing, Interactive Brokers (generally regarded as the broker that offers one of the lowest interest rates on their margin accounts) offers rates as low as 0.75%!
Source: Interactive Brokers
Of course, not everyone is going to get that rate, but still. That is an astoundingly low rate!
This low interest rate is one of the main reasons why a margin account may be an effective tool for investing in real estate.
Ways to Use a Margin Account to Invest In Real Estate
There are a number of ways to use a margin account to invest in real estate. One way is to use your margin account to purchase a property for a flip. This can be a better option than hard money lending, which carries high interest rates and fees. You can also use your margin account to fund a down payment on a long term rental property. But given the risk of a margin call on any long term project, you should try to pay off the margin loan as soon as possible.
If you are a flipper looking for a better alternative to hard money lending (which is a loan from a private lender that is often used to fund flip deals), using your margin account to buy the property can be an attractive option.
Hard money loans can have interest rates in the double digits and have heavy upfront fees. Borrowing money at 1/10th the interest rate for hard money loans with no paperwork, no fees, no liens on your investment property, and no hassles, seems like a win.
And because flips are usually completed in relatively short order, you can pay back the margin account (and close out the risk of a margin call) once you have sold the property for a profit.
Now I would emphasize that you should NOT be doing this if you are a beginner. You don’t want to be leveraging yourself in this way if you are not very confident of your ability to make a profit.
Rental Property Investing
If you are a seasoned real estate investor who buys rental properties, using margin to fund your down payment can work as a “no money down” approach to buying those properties (assuming your margin account has enough to cover the down payment).
Because you are not putting any of your own cash into the deal, your return on investment is infinite.
There may be some length of time that you need the money to sit in your account after you withdraw it in case the lender that is financing your property wants evidence of your down payment.
But this is really no different from using your home equity line of credit to fund your down payment on a rental. That is done all the time. The advantage of this approach is that you are not risking your home if you do not make good on the loan.
But there are real risks to this approach.
Unlike a flip, rental property investing is usually a long term proposition. A lot can happen to your brokerage account investments over the years. This could include a drop in the value of your securities that might trigger a margin call.
To reduce your chance of being caught up in a margin call, it is best to try to close out the margin loan as soon as you can by either refinancing into a traditional loan or applying your cash flow from the property (and maybe other sources) to pay down the margin loan.
I know a lot of experienced rental property investors who reliably make money on their rentals but run out of funding to expand their portfolio. If this is you, using margin to buy a rental with no money out of your pocket, while still keeping all of your brokerage investments intact, may be an option that works for you.
If you are looking for other options to cover your down payment that may be less risky, check out my article on no money down investing for rental properties – there are some novel and interesting ideas that you may also want to consider.
Using margin to invest in real estate can be risky. But if you are a seasoned real estate investor who has done a lot of successful deals and are very good at reducing the risk of loss in connection with a real estate investment, it may be something worth exploring.
The low-interest rates, ease of withdrawal, and lack of a monthly payment obligation (which can be really helpful to your cash flow if you are a rental property investor) can make this an appealing strategy for the right real estate investor.
But before taking the plunge, do your homework and make sure you are comfortable with the possibility of a margin call happening while the margin loan is outstanding.
As with all of the strategies discussed here, you should consult with your financial and tax advisors on whether this strategy is right for you.
Want to invest in real estate but don’t have this type of expertise or want to start off with a more conventional (and less risky) approach?
I would encourage you to start learning by reading the other real estate articles on this site. In particular, I have a detailed how to get started in real estate investing guide that takes you through the key first steps.
If you are itching to invest now in real estate, you may want to consider online crowdfunding, which is a maintenance-free option that some consider to be a safer investment than investing in individual properties.
DiversyFund, for example, lets you invest in a diversified basket of real estate investments with an initial investment of as low as $500.