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Investing in residential property for rental income follows a clear logic: you buy an asset, put it into operation, and generate income. However, there is one decision that can significantly change the final outcome of the investment: whether or not to finance the purchase.
Using a mortgage – what in financial terms is known as leverage – is one of the most common tools in real estate. But it is also one of the most misunderstood. It can improve returns… or deteriorate them if not used properly.
In this article, we explain how it really works, its impact on the numbers, and how it is approached within Urbanitae Direct Investments.
Leverage: investing with less equity
Leverage essentially means financing part of the investment with debt. Instead of contributing 100% of the capital, the investor uses a mortgage to cover part of the asset’s purchase price.
This introduces a key change: returns are no longer calculated on the total value of the property, but rather on the investor’s own capital invested.
Put simply, the asset remains the same, but the investor has less capital at stake. And under certain conditions, this can significantly increase relative returns.
A practical example: Vallecas II
To better understand this, it helps to look at a real case such as Vallecas II, one of the second-hand opportunities analyzed within Direct Investments.
In this type of transaction, the investment dossier always includes two full scenarios – with and without financing – incorporating all costs: taxes, fees, refurbishment, rental management, insurance, etc. In other words, these are not theoretical estimates, but realistic scenarios.
Below is a summary of the investment:
| Concept | Without financing | With financing |
|---|---|---|
| Initial investment | €233,493 | €85,893 |
| Year 1 | €13,956 | €7,348 |
| Year 2 | €14,235 | €7,495 |
| Year 3 | €14,520 | €7,645 |
| Year 5 | €15,106 | €7,954 |
| Estimated profit | €109,885 | €94,033 |
| Estimated IRR | 11.6% | 23.9% |
The difference between the two scenarios is clear, but it needs to be interpreted correctly.
In absolute terms, the estimated profit is higher without financing: €109,885 vs. €94,033. However, the IRR nearly doubles in the leveraged scenario. Why? Because the initial capital required is much lower: €85,893 vs. €233,493.
👉 That is the key to leverage: it does not necessarily increase total profit, but it can significantly improve returns on the equity invested.
Why a mortgage can improve IRR (and when it doesn’t)
The positive effect of leverage occurs when one basic condition is met: the return on the asset is higher than the cost of financing.
When this happens, the difference works in the investor’s favor and boosts IRR. But if it doesn’t – for example, if interest rates are high or rental income is tight – the effect can be the opposite.
That is why leverage is not a magic formula. It works when the underlying investment is solid.
In the Direct Investments model, that starting point is critical: value lies in identifying assets that are well-positioned in terms of price, location, and demand. Financing can then be a useful tool, but it does not replace that initial analysis.
The other side: higher investment discipline
Using a mortgage not only affects returns, it also changes the risk profile.
With financing comes a fixed obligation: the mortgage payment. This makes the investment more sensitive to deviations, such as vacancy periods, unexpected costs, or delays in renting the property.
In addition, the investor becomes exposed to additional factors, such as financing conditions and interest rate movements.
This does not mean leverage is negative. It means it is a tool that requires a clear understanding of how and when it is being used.
How it fits within Direct Investments
Within Direct Investments, using a mortgage is an option, not a requirement. Investors can decide whether to finance part of the transaction or execute it entirely with their own capital.
What matters is that the decision is made with full information. The prior analysis of the asset includes detailed scenarios that show how returns change in each case.
This aligns with a key principle of the model: it is not about promising above-market returns, but about presenting opportunities that are consistent with their context. If an investment offers a 5.5% net yield, it is because that level is aligned with its location and comparables.
From there, leverage can enhance returns on equity, but it does not replace the fundamentals: buying well.
A tool, not a shortcut
Leverage is a natural part of real estate investing. When used properly, it can be an effective lever to optimize capital and improve returns. But it does not change the nature of the investment.
If the asset is well selected and executed, financing can work in your favor. If not, it can amplify problems. That is why, rather than asking whether to use a mortgage, the key question is different: is the investment well structured from the start?
At Direct Investments, that is the foundation. Everything else – including financing – is a decision the investor can make with all the information on the table.
The figures shown are estimates included in the project dossier and may vary depending on the performance of the asset and financing conditions. The leveraged scenario is based on a standard assumption (80% leverage, 30-year term, fixed interest rate of 2%).
