- March 1, 2011: Vol. 5, Number 3

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Financial Leverage and Risk: Property Level and Marketwide (Systemic) Perspectives

by Jim Clayton

“The externalities to high leverage are greater than they appear, because on most days everything runs smoothly. But as we have seen time and again, in the instances where it really matters, the liquidity that is supposed to justify the leverage will disappear with a resulting spiral into crisis. …Liquidity allows for ready leverage, but it also creates the means for crises. …It is in the froth of liquidity that profits are made and demons are spawned.”

— From A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation,by Richard Bookstaber

The use of debt in real estate investment is widespread, and there is good reason for this. Real estate assets are big-ticket, lumpy and capital intensive, and hence many investors require debt financing to get in the game, especially if they want to be able to acquire enough properties to gain meaningful diversification benefits. However,

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