I'm new to the BiggerPockets community. I am also new to the idea of real estate investing and more specifically earning income via rentals.
My question is about choosing to go down the unleveraged path. I understand that leverage means more risk but at the same time more return on investment. I want the real estate part of my portfolio (I also invest heavily in index funds) to be as less risky as possible. I also have the money in hand to invest so I do not need loans etc!
It seems to me that everyone/everything I read online is about success via leveraged investments. So my question is: is it worthwhile to even think about unleveraged real estate investments? What are the pros and cons of going down that path?
@Jenson Buttwerworth I am a big believer in leverage in real estate for several reasons. The first reason is that "equity' does not actually equal low risk. Cash flow is what keeps us safe in real estate. As long as we have ample, healthy cash flow, we can service our debt and cover our expenses which allows us to hold our investment. There are plenty of properties that will not even cash flow if you own them all in cash.
Leverage is also great because the interest is paid by the tenants and is also a tax write off. In other words, you are not paying the interest. This is one of the main reasons that I personally will not own any properties out right in the near future.
Lastly, owning a property out right actually puts you at more risk in the (unlikely) event you are sued. If you have debt on a property, there is less equity at risk. I hold my apartment buildings in LLCs, so my risk is limited. If my building is completely paid for in the LLC, I have more equity someone could potentially get to. I have even heard very smart asset protection attorneys who have their clients take out debt on properties for this very reason.
This is an "old" discussion between investors, and it ties into the concept of "paying off early" and "appreciation vs. cash flow". I been researching myself the answer to this dilemma - here are some other threads that you should read to gain insight in the various pros and cons of an approach versus the other.
Should You Pay Off Your Rental Properties Quickly? (warning: this is not endorsement for Morris Invest, but the message is still worth watching)
So, what do others like to do, pay it off, or ride the mortgage wave? Or the way you put it, leveraged or unleveraged?
I think the truth is somewhere in the middle and it boils down to personal comfort. Or it depends on multiple factors:
- do you have other options to invest for better return than the mortgage interest rate? Like aggregate and use for down payment for another cash flowing property with a better ROI?
- what is your tolerance for debt/risk?
- what is your time horizon? is different if you are 30 or 65y.o.
- do you need that money? (if you need the cash flow to pay bills vs.. paying down mortgages)
On one side you have the folks that like leverage. Reason's I've retained:
- Minimize your own cash in a deal.
- Use someone else's cash to buy a property (the bank) and another person's to pay off the loan (the renter).
- Buy more properties (simplistic example: buy one 100k property cash, or finance four 100k properties).
On the other side, paying off a mortgage early (or unleverage):
- Pay off a property and increase cash flow (some people claim this is a terrible idea)
- Less risk. Jay Hinrichs points out in podcast 222 that one should pay off their properties sooner than later, in case something unforeseen/bad happens, you have multiple (good) exit strategies.
- You can still leverage your properties - you can get a HELOC (actually there is no such thing for investment properties, it's called portfolio line of credit or asset based LOC) and you'll be able to use it in case the need appears, without paying interest all the time.
Let me know the conclusion you reach. Good luck!
What John describes is called equity stripping and can be done through various ways - one is getting a LOC, another is having an LLC you own "lend" to you...the end result you end up with a lien on the property showing a lien holder with a note/mortgage for the X amount, thus signaling less equity available in the property, but not necessary with the actual debt (as long you don't draw from the LOC).
But then again, that is a question of risk threshold and asset protection (and a reason to move them into an LLC), not an answer to leveraged or unleveraged question.