A more conservative path to REI?
Old Hickory, TN · Member since 2012 · 31 posts · 6 votes
All,
I'm a young guy who hopes to get started investing in the next couple of years. My mindset (and my wife's) has always been to avoid debt like the plague. This of course creates a conflict when trying to use other people's (bank's) money to finance a deal.
How many of the pros out there have a similar, no-debt approach? Thoughts? To those who do see, and use, the benefits of leverage, where is the sweet spot where you are making good return without being over-leveraged?
Thanks!
Daniel Walker You sound like a fan of Dave Ramsey. I too am anti debt. However, I would have never been able to buy this many houses without some debt.
You could grow your business slowly by paying cash for your properties. While I avoid car payments and credit cards, I'm ok with debt on real estate since it (hopefully) goes up in value. I would never finance anything else.
That would take volumes of books for you to study as your answer is in several disalines, finance, economics, taxation and management.
But a simple way to look at it from a conservative point of view would be as the banks look at it. Seems like they will loan 90/95% on the first property that you can later move to the investment side, then 80% LTV and as you become more leveraged they will lend less, 75/70% then 60% or stop. That should tell you something. Banks are conservative and if they see a request for a loan that is too leveraged or a borrower getting in too deep, they don't lend usually.
Only you can determine what kind of return is suitable for you or define conservative. :)
Thanks for the help Bill!
Daniel Walker You sound like a fan of Dave Ramsey. I too am anti debt. However, I would have never been able to buy this many houses without some debt.
You could grow your business slowly by paying cash for your properties. While I avoid car payments and credit cards, I'm ok with debt on real estate since it (hopefully) goes up in value. I would never finance anything else.
In real estate investing debt is a necessary evil.
My plan thus far has been to eliminate all personal non re debt. (Autos, Credit Cards, Payment plans, etc)
Purchase a primary residence with a 15 yr mortgage. A home is a necessity and not having a home doesn't eliminate monthly expense of housing.
My RE brokerage was having to lease space so we decided to purchase a office building with excess space. I consider this a primary residence also because it is necessary for my business. Thus far it has been a great investment and has allowed my RE brokerage to operate with virtually no overhead. The office building is a also on a 15 yr loan.
With regard to purchasing rental property I've taken a conservative route.
Goal is to flip 2-5 homes per year and reinvest part of the profits into single family rental homes that meet the 2% rule.
I did my first last year, and am supposed to close on my 2nd this coming week.
It's slower than I'd like to go at times, but I'm just leery of leveraging on a asset that is not a necessity and that I derive no benefit from other than cash flow. Rental rates fluctuate with supply and demand like everything else. If rates drop slightly it can quickly eat through cash flow, and value of multi family property.
Ed, remember that rents also change, not as quickly as rates, but usually up. Look long term to the average of increased interest expenses and infaltionary rents, more so if you improve your properties. :)
@Bill Gulley I sure hope so!
I think my investing habits would also be more aggressive if there were more properties available that met my criteria. It's incredibly hard to find a good solid house that fits the 2% or 50% rule in my market.
Ed, you're getting good advice. Don't let anyone convince you that being conservative or debt avoidance is a bad thing. As Billy says, you have to find what your comfort level is for this business. You have a pretty good plan, keep the bad debt down, purchase a house, build some equity. You will likely find the need to use some leverage at some point, but its really up to you how much let's you still sleep at night. Start out slow, if you're more comfortable with less debt. Get some cash flow going and let it do the work for you. That's my "conservative" approach, and I'm on number 27. It's a long race, set your own pace.
Thanks for the encouragement! I just look at the rentals like a retirement savings account. Hopefully I will get some compound interest like effects once I have a few paid for properties cash flowing and saving towards purchasing additional properties.
You will. The first few seem to take forever for us "conservative" types because we tend to be cautious and it takes a while to get the first few purchases working to pay for our next purchases. It also takes some time to build the confidence (otherwise known as equity!) to learn how to live with "good debt". But those first few eventually do gain momentum and will pay huge dividends down the road by compounding into many more units. Stay the course. It can be done, and I've yet to find a more rewarding investment/passion.
Daniel Walker the people who use no debt many times are in markets where houses are 20k and they have cash flow and some money. A great way to go IMO.
If you want to deal in higher priced properties you will have a hard time not having your savings eaten away by inflation. It works like this:
You save $500 per mo to pay cash for a $60k house. Housing goes up 10% a year or $6,000. You will never save enough in your life to pay cash.
On the other hand if you wait for the nexr extreme crash in the economy and housing crash you will come out smelling like a rose.
Another way to view it is to separate your personal business from your business business. Business usually uses borrowed money and profits from a margin between the cost of that money and the return generated on it. You can then work toward being debt free in your home life but not your business. If you want to keep growing your business you will likely need to keep borrowing. OTOH if you set a goal of, lets say 10 homes and stop at that, you can see a path toward being F&C in both home life and business. An enviable position IMO. Good luck
Jeff,
Thanks for the perspective! It helps a lot.
Here are my thoughts as a very conservative investor that on occasion has taken on debt to finance properties.
My very first investment was way back in 1986 (when I was a young guy) for a fully financed deal that lost money month after month. After that I was more careful about the amount of debt I took. Over the last 25 years I've owned 15 investment properties. Some I financed, some I paid for with cash. But in all occasions after the first I never had less than 30% equity on day 1. Today I own 2 investment houses, both bought with cash. Another closing is scheduled for October 11, again all cash. I haven't forsworn debt financing, but it has to make sense.
Here's what it comes down to -- debt raises both potential risk and potential reward. It allows you to control more properties, but also raises the probability that you could lose big when bad things happen (and over the long term bad things WILL happen). Managing the risk well allows you to make lots more money; managing it poorly makes for an early exit from investing.
Here are my overall guidelines -- 1> No property will have more than a 70% LTV and 2> the entire portfolio will stay below 50% LTV. This allows some leverage to gain more properties while keeping the debt levels easily manageable. And I don't mind my current state of $0 debt. It makes for slower growth, but if you're playing the long game that's not too bad.
But I'm more conservative than most folks here. Each must find their own level of tolerable risk. And I'm sure you'll find the level you're comfortable with also.
Daniel Walker if you wanting to consider yourself as wealthier than most folks, 30 houses should do the trick. When dealing with this much RE you would be in the business and would either be working it full-time yourself or have a structured organization that can take care of all the details that goes on with an operation that size.
There are those that have that much and work full-time at other jobs though. They are smarter than most.
Jeff is accurate. I'm in that ballpark (i.e number of units) and work full time. I use a good property management company, and gladly pay for the service. It's hard to find a good pm company, but they do exist. For 8% I can't beat the service provided by my pm and would never be able to work full time to continue to grow extra capital for additional purchases without them. For those starting out, I'd recommend finding a mentor that's also owns a property management business. It can serve you two fold ( good advice and good support), but just beware there are a few unscrupulous pm companies out there too. You really need to ask around your area and find one that the more established REI's are using, and you'll probably find a good one. References from experienced REI's are invaluable because they've probably learned the hard way. As you gain experience, you can decide for yourself if you want to deal with the entire business full time and eliminate the pm company. My personal objective is to have enough free and clear to continue using my pm company long term, so I can enjoy the freedom to find and buy more properties and enjoy life. My philosophy is do what you do best and let other experts (property managers) deal with what they are good at (tenants, collections, and maintenance calls at 2am!) and you will grow your business. It's hard starting out to understand this and many younger investors, that I've met, seem to get bogged down in the more frustrating aspects of the business, and never achieve their potential of finding and making deals and gaining wealth. Understand your strengths (and your weaknesses) and focus on your strengths and supplement your weaknesses, and your RE business will get you to 30 units and maybe a lot more!
Great stuff. We are at about 65% LTV on our portfolio of 12 properties / 49 units. We are "snowballing" the highest interest rate debt first (153k loan on an 8 unit) at 1,000 extra per month until it's paid off. that coincides with our "freedom" date (empty nesters!) and will give us an extra 1,100 per month cash flow.
We'll continue plowing the same 1k / mo into the next and so on, eventually heading for "debt free" ahead of schedule.
I too like the notion of debt free (security) but agree that a higher return can be acheived initially through the use of OPM in a conservative way. We put mostly 25% down on our properties. We have 1 that put 10% down but then we have 3 props free and clear, too.
Keep it up. Hope you can use what you're learning here.
Great plan Kenneth. Smart moves, sounds like you're on track and found a conservative way that works for you! I use an equity credit line and tend to start like Michael above with at least 30% down on most of the purchases that I've made. Like you, my objective is to pay them off asap and let them work to buy the next. I paid my primary home off years ago and have continued making an extra payment on my rentals every month since (like you). I've never taken a dime out of the business in over eight years, and just let the profits and extra payments buy the next one. I know there are many big leverage REI's out there who would kringe at this philosophy, but to each his own method. This works for me very well and I never had a sleepless night. In fact, I sleep like a baby with 80% of my units free and clear. I will share, that I did break my own rule, and just closed my first owner finance deal this past spring on eight town homes with only 10% down (it was a 20 yr term-10yr balloon deal). I couldn't resist the low fixed interest rate (4.5%) and it's the second purchase from this seller (the first one I bought for cash and wished I known his willingness to finance). The OF deal allowed me to minimize my investment and use his money for a long time (relatively cheaply), while I focus my payments on my equity line so I can free it up sooner to buy my next property. First time for me with that small of a down payment, but great units, with great cash flow, so I bent my rule for the first time in eight years and put down less. But it appears to have been a great decision, and one I'd do again. I'll likely use his money for the full ten year term, and make sure my equity line is emptied in time to pay it off near the end, and then pay the remaining equity line down within two years. In the meantime, I can buy a few more buildings with my equity line and will be at my freedom date in only 3 years. Conservative and sleeping sound!
I have begun flipping houses and using the profits to buy rentals for cash. I know that other people do this and I think it is a great way to go. I do carry debt on my home and will likely refinance some properties in the future to fuel the flipping business, but of course that is not necessary. I feel that anyone who really wants to get into flipping should be able to fund the purchase out of pocket. When your new you are more likely to make mistakes and having a loan against a project like that can ruin you quickly. As you get more comfortable and experienced I think you are better able to handle the debt.
Live cheap, save as much of your income as you can, and either work for promotions or look for jobs that pay better and you can get there faster than you might expect. Before I quit my job my wife and I saved approximately 50% of our take home pay. Now between my business and her job we are closer to 75%.
Tim Czarkowski you are speaking the truth about people getting started buying fix-up RE and how things can and will go sideways. What you are doing sounds awesome.
I remember Jacksonville for the pool hustlers. Wow.
Keep in mind there is good debt, and bad debt.
I avoid carrying all types of bad debt (i.e. car loans, credit card, store credit, etc). With those, you are literally throwing money away. And usually lots of it.
However, I do utilize good debt (i.e. mortgages) to purchase/hold properties that make me money. And I will continue to do so. I see nothing wrong with taking on a new mortgage payment of $500 a month when it makes me $1000 month. In fact, if I had enough money to pay off all of my real estate debt, I wouldn't do it. I'd just use that money to buy more properties that produced even more monthly cash flow.
Daniel,
Like most people have said, debt can sometimes be your friend. Finding private lenders is always a good way to get money without having to go through large banks. With private money, the people lending to you sometimes keep the interest much lower on a short term note than a bank would. After you buy and fix the house, you just pay back the lender the money you borrowed plus interest and you are able to keep the rest of the earnings. When they see that you gave them their money back, plus a little extra, most lenders will want you to take their money and go invest in more and more properties until they have more money they know what to do with and so do you.
Ross
Question to Ed Lee. What did you mean by 2% or 50% rule rental homes?
Thanks,
Abdul
He was referring to this:
http://www.biggerpockets.com/forums/88/topics/13335-5-rule-and-the-2-rule
All,
Thanks again for all of the conversation.
I guess another way to look at an all-cash approach would be to consider that when using all cash to buy a rental, the cash-on-cash return is very low. Depending on purchase and rental prices, this conservative approach could cause a high-return investment to look more like a lousy CD with a low interest rate.
Is this comparision accurate?
Having parents who went through the great depression of 1929, their policy was "if you can't afford to pay cash for something, then you didn't deserve to have it". Bought first rental house with cash and have always wished had put it into a down payment on 4 4-plexes instead. It did not take long to realize that times had changed and to get ahead you needed to use good debt to make more money for you. The slow and sure approach will definitely work to get to your desired goals. The opposite is with the kids now from the "Now Generation" - they want everything right now without having the patience to wait. Keep with your plan or whatever you become comfortable with and you will get all of your goals in the achieved column.