IS THERE POWER HERE AT ALL ?????
Investor · Charlotte, NC · Member since 2017 · 321 posts · 157 votes
IS THERE POWER HERE AT ALL ?????
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Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
9yLeverage is great, until it is not. Today it is fantastic. In 2009 there sure as heck was value in all cash. My method and philosophy has always been use conservative leverage to grow, and all cash for wealth preservation. Put into action, this means use leverage to grow the portfolio sufficient such that the income it generates if all the units were free and clear could sustain your lifestyle plus some reasonable margin (2x for me). Once you get to that point, the leverage has done its job for you, you have control of all the assets you need, it is then time to "flip the switch" from growth mode into wealth preservation mode ... that means plowing all the profits and excess funds into paying off those mortgages in a snowball manner. When you are done paying them off, then you are done, you can do as you like after that, but I don't believe in cash out refinancing the properties after that because I don't believe in risking something you have and need in order to buy something that you don't have and don't need. I may be a bit unusual in this regard, but this has been my operational philosophy and it has worked out quite well for me.
54 Replies
- Investor · Nashville, IL · Member since 2016 · 79 posts · 51 votes9yJust a general question I have always wondered. Everyone says if you are highly leveraged and there is a market crash then watch out your going to get burned. Why? If the property remains rented out through the market crash and cash flows, how is that going to adversely affect you? I could see if you wanted to use the equity in the house (that's no longer there because of the crash) to purchase more property then you would be affected. Here's my example: (in this example my goal is to hold properties for retirement income) If I own 5 houses 100% financed and the market did what it did in 2009 tomorrow but I remain to rent them out and I am able to cover my expenses then how am I adversely affected? I might be upside down on the mortgages but if the rents are paying the mortgages down and covering all expenses then I have the staying power to outlast the down turn in the market correct??
- Real Estate Agent · Jacksonville, FL · Member since 2015 · 1k+ posts · 1k+ votes9y
This is the classic risk vs reward scenario.
How much risk are you prepared to take? Unfortunately, one can never remove all risk. Getting out of bed is risk.
Clearly there is less risk to paying all cash and not using leverage on the back end. In the event of a catastrophic event, you would only have taxes and insurance to pay. The return is lower than if you were to leverage.
There is also an argument that if you needed to raise money you are locked in to a non-liquid asset and presumably the market has dried up. If you used leverage to diversify, then you would spread the risk.
If you were to use non-recourse loans and leverage, you would effectively be managing the risk. Should the situation go badly, you are only at risk for your equity should you have to walk away, not the entire building.
- Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes9y
Originally posted by @David Faulkner:
Originally posted by @John Woodrich:
Debt will ALWAYS increase your return on investment
Really? Please explain. I take out a $100k mortgage at 6% on a property that free and clear would have a total return of 4%. Did I increase my ROI? I cash out refinance $100k on a property, then I put that $100k cash in a bank account that earns 0.01%. Did I increase my ROI?
Example - $120,000 house, $1,000 per month rent, $300 monthly expense, 6% financing rate.
All cash deal: $8,400 (Annual income) / $120,000 (amount invested) = 7% return
Leveraged with $100k loan at 6%: $2,400 (Annual Income) / $20,000 (amount invested) = 12% return
Obviously this implies that you have additional uses for funds such as purchasing more houses. His question is based off paying 100% cash and cash flowing more or using debt and purchasing more houses. The ROI on each property will be higher with leverage.
- 9yJohn CasmonPro MemberCincinnati, OH · Member since 2013 · 1k+ posts · 1k+ votes
If you're looking at an all cash return of say 7% or better, you should look to use leverage. Less than that and I'm assuming you're doing an appreciation play and cash makes sense here. However, I should point out that mortgage interest is tax deductible on an investment property.
Let's say you have $100k to buy a property. You can either buy one property for $100k or use leverage and buy 4 properties with $25k down on each. Let's assume all properties have the same monthly rent and expenses - rent of $1000 and expenses of $300. Your net operating income (NOI) is $700.
1 Property - All Cash
Annual NOI - $8,400
Mortgage Payment - $0
Cash Flow - $8,400
Return - 8.4%
1 Property - 25% DownAnnual NOI - $8,400
Mortgage Payment - $4,824 ($402/mo @ 5% interest)
Cash Flow - $3,576
Return - 14.3%1 Property - All Cash (if NOI drops)
Annual NOI - $6,000
Mortgage Payment - $0
Cash Flow - $6,000
Return - 6%
1 Property - 25% Down (if NOI drops)Annual NOI - $6,000
Mortgage Payment - $4,824 ($402/mo @ 5% interest)
Cash Flow - $1,176
Return - 4.7%Want to acquire multiple properties, but still be conservative? Only buy three properties and keep $25k in cash for added flexibility and comfort.
3 Properties - 25% down
Annual NOI - $25,200
Mortgage Payment - $14,472 ($402/mo @ 5% interest)
Cash Flow - $10,728
Return - 14.3%
3 Properties - 25% down (if NOI drops)Annual NOI - $18,000
Mortgage Payment - $14,472 ($402/mo @ 5% interest)
Cash Flow - $3,528
Return - 4.7%
The most conservative thing you can do for your money is use leverage and keep money in cash. Why tie up all of your money into one deal if you can spread it, along with the risk to a few? If you have a vacancy, major repair cost or anything else goes wrong it will kill your return if you only have one property. - Investor · Charlotte, NC · Member since 2017 · 321 posts · 157 votes9y
Originally posted by @John Casmon:
If you're looking at an all cash return of say 7% or better, you should look to use leverage. Less than that and I'm assuming you're doing an appreciation play and cash makes sense here. However, I should point out that mortgage interest is tax deductible on an investment property.
Let's say you have $100k to buy a property. You can either buy one property for $100k or use leverage and buy 4 properties with $25k down on each. Let's assume all properties have the same monthly rent and expenses - rent of $1000 and expenses of $300. Your net operating income (NOI) is $700.
1 Property - All Cash
Annual NOI - $8,400
Mortgage Payment - $0
Cash Flow - $8,400
Return - 8.4%
1 Property - 25% DownAnnual NOI - $8,400
Mortgage Payment - $4,824 ($402/mo @ 5% interest)
Cash Flow - $3,576
Return - 14.3%1 Property - All Cash (if NOI drops)
Annual NOI - $6,000
Mortgage Payment - $0
Cash Flow - $6,000
Return - 6%
1 Property - 25% Down (if NOI drops)Annual NOI - $6,000
Mortgage Payment - $4,824 ($402/mo @ 5% interest)
Cash Flow - $1,176
Return - 4.7%Want to acquire multiple properties, but still be conservative? Only buy three properties and keep $25k in cash for added flexibility and comfort.
3 Properties - 25% down
Annual NOI - $25,200
Mortgage Payment - $14,472 ($402/mo @ 5% interest)
Cash Flow - $10,728
Return - 14.3%
3 Properties - 25% down (if NOI drops)Annual NOI - $18,000
Mortgage Payment - $14,472 ($402/mo @ 5% interest)
Cash Flow - $3,528
Return - 4.7%
The most conservative thing you can do for your money is use leverage and keep money in cash. Why tie up all of your money into one deal if you can spread it, along with the risk to a few? If you have a vacancy, major repair cost or anything else goes wrong it will kill your return if you only have one property.I agree to a certian extent. But somebody like myself that has a minimum wage job and has a pale of CASH sitting in a bank with no real loan security because of DTI. It's really hard to spread the cash around too multi properties and get good rates @ %5 and lower. The lenders' that are out there who distribute loans based on assets' have interest rates @ 8%-10% and majority of the time those rates would be too high to cash flow positivity. It's easy to say, find a partner who is in a good situation as far as DTI goes but when you are a newbie and have 0 track record of an portfolio. What do you do. Personally, i would love to see a track record of some sort before i invest with someone. I don't come from money nor my family or friends that would be a great helping hand.
- Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes9y
Originally posted by @Isiah Ferguson:
I agree to a certian extent. But somebody like myself that has a minimum wage job and has a pale of CASH sitting in a bank with no real loan security because of DTI. It's really hard to spread the cash around too multi properties and get good rates @ %5 and lower. The lenders' that are out there who distribute loans based on assets' have interest rates @ 8%-10% and majority of the time those rates would be too high to cash flow positivity. It's easy to say, find a partner who is in a good situation as far as DTI goes but when you are a newbie and have 0 track record of an portfolio. What do you do. Personally, i would love to see a track record of some sort before i invest with someone. I don't come from money nor my family or friends that would be a great helping hand.
Sounds like your only option at this point is cash investing then. After you have a history of cash flow on the properties banks will start to consider your rental income as a part of your DTI ratio and your ability to take on debt will increase. In my experience banks like to see 2 years of rental history however I have gotten around this because of my how long I have been in real estate investing. My last go around was with Wells Fargo and they waived the 2year criteria for me.
- Investor · Thermopolis, WY · Member since 2012 · 4k+ posts · 4k+ votes9y
@Devin Haertling, the problem with over leverage is that even a small market drop can put you in a negative value. Now if all of your rentals are making you positive cash flow you should be able to weather it, but consider a few things. First are all of your loans 30 year fixed? Probably not. Most folks have some adjustable rates and 3 or 5 year renewals. If you have negative value the bank may decide not to renew, it DOES happen, and your rate will go up if the bank does renew and you have a negative value. Next when the economy goes bad and house prices drop, why won't rent prices drop? Folks say that all those folks who lost their house to foreclosure have to live somewhere right? Guess what those folks may not be able to pay rent either. If they lost their job or got a pay cut it affects rent money too. Not only folks who own houses lose their job. Many move back in with parents, or other relatives or friends. Some cram several families into one house. Taxes and insurance and maintenance do not go down even if rents do.
You should always have a plan B. They are often called exit plans. Multi family can make you a lot of money faster than SFRs, but if you need to sale one you can only sell to other investors. If the market drops you loner have a safe exit to bail you out things go bad, like tenants trash a house or someone drives into the side of a house, etc.
Leverage helps you grow faster, but it simply has more risk. You have to find the right balance for you. Most folks take the risk early on when they have little to lose, as you gain more assets you tend to get more risk averse as you now have something to lose, the problem is as you get more assets now banks are willing to loan you more money, so you can take more risks. This doesn't answer the question to leverage or not, but I hope it helps you understand the problems involved a little.
- 9yJohn CasmonPro MemberCincinnati, OH · Member since 2013 · 1k+ posts · 1k+ votes
@Isiah Ferguson That's going to limit your options so all cash may be the best option to build a track record and credibility.
@Jerry W. Great points, especially on those variable rate 3-5 year loans. That is certainly risky and I would not advise a loan of that sort to someone starting out. However, for a 20 or 30 year fixed rate, wouldn't a market drop hits these investors the same as cash buyers? - Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes9y@Isiah Ferguson your post explains why many on this site are into duplexes and quads... where if you can get the first one under your belt as a personal residence and as an investment, people perceive they will get a jump start on their track record. I hate the phrase but 'house hack' is, I believe, the term used on this site.
One thing to think about, and it may have been said already, if you use all cash to purchase you could still get a Line of Credit on the property. Interest accrues only if you have a balance.
- Investor · Thermopolis, WY · Member since 2012 · 4k+ posts · 4k+ votes9y
@John Casmon, a market drop would hit someone with a 20 or 30 year mortgage, but it would not cause their mortgage payment to go up. A rise in mortgage rates will make payments go up. Having a mortgage called is a very big thing. That happens when your equity goes upside down. Banks panic like everyone else. Those are the two things that will kill even a cash flowing rental in a market drop. Make no mistake if one house goes to foreclosure the banks will call the other notes. Look at your mortgage it has language that allows them to call any loan where your they believe your financial situation is bad. I hate that clause, but it is in all recourse mortgages i have seen for the last 10 years.
- Investor · Phoenix, AZ · Member since 2016 · 349 posts · 418 votes9y
I have some properties that are free & clear. But the type of investor I am and my situation allows for leverage to be optional. If I were earlier in my investment horizon, I would be very leveraged to the extent that the numbers worked.
One dimension (there are many of course) of an unleveraged property I consider is the comparison of the net income they produce to the "yield" metric that a securities position would deliver if I instead used that cash to buy stocks in my brokerage account.
- Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes9y
Originally posted by @Cody L.:
David Faulkner you're an anomaly. You're buying properties with cap rates below cost of funds :)
When you buy an 8 CAP and the money to buy it costs 5%, it would be foolish to be all cash.
But yes. If you're going to buy a 4 CAP don't take anymore debt that absolute necessary.
So to your point, the commenter saying "always" was incorrect.
My ONLY issue was the use of the commenter's word "always", which is incorrect. The properties I'm buying "always" have returns well above the cost of funds, and yes you are correct, I am an anomaly :)
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes9y
There is a misconception on BP that low or no leverage increases cash flow. It increases cash flow on that one property but not on an investment portfolio where you can earn more than 5% (the cost of debt).
Leverage and taxes are two of the greatest benefits of real estate over other asset classes. You can own one $100k property that is work $175k after 20 years, using 3% appreciation, or you can own four $100k properties that are worth $700k.
And real estate is pretty expensive right now due to the low cost of debt; so, you will be buying at high prices without the benefits of what caused prices to be high.
Real estate is too much work to only earn the cap rate. A lot of other asset classes become more attractive at that point.
Real estate is not a one size fits all thing though; so, to each their own. Hope that helps.
- Lender · Oklahoma City, OK · Member since 2017 · 138 posts · 130 votes9yLeveraging is a long term play. You can buy one 100k house for cash and get great cash flow or you can buy 10 100k houses with 10k down. With the latter you have 10 people getting up every day and going to work to pay off your million dollars of debt. Now skip down the road 10 Or 15 years. You can own those 10 properties fee and clear. Let's say that they have appreciated to 1.5 million in value. Now if you did the one house for cash 15 years down the road it's with 150k. 1.5 million vs 150k. I personally will forgo cash flow to get the big payoff down the road. That's the beauty of leverage.
- Investor · Charlotte, NC · Member since 2017 · 321 posts · 157 votes9y
Originally posted by @Rodney Miller:
Leveraging is a long term play. You can buy one 100k house for cash and get great cash flow or you can buy 10 100k houses with 10k down. With the latter you have 10 people getting up every day and going to work to pay off your million dollars of debt. Now skip down the road 10
Or 15 years. You can own those 10 properties fee and clear. Let's say that they have appreciated to 1.5 million in value. Now if you did the one house for cash 15 years down the road it's with 150k.1.5 million vs 150k. I personally will forgo cash flow to get the big payoff down the road. That's the beauty of leverage.
If cash flow is the key too the goal. Does appreciation even mattter at this point ?
- Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes9yIsiah Ferguson So, this is going to sound incredible myopic, there is power in zero leverage when you're married. When you spouse isn't in love with the idea at the outset. When there's a worry that you'll lose money. At zero leverage (I started with a 5-unit) I was always making *some* money regardless of what repairs or vacancy happened that month. Then you meet with the accountant and he (a neutral party) relays that you pay original income tax, that depreciation doesn't help with all of it, and there's this nice tool called "mortgage interest" that can help the tax burden. So, yes, there's power. But the zero leverage use cases (in my opinion) are pretty darn narrow. I can also see zero leverage use cases for borderline loan amounts ($50K or $75K) as the origination costs, appraisal costs, etc. start to represent a fairly high portion of the loan value.
- Investor · Grosse Pointe Shores, MI · Member since 2017 · 160 posts · 74 votes9y
Isiah, you've started in interesting philosophical discussion, but it seems to me that you have a problem that isn't getting solved. Are you concerned about the negative implications of purchasing with all cash simply because you can't get financing? If that's the case, I'd say go buy as many rentals as you can and just get started. Or do a house hack, perhaps with a multi-family and try to get an FHA loan. Or both. Down the road, try to do some cash out refinancing and reinvest your seed money.
I'm on the opposite end of the timeline from you, so my needs are different. If you've got the money to start, start!
- Lender · Oklahoma City, OK · Member since 2017 · 138 posts · 130 votes9y
My personal belief is that using all cash to invest in real estate is like driving a Ferrari 20 miles an hour. You aren't taking advantage of the unique opportunities that RE affords investors.....Massive leverage, depreciation, capital gains, and appreciation work in your favor if you do it right.
Leverage, done right is a good thing. If you're pulling all of your equity out of your deals to pay your bills then that is obviously a bad thing. If you are buying right 60-70 cents on the dollar and your rents will cover the debt service, vacancies, repairs, etc.... then it's not that risky.
I had a sizable "leveraged" portfolio in 2008 and never hit a bump in the road in terms of meeting expenses. The bottom line is that you have to buy right and use leverage responsibly.
- Lender · Oklahoma City, OK · Member since 2017 · 138 posts · 130 votes9y
@Isiah Ferguson appreciation, for me, is the icing on the cake. In Oklahoma appreciation is slow and steady unlike many other areas of the country where you can invest strictly based on appreciation.
- Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes9y
It's just more appealing to me to have a cash flow of 1'000$ after expenses in a free and clear property of 100k than have 250$ cash flow from being leveraged.
In your example above you are using false logic. You are not comparing apples to apples.
In the first example you are investing 100K to get $1,000 cash flow. In the second example you are investing perhaps 20K to get $250 cash flow. You are not comparing equal amounts of money invested.
The proper way to compare is to either compare your cash on cash ROI, or to compare investing all cash in one building vs using the $100K to buy perhaps four buildings. If you are using leverage (borrowing ) correctly you will get a higher percentage return by borrowing. If you invest all the money you will get both a higher % return and higher net cash in your pocket by borrowing.
Borrowing increases your cash on cash ROI% (there are exceptions). However it also increases your risk. Paying all cash will reduce your risk. Well, unless you spend every penny you have to pay all cash and then you have no reserves. This is also risky.
As a crude general rule borrowing will mathematically increase your returns on paper. The only advantages to all cash are; you can sleep and night or you might get a better price by paying all cash and moving faster.
- Hurst, TX · Member since 2016 · 192 posts · 114 votes9yIsiah Ferguson Something that always stuck in my head was a quote from the great football coach (and horse enthusiast) Bill Parcels when they asked him how to bet on horses. He replied, "You bet small to win big, you don't bet big to win small." I don't know if this quote helps, but it's a really cool quote! Lol
- Investor · Broken Arrow, OK · Member since 2016 · 210 posts · 314 votes9y
Please allow me to weigh in on this: You don't take % ROI to the bank, you take cash.. So, it all depends on your situation and your goals. I'm an investor in my mid-50's who is looking to retire at 59. Therefore, I built a portfolio of high quality rental properties using 25% down so that I was always cash flow positive - which is very important if a market downturn should happen. Once I got to the desired # of rentals (that would produce the desired amount of cash flow should I not have any debt) then I stopped buying additional properties and started taking all that positive cash flow and paying down the mortgages in a systematic and targeted fashion. So, you may look at my ROI and say I'm making less than I could had I just taken that cash and continued to buy more houses, but in reality, I'm making a lot more CASH - which is what I can take to the bank and also what I will use in retirement. I don't pay bills with ROI!!! Please allow me to reiterate: It all depends on your situation and your goals!!!
- Rental Property Investor · Las Vegas, NV · Member since 2017 · 10 posts · 7 votes9y
interesting conversation...I'm a newbie so consider the source....but I have thought about this just like everyone else. I see leverage in the same way that a lot of people here have posted but another aspect that has led me to leverage is the ability to monitor performance before sinking more capital into any one investment. My goal is to ultimately have solid cash flowing properties that produce passive income so that I don't have to go to my job everyday. Leveraging to find those performing properties seems the best way for me.
Instead of sinking 100k int a property that I hope with bring 1k cash flow per month in. I can take that 100k and leverage it to purchase 4-5 properties that i hope will bring me 1600-2000 per month cash flow and monitor the performance over a set time. Some properties along the line will not perform and those ones you sell and then the ones that DO perform you can sink your capital into them to pay off the loans.
- 9yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
@Jerry W. yup small print crippled lots of investors last GFC.
the one you mention IE if you have one default all your notes can be called that is standard language for a portfolio lender.
the other one that I saw happen a bunch was HELOC's getting froze or called.. I bailed out a bunch of flippers who were half way through projects and counting on heloc to finish and banks called those..
I like heloc but do read the small print they can be frozen and called at any time for any reason.. If you know it up front you maybe able to negotiate that condition out of the loan.
I know with my guidance lines I had for my HML company we did... as you know they are normally one year facilities... We put in our loan docs that if they did call them at the end of the year we had 24 months to pay in full.. and baby did we need it in the GFC saved us really..
- Wholesaler · Paradise , NV · Member since 2016 · 1 post · 0 votes9yit's about ROI and risk you are comfortable with. Preference. More leverage, more ROI.
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