How leveraged are you?
Investor · Saint Paul, MN · Member since 2015 · 98 posts · 64 votes
How leveraged are you?
Most Popular Reply
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
8yOriginally posted by @Thomas S.:
The major problem with investors wanting to reduce their leverage is they are simply buying their own income/cash flow. Once a property surpasses 40% equity (or less) the property itself drifts into negative cash flow in most situations. It is no longer a asset.
Residential house & plex-only investors tend to think that all loans are fixed forever at 4% or something. Blanket statements about leverage with blinders on. I dont rush out to pay off those products, either.
But not all loans are awesome. I assure you that paid off real estate is still an asset, especially commercial property that no longer is burdened by crappy commercial terms. Adjustable, callable, balloons, rates over 5% and bothering you every year for your financials.
You can say low-levered property drifts into 'negative cash flow' in theory below 40% LTV, but the reality is the opposite. I save more in interest per month than most newbies hope to earn to replace their job. I can deploy 5 figures per month extra against the next crummy commercial loan I have over 6% if I want to, or invest elsewhere. The option is available because of my 'negative cash flow' I guess.
87 Replies
- Investor · Great Neck, NY · Member since 2016 · 679 posts · 467 votes8y
(This is my own personal and professional opinion). Leveraging in today's markets is a must if you want to sustain growth. The moment I personally changed my thought process from fearing debt to using it as a means of acquiring performing assets, my entire business reaped the benefits.
Now with that being said there is a certain discipline to this that needs to be mentioned. It is not always as simple as borrowing and buying. Proper techniques and caution needs to be applied to this specific method. With rates historically low, it was a no-brainer for me to leverage.
- Investor · Saint Paul, MN · Member since 2015 · 98 posts · 64 votes8y
Ok then, group, a related question - how big is your reserves/business emergency fund? 3 times PITI? 6? And maybe more to the point - how liquid is it? Refi a property to pull out cash in an emergency? 401K loan? Cash out a Roth? No interest credit card for 16 months?
(the variety of answers is fascinating!)
For me I have a great full time job that I feel secure about and that gives me comfort in taking more risk/more leverage/more ill-liquid reserves.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes8y
In most markets today, 100% leveraged properties don't cash flow. It is also difficult now to get loans for 100% of value. For these two reasons, I doubt many people are 100% leveraged on current property values. People may have pulled all their cash out of a deal, but that is different than being 100% leveraged based on property value.
Rather than looking at leverage, I like to look at my cash out net worth. If I had to sell every property within 30 days and pay off all my loans, how much cash would I have in the bank. This takes into account selling fees, closing costs, etc.
If a property is 100% leveraged, selling it will not satisfy the loan, because of selling expenses. There is a reason banks want 20-25% down on investment properties. They know that 75-80% is the quick cash-out value of a property.
I agree with Thomas that if you have low interest loans, it is best to invest your cash in higher performing funds, rather than pay down a mortgage. If your loan is under 5% and investment is over 10%, there is a good spread there where you can make money.
Paying off loans does provide piece of mind. You could also argue holding equity in properties is more secure than having money in the stock market.
My belief is early in rental property investing, you should have the highest possible leverage. As you mature, debt pay down should become part of your strategy. The added cash flow from paid off properties can either be used to snowball other loan payoff or invested.
- Member since 2016 · 13k+ posts · 12k+ votes8y
Growth requires leverage, when a investor is finished investing, having the maximum income they require, then parking cash is logical. When you no longer have use for a tool you put it away. If this is viewed as security all the better.
Leverage is a valuable high quality tool. Dangerous in the hands of inexperienced or incompetent, invaluable in the hands of a craftsman. I could never function without my power tools, for others the sound of a table saw is frightening. Yes you can cut off a finger or hand but I would never allow irrational fear to prevent me from using it.
- Contractor · Jacksonville, FL · Member since 2017 · 1k+ posts · 2k+ votes8yzero leverage. nothing feels better than streams of long term income with no bills to pay. leverage might get you more properties but nothing beats opening the mailbox and getting a check versus a bill...
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes8y
If you consider your portfolio as your corporation, all you really need to do is look at how the world's most successful corporations operate (other than ruthlessly slitting the throats of their competition!). There are times when corporations issue massive amounts of debt, and times when they buy that debt back. When money is cheap, they leverage to the hilt *if* there is growth opportunity. When money is expensive, or growth opportunities limited, they reTrench (see what I did there @Scott Trench ? :D), buy back their outstanding debt, and park their cash waiting for the next opportunity. The leverage that I have was taken when there were outstanding buy opportunities and all of my cash was tied up on projects. Now buy opportunities are getting really slim, and it wouldn't make a lot of sense to pull my cash since there's not many good options to put it elsewhere.
Leverage should really just be looked at as a tool, nothing more, nothing less. I like the table saw analogy of @Thomas S above. You could do all your wood cutting with a hand saw, and sometimes it makes more sense to use a hand saw - maybe there's no electricity, or you have to cut such little wood that setting up the table saw makes no sense. If you're cutting a couple of dozen boards, and you have a table saw, why would you kill yourself using a hand saw? A zen thing, maybe? Maybe - I love my hand tools - but sometimes you just need to get a job done, period.
Skyline Properties - Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes8y
Originally posted by @Thomas S.:
The major problem with investors wanting to reduce their leverage is they are simply buying their own income/cash flow. Once a property surpasses 40% equity (or less) the property itself drifts into negative cash flow in most situations. It is no longer a asset.
Equity doesn't kill cash flow, equity increases cash flow. Less debt = more cash coming back to the owner.
Equity can kill cash on cash return but if there are no good uses for cash in your market keeping equity could be a good thing. I personally am not investing across the world so investment options to do get limited at times.
And clearly a performing rental, which now has equity, is still an asset. Weighing the opportunity cost doesn't make it a liability.
- Rental Property Investor · Racine IL · Member since 2017 · 41 posts · 15 votes8y
I have 4 rental properties. 1 is my old townhouse in the city. 30 year loan. Property is horrible CF but my ir is 30 years at 3.37 % so I am just going to ride that out. pays off $800/month principal and 300 month CF (I manage myself and this doesn't include ANY repairs). that is about 25% equity now. 2nd place is a small 4 unit that I bought all cash. Rehabbing and will refi in 6 months. both other places are 20/80. Overall I am fairly leveraged but I have a good job and investments I can tap elsewhere if needed.
- 8yPeter TverdovBusiness MemberDeveloper · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes
Originally posted by @Erik Sherburne:
Ok then, group, a related question - how big is your reserves/business emergency fund? 3 times PITI? 6? And maybe more to the point - how liquid is it? Refi a property to pull out cash in an emergency? 401K loan? Cash out a Roth? No interest credit card for 16 months?
(the variety of answers is fascinating!)
For me I have a great full time job that I feel secure about and that gives me comfort in taking more risk/more leverage/more ill-liquid reserves.
Based on my experience trying to generate discussion about reserves on this website, you will get a lot of crickets. Some people will say "credit cards!" "HELOCs!"
I have 6 months of PITI per property that is cash or equities. Some banks require that, some require a little less. I also have each property calculated so I know how far current rents must drop before I lose all cash flow and have just enough to pay PITI. I sleep well at night.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes8y
@JD Martin it is interesting with corporations, most of their decisions are based around tax implications. Apple is sitting on piles of cash overseas, that is invested in conservative investments. At the same time they have issued bonds to pay share holder dividends and for stock buy back. On the surface, someone may suggest just using their overseas cash, but the tax implications are too great. Similar concept with investors. If you have a pile of cash, it may make more sense to invest rather than to pay off low interest loans.
- Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes8y
Originally posted by @Erik Sherburne:
Ok then, group, a related question - how big is your reserves/business emergency fund? 3 times PITI? 6? And maybe more to the point - how liquid is it? Refi a property to pull out cash in an emergency? 401K loan? Cash out a Roth? No interest credit card for 16 months?
(the variety of answers is fascinating!)
For me I have a great full time job that I feel secure about and that gives me comfort in taking more risk/more leverage/more ill-liquid reserves.
The reserve and new opportunity fund are bloated, fat, stupidly overfunded & earning little. I moved most to vanguard to at least get out of a bank. 3% is better than .5 Not a lot of screaming deals out there for me to buy anymore.
I imagine there is a lot of cash on the sidelines out there. When it grows enough, I will slap it against my next 6% mortgage and pay off another one. Guaranteed, tax-free and hassle-free 6% returns are enough for me at my stage. But then with another paid off mortgage I'll have more of Thomas' negative cashflow, which got me with the too much cash problem in the first place:)
What I'm afraid of is what to do when my last 2 6% crummy mortgages are gone. They are easy pickings. Then I'll actually have to put some time in to get my $ to earn it's keep. Index funds at current frothy levels doesn't seem wise. Curious as to what others are experiencing...
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes8y
Originally posted by @Steve Vaughan:
Originally posted by @Erik Sherburne:
Ok then, group, a related question - how big is your reserves/business emergency fund? 3 times PITI? 6? And maybe more to the point - how liquid is it? Refi a property to pull out cash in an emergency? 401K loan? Cash out a Roth? No interest credit card for 16 months?
(the variety of answers is fascinating!)
For me I have a great full time job that I feel secure about and that gives me comfort in taking more risk/more leverage/more ill-liquid reserves.
The reserve and new opportunity fund are bloated, fat, stupidly overfunded & earning little. I moved most to vanguard to at least get out of a bank. 3% is better than .5 Not a lot of screaming deals out there for me to buy anymore.
I imagine there is a lot of cash on the sidelines out there. When it grows enough, I will slap it against my next 6% mortgage and pay off another one. Guaranteed, tax-free and hassle-free 6% returns are enough for me at my stage. But then with another paid off mortgage I'll have more of Thomas' negative cashflow, which got me with the too much cash problem in the first place:)
What I'm afraid of is what to do when my last 2 6% crummy mortgages are gone. They are easy pickings. Then I'll actually have to put some time in to get my $ to earn it's keep. Index funds at current frothy levels doesn't seem wise. Curious as to what others are experiencing...
Poor Steve, what to do with those piles of money... Buy a car wash or put piles in a storage unit are two options. My hope is that the interest rates keep rising and that should help people with cash. I know all the realtors on BP will hate me for saying that...
- Investor · Arlington, VA · Member since 2012 · 1k+ posts · 491 votes8y
Originally posted by @James Ma:
@Thomas S. Curious where you get the number $866/month from 100K equity ?
I understand the more equity in a property the less hard your money is working for you but I wouldn't go as far as to say it's no longer an asset since it is still making you money, but it is certainly a less profitable investment
He is assuming an ~10% return on the equity if he placed it in another asset. $100K x 10% = 10K/year or or $833.33/month.
- Real Estate Investor · Des Moines, IA · Member since 2016 · 922 posts · 533 votes8y
After just reviewing now it appears that our loan to value ratio is:
53%
I'm pretty happy with it.
We will be starting to put on average $50/mo on more aggressive pay-downs with existing notes, starting next month.
- Investor · Arlington, VA · Member since 2012 · 1k+ posts · 491 votes8y
Originally posted by @Peter Tverdov:
I created a rule that I will not let my portfolio to go about 75% LTV. If you need cash in an emergency and don't have enough or can't REFI you are going to lose your shirt. I notice a decent amount of people on this site swim naked. Which is good, I aim to scoop up houses from fiscally irresponsible investors. 100% leveraged? Lol. People who use HELOCs as their "cash reserves" especially trouble me. Blinded that those can be frozen by a bank at any time.
@Peter T What is the probability that a bank will freeze a HELOC? I've never heard of this, but strangely, was thinking that was could be a possibility.
I do use HELOCs and LOCs as emergency funds, but I also have access to my 401k loan if that "freeze" ever happens. I think the 20-25% equity is the sweet spot for most investors because it gives them some wiggle room if the market turns, while still allowing the investor to deploy accumulated equity into better performing assets as the mortgage is paid down. However, as many have already stated, it depends on your goals, risk tolerance, and experience among other considerations specific to his/her situation. This is a fantastic discussion.
- Member since 2016 · 13k+ posts · 12k+ votes8y
"Equity doesn't kill cash flow, equity increases cash flow."
Equity kills the cash flow from the property which is suppose to be the asset you are investing in. This turns the asset into a liability when it is only your own cash generating a return. Why not invest the cash in something other than brick and mortar (eg: income funds) and bypass the hassles of owning/managing property and tenants.
Supposing you have a 300K property owned free and clear with a $3000/month rental income. Your $300K has a opportunity value of 10% ( + or -) which equates to a income value of $2500/month ($833 X 3). Rental income of $3000 - $2500 = $500 generated by the property. Subtract from that $500 your expenses on a property and you will have negative cash flow from the property itself = liability.
One could give a value of zero to your cash to artificially increase the cash flow from the property but what investor would place zero value on their cash.
You can not have your cake and eat it too.
- Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes8y
Originally posted by @Joe Splitrock:
Joe! Just saying after a few liquidity events and facing a frothy market without an obvious place to re-deploy, sometimes our reserves get bloated. I have the same problem Apple has LOL
I have been doing some small business lending and looking (kinda) to diversify into other businesses like you mention. My NAP correlation index is skewed in my old age, though. The effort/reward ratio is too high out there. I'd rather take a nap than analyze 100-200 deals. 3% COC returns are reflected in that and is my punishment. A younger me would never settle for 3%!
- 8yNicole A.Pro MemberRental Property Investor · Baltimore County Maryland and Tampa Florida · Member since 2013 · 2k+ posts · 2k+ votes
I purchased my previous properties almost 100% leveraged. They are all around 40% leveraged LTV by this point, which is 6 years from the first purchase. A bit risky, but it's worked out and the cash-flow from day 1 is great.
While having a property that cash-flows, and cash-flows well, when 100% leveraged is great, I felt stressed. So for a few years, took a step back in acquiring more and just focused on paying down, saving, networking, and learning a ton about Baltimore County rental laws. Ready to start acquiring more now, but not using same methods I used in the past.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes8y
Originally posted by @Steve Vaughan:
Originally posted by @Joe Splitrock:
Joe! Just saying after a few liquidity events and facing a frothy market without an obvious place to re-deploy, sometimes our reserves get bloated. I have the same problem Apple has LOL
I have been doing some small business lending and looking (kinda) to diversify into other businesses like you mention. My NAP correlation index is skewed in my old age, though. The effort/reward ratio is too high out there. I'd rather take a nap than analyze 100-200 deals. 3% COC returns are reflected in that and is my punishment. A younger me would never settle for 3%!
You know I am totally just having a little fun with you. Nothing but respect for your success. I couldn't be happier for you.
I hear what you are saying though. You could sink that money into some massive project, but that would be tons of work. So there is a time vs reward decision. If you can get a more conservative return and do nothing, taking the easy money frees up time. Like time to spend with kids that will be grown and out of the house before you know it. That is where I am at, valuing my time over money. I mean I like money too, don't get me wrong.
- 8yKerry BairdPro MemberRental Property Investor · Melbourne, FL · Member since 2011 · 3k+ posts · 2k+ votes
This is similar to @Brie Schmidt’s recent post, regarding the “right” time to pull equity out. I think the answer to her (and me, with my smaller portfolio) would be based upon the Internal Rate of Return, which diminishes over time.
My houses are leveraged around 55% with the increase in values and debt pay down over the past few years. With the talk of "dead equity" I wonder whether a refinance back up to 70 or 75% LTV is recommended, @Thomas S.? Is that sort of the leverage that you find suitable?
- Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes8y
@Kerry Baird - Yeah it is, you can read the thread here for those interested
https://www.biggerpockets.com/forums/311/topics/54...
I don't feel comfortable going over a 70% LTV personally and right now I think we are around 55%
Second City Real Estate4.821 Reviews - 8yPeter TverdovBusiness MemberDeveloper · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes
Originally posted by @Frankie Woods:
Originally posted by @Peter Tverdov:
I created a rule that I will not let my portfolio to go about 75% LTV. If you need cash in an emergency and don't have enough or can't REFI you are going to lose your shirt. I notice a decent amount of people on this site swim naked. Which is good, I aim to scoop up houses from fiscally irresponsible investors. 100% leveraged? Lol. People who use HELOCs as their "cash reserves" especially trouble me. Blinded that those can be frozen by a bank at any time.
@Peter T What is the probability that a bank will freeze a HELOC? I've never heard of this, but strangely, was thinking that was could be a possibility.
I do use HELOCs and LOCs as emergency funds, but I also have access to my 401k loan if that "freeze" ever happens. I think the 20-25% equity is the sweet spot for most investors because it gives them some wiggle room if the market turns, while still allowing the investor to deploy accumulated equity into better performing assets as the mortgage is paid down. However, as many have already stated, it depends on your goals, risk tolerance, and experience among other considerations specific to his/her situation. This is a fantastic discussion.
Search the forums on here. It happened during the last recession and housing crisis. Your 401k should be ok but credit lines absolutely can be frozen. You're swimming naked if that's the case. Just my 2 cents.
- Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes8y
Originally posted by @Peter Tverdov:
My conservative side is coming out with the 401k loan reference as an emergency fund.
If you lose your job or quit or die, the 401k loan is due. Period. If not paid back, it will be considered a distribution and you will be penalized and taxed. Not the best scenario if you lose your job....
Banks freeze lines when times are bad. When times are bad, people lose their jobs. Perfect storm of reasons to have an emergency fund that isn't borrowed money!
- Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes8y
Originally posted by @Thomas S.:
"Equity doesn't kill cash flow, equity increases cash flow."
Equity kills the cash flow from the property which is suppose to be the asset you are investing in. This turns the asset into a liability when it is only your own cash generating a return. Why not invest the cash in something other than brick and mortar (eg: income funds) and bypass the hassles of owning/managing property and tenants.
Supposing you have a 300K property owned free and clear with a $3000/month rental income. Your $300K has a opportunity value of 10% ( + or -) which equates to a income value of $2500/month ($833 X 3). Rental income of $3000 - $2500 = $500 generated by the property. Subtract from that $500 your expenses on a property and you will have negative cash flow from the property itself = liability.
One could give a value of zero to your cash to artificially increase the cash flow from the property but what investor would place zero value on their cash.
You can not have your cake and eat it too.
I understand what you are trying to say but disagree. Paying down debt will directly increase cash flow. You take a property with a $500 mortgage payment, remove the payment, you will have $500 more in cash flow. Sure, it may not be directly $500 due to tax benefit of interest but cash flow will not decrease by reducing leverage. It may not be the best use of funds however you will have more cash flow.
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