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
- Winston Salem, NC · Member since 2016 · 94 posts · 111 votes8y
My opinion on this is that you want to be maximum leverage based on the worst case scenario. What I mean by that is if you have cash reserves sitting on the sidelines, maybe 100% leverage is not a bad idea. If you don't have any cash reserves to support a downturn, maybe it is a terrible idea. You need to figure out how much liquidity you have to support you in downturns or when things don't go the way you planned. That is how all large corporations manage their cash for maximum equity.
Practically, I would start with the DCSR ratio (mortgage/noi). I personally wouldn't want to do anything less than 1.2 or that would be too risky for me. Then I would stress test it with what-if scenarios. If I have cash or lines of credit that can support through any downside scenarios, I am good. Otherwise, I reduce the leverage.
Hope that helps.
- Wilmington, NC · Member since 2017 · 31 posts · 23 votes8yNo investor plans on failing or filling bankruptcy, but still it happens all the time. You also can’t plan for the worst case scenario because it’s impossible, instead you need to balance leverage/risk. Buying only cash is probably a mistake, but so does 100% leverage. You spend years building a portfolio and all it takes is a few months/years to potentially lose it all. Banks keep a certain LTV requirement because statistically they deemed it safer for them over a long period of time.
- 8yJordan MoorheadBusiness MemberReal Estate Agent · Austin, TX · Member since 2015 · 5k+ posts · 3k+ votesI try to keep 25-30% equity in a property. I’m risk averse and don’t mind hustling to get more down payment money. I’m currently selling a place instead of refinancing to buy others because it makes more sense to me.
The Moorhead Team5140 Reviews - 8yChad CarsonPro MemberInvestor · Clemson, SC · Member since 2008 · 198 posts · 156 votes
Love this discussion!
We've got about 6 months of PITI cash reserves (as in a real savings account). Those reserves served us well in 2008-2010 as both a cushion for negative cash flow events and sometimes as opportunity fund.
We're at about 60% leverage overall. But a good bit of that leverage are private loans from me or my business partner. So, we're probably more like 40% LTV.
I didn't read this anywhere, but I think the overall LTV isn't the only thing to consider. Two people with same LTV could have drastically different risk profiles.
For example, having 10 properties all with 40% LTV loans is less desirable to me than 5 properties with 80% and 5 properties free and clear. If things get bad (i.e. deflationary events), a bank is more likely to negotiate with you at 80% LTV because they are less excited to take that property back. And obviously the free and clear property has less risk in a downturn.
Also, the type of debt and the lender matter. Like @Steve Vaughan, I can't stand the commercial stuff or anything with balloons, adjustments, etc. That's the kind of debt that killed investors and corporations in the most recent downturn. Seller financing and private loans have always been my preference instead of commercial loans because in a worst case scenario I can sit across from that real person and have a reasonable discussion. My commercial bank loan officer would likely be gone or changing his/her tune about the refinance promised earlier.
@Erik Sherburne, my reserve fund for my 10 class c SFR's is 30k, sitting in a savings account. I know it's not sexy, but it's peace of mind. We put 1k a month into the fund, and it's used for repairs, maintenance and other expenses, not counting taxes, insurance or mortgages. Above 30k, is money we feel we can use for other things, below 30k, the 1k or remainder after expenses goes into the fund.
- Rental Property Investor · St. Paul, MN · Member since 2016 · 3k+ posts · 3k+ votes8y
I am about 65% leveraged, but my cash basis is very low. All of my properties that I bought, other than the few apartments that I have recently purchased, I purchased and increased the value and then refinanced to be able to be into them with no money. Every time I do a cash out refi, I look a lot at the cash flow and leverage. If I am going to be over 70% LTV, I will lower the principal balance and take less money. I love leverage, but also think it is important to be aware that the market has cycles and you will end up loosing everything that you built if you're not careful.
@Thomas S. @Steve Sell Would love to talk more about what you guys put your money into to generate 10% returns. I usually do a mix of ETFs and equities, but always like to get other thoughts on alternatives.
Recent years have been great but a big market downturn usually brings the ROI % back down quite a bit. How did your portfolios perform during the 08 crash?
My leverage level depends on the property but I am working to increase it in order to do more deals. I wouldn't want to be more than 75%-80% leveraged in order to have an exit strategy and a little protection but might consider going more if it would be to fund a deal that makes a lot of sense to do and that is the only way to make it work.
The problem I am running into now is that my SFRs have appreciated over the last several years and pulling equity out to leverage them at 75% gets them to the point where they don't necessarily provide a good cash flow return since they appreciated faster than rent levels. They definitely would be properties I would not be jumping to invest in at 75% LTV.
At 75% LTV, I would be able to completely cash out on my initial investment, but it doesn't seem like it would be worth having them as rentals at that point since my return on equity would be low and renting a home for ~$100/mo after all costs, maintenance and cap ex does not seem worth wasting time on as it is only $1,200/yr (and principal pay down) to manage the property. It isn't worth the return even with good renters.
If I do refinance, I could use those funds to purchase another property at 75% LTV but I would essentially just be dropping the cash flow of my initial property in order to get it back on another. The net cash flow impact is probably a wash, and the result is I have another property to manage at the same cash flow level. More work for the same amount of money...
My strategy will likely be changing more over the next year or so as I try to make better use of my equity. When the market was down, I initially preferred to invest in SFRs from the standpoint of having a better exit strategy and because I could buy a SFR for the same unit cost as a unit in a multi family property. Now I am thinking more about cashing out of some of these SFRs while prices are up in order to get something a bit bigger.
- Investor · Cincinnati, OH · Member since 2015 · 242 posts · 182 votes8yI’ve borrowed against 401k and used HELOC. However I view those as short term vehicles to raise funds for REI. I don’t like having them outstanding for a long time. 401K loan has high payment due to short term so it hurts cash flow. For HELOC you need to understand if the lender has the ability to call the loan. I don’t like that exposure. As far as % LTV, if you have ARMs and you’re getting commercial, non-conforming loans you also need to understand the lender’s ability to call the loan or change terms. Leverage equals risk. Leverage is probably the main reason people go broke in this business. Risk tolerance is a personal matter which varies based on age, net worth, etc. If you’re young, you have time to recover from losing it all. If your net worth is low, why not risk losing it all if it’s not much? If you want to learn from someone else’s mistakes with leverage, read about Dave Ramsey. I believe he has personal experience with this which he readily shares with the public.
- Investor · Cary, IL · Member since 2017 · 15 posts · 14 votes8y
Originally posted by @James Ma:
@Thomas S. @Steve Sell Would love to talk more about what you guys put your money into to generate 10% returns. I usually do a mix of ETFs and equities, but always like to get other thoughts on alternatives.
Recent years have been great but a big market downturn usually brings the ROI % back down quite a bit. How did your portfolios perform during the 08 crash?
I'm still pretty young, but in the mid 2000's I was spreading what money I had over a few dozen promising stocks. Had a few real winners like AAPL, NFLX [No AMZN unfortunately]. Some losers and a lot that just went sideways through the crash. I wish I kept better analytics of the portfolio but it feels like it didn't get shocked as much as the broad-based indicies during '08. Once stocks become popular and liquid enough their correlation with each other really starts to steepen.
I keep just enough reserves to cover worst-case scenarios with my RE holdings and they're held through a mixture of diversified assets. One might be able to make a good case that looking forward 10% is a little optimistic, but the CAGR on the S&P itself or an equities-heavy basket of ETFs usually comes out around 8-9% over a long enough timeframe iirc. There's an argument sometimes made that a slight degree of leverage can be used on such portfolios to increase returns a few more % without taking on any real risk of ruin, just the cost of higher volatility.. but we're on an RE forum here.I stopped scrutinizing over details like these a few years ago because by and large I found a far more efficient vehicle to carry my equity. 10% on your money with an investment property shouldn't be a stretch at all even if you're poking around the MLS once you consider all of the ways you're making money holding RE [CF, Appreciation, Equity gain, tax benefits..]
- Rental Property Investor · Saint Paul, MN · Member since 2016 · 46 posts · 37 votes8y
For all you 100% leverage folks out there how did that work out for you between 2007 and 2012? Because we weren't leveraged anywhere near there all we noticed was that rents were flat for a time and there were piles of buying opportunities of foreclosures from folks that were over leveraged but we had zero concern about making mortgage payments or losing properties due to the need to liquidate to pay bills. There will be another RE correction at some point with a similar result (hopefully not to the same degree/extent). Also, I agree with Mr. Woodrich that having 100% equity DOES NOT reduce cash flow but instead increases cash flow. It may negatively impact your theoretical cash on cash percent return but it certainly does NOT reduce cash flow.
- Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes8y
There is no guarantee of 10% anywhere, if there was HMLs would not invest in people without cash taking on risk when they could just park their money and avoid the risk.
At the same time, I don't think you will find many people on here who will go through the hassles and risks of owning RE for only 10%. I surely wouldn't.
- Investor · Little Elm, TX · Member since 2017 · 6 posts · 1 vote8y
@Frankie Woods I used to work at one of the Big Banks and I had several clients that had HELOCs that were outright frozen, or had their limit lowered from say $160k to $12k overnight. This was during the downturn. Same thing on unsecured business lines of credit if I remember right.
- Real Estate Agent · Jacksonville, FL · Member since 2015 · 1k+ posts · 1k+ votes8y
I think it comes down to risk tolerance. Do you have a back up plan should the economy drop? I am bullish on RE as an investor and make my living as an agent, but I am diversified. Perhaps not as much as I should be, but it is on my mind. I use a lot of leverage and keep cash. I have multiple streams of income. There is a bigger picture to consider, RE leverage is just one piece. I do not like keeping equity in properties. It is money that is not working and I a morally opposed to my money not working for me.
@Steve Sell I agree that good RE investments should give 10%+ returns, but usually there's a period where you're leveraged out and need to pay down debts or save up for a downpayment for a new property where investing in the market will help you get money faster to do that.
Originally posted by @Ryan Schroeder:
For all you 100% leverage folks out there how did that work out for you between 2007 and 2012? Because we weren't leveraged anywhere near there all we noticed was that rents were flat for a time and there were piles of buying opportunities of foreclosures from folks that were over leveraged but we had zero concern about making mortgage payments or losing properties due to the need to liquidate to pay bills. There will be another RE correction at some point with a similar result (hopefully not to the same degree/extent). Also, I agree with Mr. Woodrich that having 100% equity DOES NOT reduce cash flow but instead increases cash flow. It may negatively impact your theoretical cash on cash percent return but it certainly does NOT reduce cash flow.
I agree - always good to not be fully leveraged and to have some capital on hand at all times in case there's a crash somewhere and you can get some huge value IMO.
- Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes8y
Our debt to equity is about 2:1 and we try to keep it in that range. That way we're not leaving too much on the table and letting the advantages of OPM go to waste, but we also have plenty of equity in case the market turns.
- Investor · Cary, IL · Member since 2017 · 15 posts · 14 votes8y
Originally posted by @John Woodrich:
At the same time, I don't think you will find many people on here who will go through the hassles and risks of owning RE for only 10%. I surely wouldn't.
I think we're on the same page. I've heard people refer to the return on T-bills as the risk free rate, but even that's contingent on the government remaining solvent :)
There's no way I'd go through the trouble of operating income properties for a 10% return either.. and I'd like to assume most others wouldn't either.. although seeing some of the price to rent ratios for recent sales around the nicer suburbs in my area makes me question that assumption sometimes...
All in all the thrust of the argument was that a reasonably competent investor should not have much trouble securing, at the very minimum, a 10% return on their capital without taking on excessive risk or administrative burden. If one agrees with that premise, parking equity in properties to save ~5% in bank debt is not an efficient decision. If one is already past the wealth expansion stage and the marginal utility of the next dollar is not worth the effort it takes to keep ROE up.. more power to them.
I hope to be in that spot myself a decade or two down the road. I'd still probably keep mortgages on any properties I own if the interest rate is reasonable and just start amassing reserves in diversified funds rather than own an 8cap free and clear and have to work for the return vs. parking the money in a few index funds. "Paying down debt will directly increase cash flow."
Not sure you fully understand what I am saying.....paying down debt is buying cash flow, To buy $500 in additional cash flow by removing a mortgage interest payment is in my world costing $1000 due to the opportunity value of my cash. Money must earn it's keep and it can not do that with a return of 5%. If you deduct the $1000 opportunity value of your cash off of the top of your rental income to pay a descent return of 10% on your cash you end up with a negative $500 not a positive $500. It is very easy for investors to only see what they want to see and as such can simply ignore the realities of the cost of investing...........Look See I made another $500 in my property investment by throwing cash at it......NOPE.
Investing is never about perception it is about reality. The reality is that by reducing ROI you are reducing the potential value of your money. Dead equity is not investing, it is hoarding. I have said it before and I will say it again, if you want to hoard cash that is fine but do not pretend that buying cash flow and increasing cash flow are the same thing.....they are not.
"during the 08 crash?"
All my properties maintained positive cash flow during the crash and held their value due to being driven by rental rates which held firm for the most part in my area. I never invest in SFHs which are far to volatile even with my high tolerance to risk. I do not invest for appreciation and prefer that appreciation to be driven by rental rates not economy driven home buyers.
My income fund investments only dropped 30% but I threw a pile of cash I had in reserve into the funds when they were in the basement and within 18 months recovered fully plus, plus. so I did quite well.
- Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes8y
@Thomas S. I completely understand what you are saying but I was trying to make it clear that buying equity does increase cash flow. It may not be the most efficient use of cash but it is what it is. Sometimes it can be the best option available for someone but that largely depends on financing capacity, time to commit, and inventory of investment grade properties in an area.
@John Woodrich There is a distinction between true cash flow and artificial cash flow. That is what we are talking about here.....the definition of "cash flow". One, true cash flow" is generated purely by the property itself. The other, 'artificial cash flow" is purchased through cash infusion.
Every property has two separate income streams. The property is a separate entity from the equity. The equity, having a opportunity value, is a expense that you deduct from the income generated by the property to arrive at true cash flow. Investing in a income property is good, buying cash flow at a higher rate than the return is bad. The reasons a investor may do it does not change that fact. Seeing the plus and ignoring the negative only buys bragging rights. I am 6' tall....when I ware 2" heals.
It's magic money, smoke and mirrors. It is the same as saying I can get positive cash flow from a 1M property with rents at 3K a month by purchasing with all cash. Show me the money.
Leverage the property and put the cash in a vehicle that will return higher % than prevailing mortgage rates. That is how you increase real cash flow on net worth.
- Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes8y
@Thomas S. as I mentioned, I completely understand your angle but cash flow is cash flow. Paying down equity is still investing. Sure, you may be paying down a loan to effectively earn 5% but that is still investing. It is no different than someone deciding to purchase a bond to get 3% interest. The fact that they could get more with leverage in RE doesn't matter. That 5% is not artificial, it is real. It is purchased just like any other investment we get into. There is no point in borrowing at 5% if you don't have anything in the works that will guarantee a greater return.
If you take a step back to how most of us have to purchase property, we have to invest cash. The fact that you invested cash in your example would make this artificial cash flow because the cash flow was purchased which makes no sense.
Cash flow is cash flow, there is no distinction between real and true. Money coming back into my pocket is still cash flow earned, doesn't matter whether it was earned on bank funds or if it was earned by my cash investment :)
Opportunity cost is something we should all consider when choosing to keep equity but knowing we can get a better ROI doesn't always justify the time commitment, taking on risk (debt), and there aren't always feasible opportunities. I would rather pay down a LOC at 5% than I would rather buy a place to get 10%.
- Rental Property Investor · Venetia, PA · Member since 2015 · 107 posts · 47 votes8y
Based on the contexts in which I see the term cashflow being used, I define it as what's left over after all your bills and after your no-BS reserves (e.g. repairs & capex which I don't see how anyone can put less than 200/month towards, prop management, vacancy).
I'd consider anything before accounting for these to be revenue, not income.
- Real Estate Agent · Tulsa, OK · Member since 2016 · 408 posts · 242 votes8y
Approx 70.4%
Reading this thread makes me a little nervous, I have my emergency funds in a HELOC tied to 3 properties. Any suggestions to keep myself safe?
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