How leveraged are you?
Investor · Saint Paul, MN · Member since 2015 · 98 posts · 64 votes
Curious out there what people use as a general rule for how leveraged they are. How comfortable you are with debt. Do you have 401K loans? Would you cash out a Roth IRA? Do you use HELOCs off your primary?
For me I'm ok with leverage and a little risk but I'm at a point where I need to get creative/leverage myself a little more than my comfort zone or a little bit of both.
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.
Thanks for your great contributions to the post thus far! I'm curious how each of you would handle this: I have a property (my first home that I bought years ago) that has good equity in it. I could refi and pull out cash to buy another property continue to pay it down. Because I lived there for ~ 10 years I didn't start to rent it, thus didn't start depreciation, until 3 years ago. It's it a good location to rent, easy to fill, and close to my home thus easier to manage. It is on an ARM right now based off the Libor which is increasing (20 yr amortization started after the first 10 years - yes I was one of "those" borrowers back in the day but as luck would have it, it has worked).
I could refi now, increase the cash flow significantly, take that cash to buy another cash flowing property, but increase the loan thereby reducing my equity in it and now have a 30 yr note on it.
Thanks in advance!
Thanks for your great contributions to the post thus far! I'm curious how each of you would handle this: I have a property (my first home that I bought years ago) that has good equity in it. I could refi and pull out cash to buy another property continue to pay it down. Because I lived there for ~ 10 years I didn't start to rent it, thus didn't start depreciation, until 3 years ago. It's it a good location to rent, easy to fill, and close to my home thus easier to manage. It is on an ARM right now based off the Libor which is increasing (20 yr amortization started after the first 10 years - yes I was one of "those" borrowers back in the day but as luck would have it, it has worked).
I could refi now, increase the cash flow significantly, take that cash to buy another cash flowing property, but increase the loan thereby reducing my equity in it and now have a 30 yr note on it.
If you plan to keep it and if your plans are growth, I think we would both agree that it would make sense to refi, pull out what equity you have, and use that for a down payment on another property. You will want to look at your cashflow (don't get confused, only one kind :) ) to make sure you have enough to cover needed repairs and a possible reduction in rents if we do find our self in a recession. Some people who levered up were hurt bad when rents contracted so you will want some cushion. You don't want to get near a position of negative cash flow.
You will also want to consider whether this house is a good investment compared to what you can buy. Not sure exactly where you are but if you still meet the test of having lived there for 2-5 years you may be able to sell without paying any tax. A year ago that probably would have been my advice but that would revolve around you being able to find investment property in an area you are comfortable.
If you message me we could schedule a call to discuss in more detail.
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.
Thomas, I think you make a good point about always building in opportunity cost and comparing what you COULD be doing when you make a decision like paying off debt. But the only thing I see missing from this ROI equation is risk. Risk adjusted returns are the bottom line so you can compare apples with apples.
Yes, there is opportunity cost to basically purchase your own debt at 5% when you could invest it elsewhere at 10%. But by doing that you're dramatically decreasing you risk profile. If rents had cratered in 2008 - 2010, for example, the free & clear people who wasted their money on sub-optimal returns would be the only ones still standing. You might have to sell those income funds (likely at a loss) to pay off your upside down debts or fund negative cash flow on properties.
And the other thing not in the equation is timing and life goals. It may make sense to always try to optimize returns and build the biggest pile of wealth in the end. But at some point people reach enough. And peace of mind, less complication, less risk, less volatility all matter. Getting those in exchange for lower returns can make sense. So, it's hard to say something is suboptimal without all of that context.
Awesome discussion!
Great post i'm learning so much on this thread as for me i have too much equity across my 10 properties will have to do what most folks in this thread
Great post i'm learning so much on this thread as for me i have too much equity across my 10 properties will have to do what most folks in this thread
May be confusing depending on what you are reading on here but too much equity is never a problem. Too much debt can be a big problem if rents start to drop.
By having too much equity you may not be getting the best ROI on your cash however there is more than ROI to consider.
Investing defined: expend money with the expectation of achieving a profit or material result by putting it into financial schemes, shares, or property, or by using it to develop a commercial venture.
Pretty simply really. Equity is by nature a part of profit and therefore an investment. Putting money in T-bills is still investing...
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?
Good to see you have 30% equity, Deren.
Blanket Heloc loans are scary, so glad you recognize the risk using that as an emergency fund.
Of course it's best to have cash as a reserve. 2 ways to build that up - reduce expenses and/or increase income. Reductions in spending is usually easier if you aren't really doing it already. No car payments, brown bag your lunch, brew your own coffee. Have friends over vs going out. Build those reserves up the old fashioned way!
As we all know greater risk = greater potential for reward. However risk is primarily state of mind based on perception.
Some would say that 100% leverage is high risk. They view this from the most negative perspective, what if the sky falls, that is perceived risk.
From my perspective first I make my money on a property when I buy, I am experienced, I know that when the economy turns rents do not drop to zero and every tenant does not stop paying rent. I have multiple properties and multiple income sources. I am not a one trick pony as may real estate investors may be.
As for having equity in my properties I have generated tons of it, much when I buy. but unlike ultra conservative investors I "move my equity" to higher paying investments. It still exists, it does not vanish and is very secure. Is there risk, sure but I prefer to take educated risks rather than hide under my bed.
I don't care how much risk others may take with investing since they do not share my perspective. I prefer not to fear the boogie man. Personally we all know the most successful investors have taken the higher risk. Many of those have also been dismal failures, some keep trying and will still succeed.
I did not get into this to just get by and was prepared to risk it all for success. However I do not believe I was successful through luck.
My definition of high risk......Faith investing also known as appreciation speculators. Perspective.
I am on average 88% leveraged on my houses, and 90% in stocks in my other investments. I am ok doing this because I have enough resources to get through a downturn in rents or housing prices and I understand the use of leveraging money with lower interest rates to go after potentially higher returns. It doesn't make sense for everyone to be as highly leveraged because not everyone has the financial resources to survive a downturn.
If I pay down a loan that has a 5.5% interest rate vs invest that cash in an alternative investment that I think will return an average of 10%, then I placing a value a value of 4.5% on the higher risk of the 10% investment. There are times when it makes sense to take the guaranteed return of 5.5% rather than take the risk of 10%. I use 10% as you have mentioned multiple times that you can invest your money somewhere else and get consistent returns. Can you share where you can get 10% returns every year with no loss in principal value?
11% average returns over the past 10 years.
Diversified income funds, mutual funds, moderate risk.
The S&P 500 has yielded an average return of a little over 10% for the past 10 years, and most of the major stock indexes have had similar results. What's important to note is that 2008 saw a return of -37% on the S&P 500, and we have had a near record bull market in the 9 years since. Multi year averages are a fine measure as long as you don't need to pull a large amount of money out in a specific year. If someone would have needed to pull a large amount of money out of their income funds in 2008 when the stock market tanked to cover an issue with real estate, this would have destroyed the 10 year average for their own stock returns.
Sounds like you have done well with your strategy when measured over the past 10 years, but your strategy isn't the right answer for everyone. There is nothing wrong with someone choosing to leave some equity in a property to have some security and get lower average returns with significantly less volatility.
@John Woodrich I once remember Rich Dad Robert Kiyosaki used to say always be moving your money, he calls it velocity of money. The key is to aquire as many assets as possible. I just sat with my equity, i should be following his advice since i listen to him religiously. ;)