What is over leverage ?

Question

Hello all, excuse my question and I hope it doesn’t sound stupid. With a potential recession looming and perhaps may affect real estate, I wonder what fellow investors’ thoughts on what’s considered over leverage? What percentage of LTV or however else you would define this. I’d appreciate everyone’s input.

Jay Hinrichs · Answer

well 100% comes to mind.. those that borrow on their helocs and then borrow on the asset so 100% of the funds that bought the asset are borrowed.. that to me is over leveraged.

Account Closed · Answer

In my mind, over leveraged is when you are upside down (owe more than the property is worth) or have very little equity. When those things happen, you may have to come to the table with money if you have to sell it. Some of the ways to protect yourself are to use the BRRR method so that you have some equity built in. (But requires more work) But remember, equity doesn't pay the bills. Cash Flow will always be king.

Ivan Barratt · Answer

Study up on debt coverage ratio. It's another great data point.  Loan terms also affect how much leverage risk I'm willing to take.

For example: I'm taking out 85% leverage on a 34 million dollar deal. Why? The terms are 35yr AM, 3.38%, and it's fixed for the entire 35 years if I hold it.Another deal recently was 70% leverage with a 12 year rate lock. Since I have to refinance no later than year 12 I backed down the leverage.Happy educating! You're on the right site for it!

Account Closed · Answer

First, there is Not a recession on the horizon. A recession is 6 months of negative growth. I prosper in recessions anyway.

Second, if you have sufficient cash flow, you can be "over leveraged" and still keep your properties and be perfectly content. You just wind up getting rich during that period instead of getting very rich. You should not buy properties that have insufficient cash flow to service the underlying debt, even if you have to lower rent, IMHO.

Third, if you mean the "Stock Market takes a dive", which it will, (that isn't a recession by the way), that very large amount of money is simply being taken out of the Stock Market and will probably be used to buy real estate and drive up real estate prices for some very complicated reasons.

Ivan Barratt · Answer

Didn't back out. I took less leverage. :)

Sam Shueh · Answer

debt to net income ratio <<45%

Craig Jeppesen · Answer

Basically when you have too much debt and not enough cash, reserves and equity for when issues come up like evictions, repairs,  loss of income, job loss etc and you cant meet all your obligations and start robbing Peter to pay Paul and before long it is a mess and the bank forecloses on you.

Nathan Roberts · Answer

Hi @Zk Lani,

There is no exact percentage when it comes to LTV that would make an investment over-leveraged. Your leverage is based on the potential income that you recieve minus all expenses and your loan payments. If at the end of the month you make $300 in passive income after expenses but you still have a mortgage payment of $500, you are over-leveraged $200. A bank is not going to lend on this property in the first place because they know that the debt-service coverage ratio (DSCR) is too low. If the DSCR is below 1 then that indicates that the property does not generate enough revenue to cover the debt payment you owe. If the DSCR is above 1 then the property should be able to generate enough revenue to cover debt payments. You can be over-leverage on an investment property for a variety of reasons. Banks for the most part don't lose money on a mortgage that goes bad, especially if the property is worth more than the debt owed to them. That is why most banks will not lend 100% LTV on a property. Let me know if you have additional questions.

Nathan Roberts · Answer

If you are doing a flip you have a potential to be over-leveraged. For example, and for the sake of simplicity, if the estimated ARV for a property was $100k prior to a market crack, but it went down in value to $80k you could be over-leveraged. It all depends on the amount of equity you put into the flip. If you were an all cash buyer that purchased the property for $50k and put $30,000 into it for the rehab you are over-leveraged because you won't make any profit on the flip if the property is only worth $80k. On top of this, you'll lose money because you have to account for closing cost and possibly cost associated with having a Realtor list the property for you. Rental values can definitely go down during a market crash but they are not as depended on the market as a fix and flip property. If your property is leased out for market rent you should be fine during a market downturn. Luxury apartments or properties worth more than the average person can pay for it tend to go down in value more than a non-luxury market rate property. Those who can afford luxury may have to move to a non-luxury property during a market downturn. For the most part, rental markets are not affected by a market downturn or recession.

Richard Sherman · Answer

I do not want to have more than 60% LTV...now, I will buy at higher than that, all the way to 100% IF it is a turn around the property and I am aiming to drive the value and income up.  Winter is coming....get ready for it, there is going to be a lot of pain AND  a lot of opportunities.

What is over leverage ?

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