What is Low Leverage to you?

Question

I was thinking about my personal portfolio and the amount of debt I have.  I know most people will think I am under leveraged, but I like the freedom and flexibility this provides me.

But it got me thinking: What is low leverage to you?  If someone said, I prefer low leverage investments, what does that mean to you?

EDIT: I am thinking specifically for investment properties (non-owner occupied real estate), passive investment or direct.

Todd Dexheimer · Answer

I think leverage as a percentage of value when talking about investment properties is misleading. What is riskier?

1. Buying an apartment at $2mm at the bottom of the market with 80%LTV and a 2.0 DSCR

2. Buying an apartment at $5mm at the top of the market with 60% LTV and a 1.25 DSCR

In my opinion debt service coverage ratio (DSCR) is the much more important overall to be looking at. I like to see my properties at a minimum of a 1.5 DSCR.

Most of my properties are leveraged at 50% or less LTV because of that.

Erik W. · Answer

Low leverage = sleeping easy at night and not freaking out when the world dumps a financial or biological pandemic on you.

My personal residence is 100% paid off, we have no credit cards, no car loans, no student loans, etc and are "personally" debt free.  Still working on knocking out the rentals, and feeling more at peace and relaxed all the time.  I think this in turn has helped me make wiser investing decisions, which has raised my net worth.  This is one area folks fail to give Dave Ramsey enough credit (hah, see what I did there?): he teaches financial PEACE, not just raw dollars and cents.

But to answer your question directly, anything below 30% is low leverage.  31-70% is moderate, 71-90% is high leverage, and over 90% is get read to have your face kicked in the next time a flea sneezes.

Greg Dickerson · Answer

In general terms from an institutional viewpoint 50% or less is low leverage. The leverage you decide to carry is a personal decision based on your goals. For me it's al about the velocity of the cash. I prefer to keep max allowable leverage on properties (usually 75-80%) as long as they have proper cashflow. Debt is so cheap it makes no financial sense to keep equity locked up when you can deploy the cash and earn way more on your money.

In terms of equity and net worth you can not spend or invest either if it locked up in the property and when the market turns and properties lose value you in turn lose net worth. If your properties cashflow and are leveraged with non recourse debt the values do not matter as you have pulled all you're cash out and are still positive cashflow. The only issue is the debt. If you use higher leverage you want long term debt so you can weather a downturn. Again this is a personal strategy and will depend on your business model and comfort level but this saved me in 2009 when real estate values crashed. I had high leverage, pulled all my cash out before the crash and made it through just fine because I had proper cashflow to debt service ratios and non-recourse loans so when the lenders tried to call them they had no leverage on me.

Erik W. · Answer

I want to clarify something about why my "low" leverage number seem far lower than others have said.

During a crisis, values often drop significantly and rapidly.  Let's say you're at 70% LTV today, which many responders on this post said was "low", but by this time next year values drops 25%.  You are now about 90% LTV.  That only thing that changed is you went from "low" to "high" even though you may have paid down more of the debt and overall owe less money.

Too, when economic times are good lenders are usually okay with 80% LTVs.  When times start to get bad, they scale back to 75, 70 or even 60% because they know values are dropping and they want extra cushion.  This in turn causes values to drop further since there are fewer buyers able to qualify, which becomes a self-perpetuation downward spiral.

To sum up: LTV is not static and other factors outside your control can cause dramatic, relatively sudden shifts.

Steve Vaughan · Answer

In addition to LTV and DSCR, the type of leverage matters to me.

I just saw a deal 'success' story on a new 48 unit value add.  1 year loan.  I commented that I hope the credit environment in that commercial space is still favorable. It was a 66% loan with a 1 year balloon.

I felt overleveraged on my commercial loans (callable) and a couple seller-financed loans with drama in their family so I paid them off.

There are other risks in some loans than just percentages of value or NOI, especially with commercial, blanket, portfolio, private and hard money loans.

in general I am about 50% leveraged.  Some have 70ish%, some 0.  More options with 0% on some than 50% on all.

Ryan Daigle · Answer

@Evan Polaski great question. I think anything less than 70% LTV is low-leverage in my mind. 65% and less, ideally.

I'm assuming this is for a collateralized debt like real estate. If we're talking about other leverage like buying stocks on margin, well then my answer would be a lot different!

Ryan Landis · Answer

@Todd Dexheimer interesting way of putting it and I like that. I think the overall "value" on can really influence the comfort level. To your point, owning a retail center with 40% LTV still might be tough on DSCR right now with things going on. I would agree that I care more about what is coming in to cover the obligation than the size of the obligation, all things equal.

I would say sub 65% LTV though in general is getting on the lower side of things for purchase transactions. When you get under 50% LTV, you are pretty low leverage tbh (again on the purchase side). But hey, 5% down on a vacant apartment building that you are going to go turn around that ends up performing like crazy might be low leverage too...

Paul Shannon · Answer

I think it's a personal opinion, b/c it relates to risk tolerance.  To me 65% LTV is low leverage.  However, depending on the deal, 75% is completely acceptable.  You may not grow quite as quickly with having a little more cash in deals, but you also won't have a dumpster fire on your hands when things don't go exactly as you planned.

Sam Shueh · Answer

Debt to income ratio of 20-25%.

Kevin K. · Answer

I concur with what some of the above posters have stated in regards to DSCR vs. LTV. I’ve seen some deals where the underwriting is very light on the expenses and vacancy rates with tight debt coverage ratios. Even a 1.30 dscr on a retail strip of say 4-5 tenants or less can run into trouble if you have a long term vacancy. Dropping your income by 20-25% and no being able to service the debt can get you in trouble. A multi-family building with an LTV of 90% is risky and would be under water if values dropped 15-20%, but unless the owner needs to refinance soon, they should be ok.

Unfortunately due to the new rent laws in NYC which have driven cap rates up. This exact problem is happening. Many people refinanced and cashed out at sub 4% cap rates. The income on many of these rent stablized buildings hasn’t increased enough to keep up with the change in cap rates. So things are getting pretty tight here. When the owners are trying to refinance.

What is Low Leverage to you?

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