Urbana, IL · Member since 2012 · 1k+ posts · 425 votes
11y
I doubt there is a formula out there that can dictate whether you are over leveraged or not. Even if there is one and you're not overleveraged according to the formula you can still run into trouble. Its all a matter of how well you can manage the debt and any problems that occur that you don't anticipate. You'll also have to take into consideration what type of investments you have and if those markets change.
Investor · Madison, CT · Member since 2014 · 710 posts · 458 votes
11y
I was going to say that there is no formula, and you just have to be comfortable with the risk of the leverage you have, but I like Joe's answer better.
At today's interest rates, many would argue that young people should be borrowing as much money as possible, whether to invest in real estate, the stock market, or anything else. You'll know you're over leveraged when you can't sleep at night because you're worried about the loans. If you can mentally handle the risk, and your rental income covers the loans, property maintenance, and satisfactory cash flow, then you are not over leveraged.
Investor · Tampa, FL · Member since 2011 · 2k+ posts · 3k+ votes
11y
As long as you have cash reserves and are cash flow positive, you are not overleveraged. But everyone has a different risk tolerance to debt, that's what it boils down to...
Real Estate Broker · Indianapolis, IN · Member since 2014 · 3k+ posts · 2k+ votes
11y
I personally like to have a certain equity % in each property. As long as I am cash flow positive and the rent in a crash covers my costs I'm happy.
People are always going to need somewhere to live. If the market crashes tomorrow and my homes are worth less than what I owe but they still cashflow I'm not losing any sleep.
Now if you're buying with no equity and cashflowing 50.00 you may have a problem if the uncontrollable happens. (Vacancies, Market fluctuations, or repairs)
Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes
11y
You are never over leveraged until one day you are.
By this I mean what can you withstand and is that reasonable? If it is you are probably not over leveraged from an impartial point of view though you still may be deemed so if the worst case happens like it did in 2008. Reasonable things would be turnover, capex, etc. that do not happen often but when they do its really expensive.
There are also personal considerations. If you are full-time and this is all your assets over levered might mean something different than someone who has a nice sized investment portfolio because your family and your financial life relies on these investments and presumably the cash flow.
I was going to say that there is no formula, and you just have to be comfortable with the risk of the leverage you have, but I like Joe's answer better.
At today's interest rates, many would argue that young people should be borrowing as much money as possible, whether to invest in real estate, the stock market, or anything else. You'll know you're over leveraged when you can't sleep at night because you're worried about the loans. If you can mentally handle the risk, and your rental income covers the loans, property maintenance, and satisfactory cash flow, then you are not over leveraged.
The risk in the loan is to the person doing the lending...not the person paying it back. The person paying the loan back is "the risk" to the lender. Just ask any bank.
I doubt there is a formula out there that can dictate whether you are over leveraged or not. Even if there is one and you're not overleveraged according to the formula you can still run into trouble. Its all a matter of how well you can manage the debt and any problems that occur that you don't anticipate. You'll also have to take into consideration what type of investments you have and if those markets change.
Here's my formulas to tell me if I'm overleveraged:
1 - Cash flow = Rent minus all monthly expenses =>300/month 2 - Cash reserve =>$3000 x # properties control
EBITDA (Earnings Before Interest Taxes Depreciation Amortization) / Interest Expense
> 3 is good ; < 1.5 is bad
Can you elaborate on how to calculate this? Thanks!
EBITDA = Revenue - Expenses + Back Out specific Expenses (Income Taxes, Interest, Dep, Amort)
Say for example you have hold a property that generates $1000 a month revenue after vacancy and has the following monthly expense profile:
- PM $100
- Property Tax $100
- Insurance $50
- Repair and Capex Deferred Expense: $150
- Principal on Mortgage $50
- Interest on Mortgage $200
- Depreciation $200
Total $850
EBITDA = $1000 - 850 + (200 + 200) = $550 (we don't add back property tax as it is a different class of tax that is simply an operating expense. the taxes in the EBITDA equation refer to bottom line state and federal income taxes)
EBITDA is a useful metric in real estate because simple cash flow calculations can be obscured by the business owner's choices regarding financing (a house that could be positive cashflow with 20% financing becomes 0 or negative cashflow with shorter term financing). EBITDA fixes this by segregating the interest portion of the loan and the principal portion of the loan.
EBITDA (Earnings Before Interest Taxes Depreciation Amortization) / Interest Expense
> 3 is good ; < 1.5 is bad
Can you elaborate on how to calculate this? Thanks!
EBITDA = Revenue - Expenses + Back Out specific Expenses (Income Taxes, Interest, Dep, Amort)
Say for example you have hold a property that generates $1000 a month revenue after vacancy and has the following monthly expense profile:
- PM $100
- Property Tax $100
- Insurance $50
- Repair and Capex Deferred Expense: $150
- Principal on Mortgage $50
- Interest on Mortgage $200
- Depreciation $200
Total $850
EBITDA = $1000 - 850 + (200 + 200) = $550 (we don't add back property tax as it is a different class of tax that is simply an operating expense. the taxes in the EBITDA equation refer to bottom line state and federal income taxes)
EBITDA is a useful metric in real estate because simple cash flow calculations can be obscured by the business owner's choices regarding financing (a house that could be positive cashflow with 20% financing becomes 0 or negative cashflow with shorter term financing). EBITDA fixes this by segregating the interest portion of the loan and the principal portion of the loan.
Hmh.. Will have to calculate that on some properties. Much thanks.
Rental Property Investor · Sandefjord, Norway · Member since 2015 · 202 posts · 87 votes
11y
An interesting factor indeed. I certainly thank you for the input. I need to find a way to convert it to the Norwegian market, as we have some slightly different ways to calculate here.
But based on this formula i end up with 2.57, which looks to be pretty decent by this formulas parameters.
Would you say that The parameters still work if i was to bundle up several units into one formula, to see if I am over leveraged in general?
Would you say that The parameters still work if i was to bundle up several units into one formula, to see if I am over leveraged in general?
Yes, should work fine.
Please keep in mind that this is just a single metric regarding leverage (there are other interesting ones such as DSCR, which is basically the same thing except it incorporate all payments to debt service including principal in denominator) and don't forget to do your homework on liquidity and cash reserves.