Possible to grow without taking on debt?
Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes
Possible to grow without taking on debt?
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Investor · Houston, TX · Member since 2011 · 26 posts · 37 votes
10yLeverage is your friend in real estate. Think of it this way. If you have to save your way to buy a $100k property how long will it take you? Conversely, you can use leverage and put down $20k and take control of a $100k property. While your cashflow maybe a couple hundred per month, you will also enjoy paying down of the debt over time.
Instead of buying 1 100k property cash you could buy 5 houses with 20k down each and make perhaps $1000/month cashflow. In addition presuming you had a 30yr loan. In 30 years you'd have 500K in paid off assets.
Which is better? One builds wealth faster using leverage and time.
132 Replies
- Investor · Princeton, TX · Member since 2014 · 1k+ posts · 1k+ votes10y
With interest rates this low, long term fixed rate debt is not a bad idea.
- Investor · Rochester, NY · Member since 2016 · 477 posts · 426 votes10y
I'm more to the side of the debt-averse guys here, so this thread caught my eye immediately.
A lot of people bought property as an 'investment' the last time 'round the bubble using the "leverage everything possible to buy everything possible" mentality because everyone KNEW that REI was the way to get rich, and that the markets were only going to go up forever. So much so that they bought 450k SFRs that rented for 1500/mo because obviously the appreciation would carry their cashflow losses when they sold the house at 600k. Many of them used HELOCs to do so. Many of them then lost everything they had, including their primary residence when the market tanked and that house was worth 150k again. If they were smart, they kept as much cash in the mattress as they could the last couple of months before losing everything else, so they could pay rent to a guy who owned his houses outright. That's a risk of using leverage that doesn't exist by using cash. It's also an idiotic thing to do, but there you go.
All that to say this: I think there is an acceptable amount of debt for a business to have, but I want nothing to do with personal debt, or putting my personal assets at risk (no matter how small. I have a family to provide for.)
I think of the REI I'm currently doing as a business, so carrying mortgages on property I own is a smart business and accounting move. The amount of debt a person's REI business has should be driven by their finances and personal beliefs and goals. I also am only interested in properties that I can buy below replacement cost (really, really easy in my area) and cashflow well (rents don't change much around here.) This essentially protects you from the above scenario. The fact that folks in the business call it leverage, rather than calling it debt, is a little telling by itself: debt = bad, leverage = good*...supposedly.
I'm a mechanical engineer, so when I think about debt/leverage, just remember that the fulcrum can move in these markets. And if it does, it might mean everything you had leveraged starts working against you. Smart investors understand this and leverage correctly. Very conservative investors understand this and keep a good eye on how long that lever is, or don't use one at all. Poor investors buy real estate because "they knew a guy who made 250,000 last year" flipping houses/wholesaling/renting/etc. and use tons and tons of debt to do so.
- Residential Real Estate Agent · Miami, FL · Member since 2013 · 195 posts · 138 votes10y
Originally posted by @Brandon Cravens:
Oh. My point is that debt does not equal risk, overpaying is risky, not debt.
I never said that debt, in and of itself = risk.
Just meant that, everything else being equal, the more leverage used in a purchase, the riskier the investment.
Obviously if you'd be willing to lend me 100 million on a balloon loan with a term of 100 years and an interest rate of 1%, I'd be quite happy to accept, and I'd even call that debt risk-free!
- Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes10y
Originally posted by @Jason V.:
I'm more to the side of the debt-averse guys here, so this thread caught my eye immediately.
A lot of people bought property as an 'investment' the last time 'round the bubble using the "leverage everything possible to buy everything possible" mentality because everyone KNEW that REI was the way to get rich, and that the markets were only going to go up forever. So much so that they bought 450k SFRs that rented for 1500/mo because obviously the appreciation would carry their cashflow losses when they sold the house at 600k. Many of them used HELOCs to do so. Many of them then lost everything they had, including their primary residence when the market tanked and that house was worth 150k again. If they were smart, they kept as much cash in the mattress as they could the last couple of months before losing everything else, so they could pay rent to a guy who owned his houses outright. That's a risk of using leverage that doesn't exist by using cash. It's also an idiotic thing to do, but there you go.
All that to say this: I think there is an acceptable amount of debt for a business to have, but I want nothing to do with personal debt, or putting my personal assets at risk (no matter how small. I have a family to provide for.)
I think of the REI I'm currently doing as a business, so carrying mortgages on property I own is a smart business and accounting move. The amount of debt a person's REI business has should be driven by their finances and personal beliefs and goals. I also am only interested in properties that I can buy below replacement cost (really, really easy in my area) and cashflow well (rents don't change much around here.) This essentially protects you from the above scenario. The fact that folks in the business call it leverage, rather than calling it debt, is a little telling by itself: debt = bad, leverage = good*...supposedly.
I'm a mechanical engineer, so when I think about debt/leverage, just remember that the fulcrum can move in these markets. And if it does, it might mean everything you had leveraged starts working against you. Smart investors understand this and leverage correctly. Very conservative investors understand this and keep a good eye on how long that lever is, or don't use one at all. Poor investors buy real estate because "they knew a guy who made 250,000 last year" flipping houses/wholesaling/renting/etc. and use tons and tons of debt to do so.
Completely agree ... all those people that lost their houses in the last downturn were using leverage. Those that didn't use leverage held on and bought those foreclosures for pennies on the dollar. It is hard to go broke if you don't owe anybody anything.
One more thing to add, I try to live and invest counter-cyclically ... that whole be greedy when others are afraid and afraid when others are greedy. With leverage, I deleverage when the market is hot (as it is today) by saving aggressively, paying down/off debt, not cash out refinancing when values go up, and by selling off my poor performers and odd balls that no longer fit my strategy and goals. Then, when the market turns, I have some "dry powder" to invest, lever up, and spend like there's no tomorrow trying to buy every good deal I can get my hands on ... emotionally this is easier said than done, but this strategy has served me well over the years.
- Investor / Mentor / Contractor · Arcadia, CA Buying Out of State · Member since 2015 · 654 posts · 622 votes10y
There is Bad Debt and there is Good Debt. I think you are talking about not liking the Bad Debt. If you agree Good debt is Good then you can't still hate can you?
You need to leverage in real estate. When a bank offered me 3.83% interest amortized for 30 years with a 10 year balloon and funded 80% of the 104 unit property, why would I ever turn that down??
That's the same for a single family. Today's interest rates are practically free money!
CapEx is used on multi-family. There is no extra money available on small properties. When the roof needs replacing, you will be scrambling for the dough. Or just save ALL your so-called Cash flow on the single family rental and expect to spend it on the Capital Expenditures that WILL come up. Sad but true.
- Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@Alex Franks Sounds like you have done some great work! I too used to be interested in flipping. But after doing a few with my family I decided the work was not for me. Leverage seems to be a tool that can be used with great caution from what I am hearing. Like what you're doing out there, keep it up!
- Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@Jason V. – Bump for debt-averse. So many tragic things have happened when people leveraged the farm to scoop up property in the housing bubble. It amazes me how people can confuse their primary residence with their business work. If you want to be successful you need to understand that you are running a business and treat it like so. That means having completely different books, bank accounts, LLC incorporation's and doing everything to keep it from being able to affect your personal life if everything should go south. That means even treating it with a whole different mindset than you would treat your own life. If you would take out a 100% financed loan on your primary residence, that does not mean you should be doing that for an REI business. After all do you really like the sound of getting foreclosed on if you cannot fill the vacancy? That is the only thing you never have to worry about with your primary residence.
- Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@David Faulkner – I like how you use leverage as a tool. I know I will never go broke right now because I don’t owe anyone anything! And it is glorious and stress free I might add. Counter cyclic investing sounds like an interesting method of investing. I like it.
- Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes10y
Originally posted by @Brandon Cravens:
Originally posted by @Account Closed:
Originally posted by @Brandon Cravens:
Check out the rental property calculation tools here and learn what the inputs are and why they are used. Most folks don't think to factor in vacancy, repair, and capex. Some don't even think about property taxes!
I don't think one should equate leverage to risk. Back to my example, if you pay $100,000 for a property, I pay $60,000 for using leverage and the market corrects 50% you have lost $50,000 and I have only lost $10,000!!
The REAL risk in real estate is overpaying.
With all do respect this example makes no sense. You are saying if you put $60,000 down, finance $40,000 (for a total purchase price of $100,000) and the property loses 50% of its value (now worth $50,000) you have only lost $10,000?? I assume you are suggesting $10,000 of your cash down payment, but what about the $40,000 loan?? Your loses are identical whether you pay cash or finance.
No. Person A buys a property that's value is $100k and he pays cash. Person B buys an exact duplicate of that property but he pays $60k and uses a 100% loan. The market corrects 50%. Person A will have to take a $50k loss to dispose of his property. Person B can dispose of the property for a $10k loss.
Person A has much more risk than Person B.
Huh? Why would you get $40k off the purchase price by leveraging? If anything, Person A paying cash is likely to get the better deal depending on the type of home you're buying. There are many foreclosures that you would have a difficult time financing due to their condition, if you're a rehab guy.
- Investor · Wayne, PA · Member since 2014 · 40 posts · 18 votes10y
I'm not a fan of debt though I did use some on my one rental purchase. Mostly, investors will say to use debt for all the reasons given above. Those reasons all appear to be mathematically sound. When buying all cash, I would just be wary of the cashflow. Without a mortgage, all properties will give you cashflow at a reasonable rent but you may miss much better deals.
- Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes10y
It all depends on your strategy. I remember reading about a couple in The Millionaire Real Estate Investor who bought one house with debt and would pay it all the way down and then buy the next. It was extremely conservative but they were able to retire with something like 30 free and clear properties. I'm sure they could have done it without any debt at all. I personally like using debt as I think that's one of real estate's main advantages, but it all depends on what you're looking to do.
- Investor · Dayton, OH · Member since 2015 · 73 posts · 25 votes10y
Hello to a fellow Dayton investor!
My husband and I are very much like you. We are Dave Ramsey followers, do not believe in any consumer debt, however, with real estate we have realized the growth possibilities with using some good debt for our real estate business. We aim for being as low risk as possible though. We focus on A/B neighborhoods where rents will continue to be strong, we make sure to have a good cash on hand cushion in case of emergencies, we always keep 30% equity in a property and financed with a fixed rate and we always buy low. Also, keeping the personal side separate, we keep a 6 mo cushion of expenses on hand should our investment income go to zero.
- Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@Andrew Syrios - I have not read that book but it sounds like a very safe way to approach REI. Thanks for the tip, it all depends on our goals
- Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@Jim Vlope - Solid advice, definitely important to run the numbers on any investments before pulling the trigger, and you always have the risk of missing out on a better one
- Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@Andrea Castor - Yes buying low is always an important factor in my opinion, and there is plenty of opportunity for that in Dayton Ohio. I would be interested in hearing what neighborhoods you like and why. Currently I have one in Huber Heights and another in the Harrison Twp area. Both are alright, Huber being a much better neighborhood than Harrison Twp, it also cost about 4 times as much to buy the house in Huber.
Low risk is the only way to go in my opinion, I don't like not being able to sleep soundly at night!
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes10y
Originally posted by @Account Closed:
What I don't understand is why you are assigning different purchase prices to Buyer A and Buyer B? For a comparison to make sense all things should be similar other than the variable, which in this case is cash or financing.
I think he was having trouble making the point that two people all in for the same amount of money are risking their own cash differently, but this assumes Buyer A just lets it go back to the bank. You are correct in that the risk to value is the same, but who absorbs the loss is different.
Nevertheless, that gets off the original subject. OP: you will grow your portfolio faster by using leverage. Leverage does entail some risk, which is why you pay 4-6% to the bank for the mortgage instead of paying 0% to the bank. If you are buying smart, your exposure to risk is quite small - if that wasn't the case, no one would buy houses, period, whether to live in, hold and speculate, flip, rent out, etc. Furthermore, by going completely "all cash" into all units at the beginning to midpoint of this adventure, you are having money "workers" sitting around doing nothing. The example of leverage is posted 18 times till Tuesday on here, so I won't cover it again, but shorthand not only do you create greater cash flow in the short term by using leverage, you also diversify your holdings (one vacancy is less damaging the greater your number of rentals, for example) and build long-term wealth by having tenants paying off your holdings.
I believe there is a time to shift some/all capital into more of a holding pattern than a greater rate of return - near your "demise", for example, if you are planning on exiting the market, tired of working the job (this is a job, even if not in the classical sense), or if you have other plans for the capital, because successful buy & hold is going to (usually) depend on long-term strategy, kind of like blue-chip stocks. We have friends that did the landlording gig and worked many years, made their fortune, and now have amassed all the capital they really want or need and exited the market, owning a few properties outright, moving the rest into other vehicles.
There's no right answer here, because it depends on your personal goals. But without leverage, you have the great equalizer working against you, because you only have so many years to accumulate your wealth.
PS: I see your next post regarding "low risk". All investments entail risk, even those that you have 100% cash into. People who pay all cash (including myself!) sometimes fool themselves into thinking they have better protection than those who use leverage, but that's simply not true. If a property provides healthy cash flow - I'm not talking about 50 bucks on a property carrying $1000 note - the likelihood of having a vacancy so long that you have to dig into your own pocket to make the note is almost nil. Further, you see having all cash as no risk because you have a job and thus "don't need the money". That's akin to having a low-growth mutual fund or something similar. If you were 55 or 60, you probably want to shift your funds into low-risk options, but while you are young you would be better served long-term financially to pursue aggressive growth.
Skyline Properties - Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@JD Martin - Yeah you have got that right, old father time is still undefeated. It is all about where we are at in our career's / money making years. I can see how leverage would be useful in getting ahead with the number of units I own vs the amount of time I have left on this earth. I just don't want to die off early and have my whole life been spent working to pay of some mortgages. Guess I can't be pessimistic when planning for my future
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes10y
Originally posted by @Bradley Marion:
@JD Martin - Yeah you have got that right, old father time is still undefeated. It is all about where we are at in our career's / money making years. I can see how leverage would be useful in getting ahead with the number of units I own vs the amount of time I have left on this earth. I just don't want to die off early and have my whole life been spent working to pay of some mortgages. Guess I can't be pessimistic when planning for my future
If you've bought properly, someone else should be paying off those mortgages!
Think of it this way: not using leverage shifts the risk from now, when you're working, to later, when you might need that money for survival. If owning rental property is part of your long-term strategy of creating passive wealth - and there are other vehicles, from inflation-eating CDs and treasury notes to all-out-financial warfare Third world financial currency - one of your biggest risks is having enough money to get you through the 5-30 years that you will be too old to make much/any money through your labor. Someone who uses some leverage, makes smart purchases, reinvests proceeds while they are working is likely going to come out far ahead of you 30 years from now; when you are counting on the income from 3 or 4 rental properties plus your SS to sustain you, hoping for no vacancies (one vacancy for you will be 25% vacancy rate!), they will be counting on the income from 30 or 40 rental properties, all/nearly all paid for the same way you just paid for one at a time, because they used the compounding principle of tenant workers to pay off the notes. Looking at it that way, who really has the most risk?
I listened to a entrepreneur book one time that said something that really changed my thinking. They were talking about working jobs and creating entrepreneur value, and were discussing the view that many people have on how "striking out on your own" is risky, wherein they asked the question: What is more risky - making your own way through the world, creating value and wealth, or working for someone else, hoping that the value and wealth filter down to you?
Skyline Properties - 10yDarrin CareyPro MemberLender · Dayton, OH · Member since 2008 · 1k+ posts · 705 votes
@Bradley Marion Welcome to BP, it's a great site. There are a lot of good people here that are all willing to help and offer their opinions.
To answer your question, Yes, you can grow without taking on debt. If debt free is what lets you sleep at night, then do it that way. It's all about what works for you.
Debt (aka leverage) does not directly equal risk, Debt amplifies the risk that already exists, and it goes both ways. Using leverage can accelerate your portfolio, and it can also doom it. I've been on both sides of that equation, only one side is fun.
You've got two properties in good rental areas (I have some in the same areas). Simply keep the profits in your real estate business, and keep it growing. Add more capital regularly.
Sounds like you need to learn a little bit about capital reserves, maintenance reserves, and other expenses related to holding property long-term. Not fully understanding the expenses that don't show up every month cost me big time when I started out.
You're welcome to join us at the Dayton Meetup. The next one is 2/8/16. Plenty of local real estate investors will be there.
- Investor · Topeka, KS · Member since 2015 · 1k+ posts · 1k+ votes10y
I definitely agree with what you are saying, regarding good and bad debt. The problem is those aren't static, you don't take on good debt and then have any guarantee that it stays good debt. Good debt is good because it push a reasonable amount of extra cash into your pocket. If, through markets, or a spike in vacancies or maintenance or interest rates, or local economy, your debt stops doing that then it is bad debt.
Thoughts?
- Investor · Farmington Hills, MI · Member since 2016 · 21 posts · 7 votes10y
Hello Bradley,
I understand the idea of being "debt-free". I do have a mortage on my recently purchased current primary home. Since my divorce in 2009 (and her side forced a BK), I've had to live with Debit cards and honestly, it is refreshing to not have to worry about paying down any 'revolving' credit - which, since the 80's? is no longer a tax benefit.
The two rental condos I have are 'free and clear' because of it's all the money I had after liquidating my 401k's to get back into RE investing.
I agree with Dax on the benefits of leveraging your money. If you put 20k down on a 100k home and it appreciates 5% per year...you've 'earned' 5k on the 20k in the first year...and hopefully net positive each year following. You also have huge tax benefits because you deduct the mortgage interest from your rental income and can in some cases have a "net loss" that can reduce your employment based taxes...
I'm now in the process of a REFI on one condo to pull out money to purchase the next. I believe it's called "leap-frogging"...but this got a lot of people in trouble in past couple decades. You have to be comfortable with the level / % of debt and risk.
Having access to "funds"...and "seasoned funds" will allow you to take advantage of more opportunities as they arise.
Good luck!
Cheers,
john
- Littleton, CO · Member since 2015 · 59 posts · 14 votes10y
Originally posted by @Alex Franks:
Originally posted by @Bradley Marion:
To me its all about leverage. I have raised and used a lot of private funds. Have had loans in both my wife and my name. Money is cheap today. So the leverage is using cheaper I like to call it making money off borrowed money. For me, my goal was free and clear properties. Then again when I first started my mind set was buy 4 properties at time. Fix and flips selling 3 and keep the 4th free or almost free slowly building my portfolio.
Why did you change your investing strategy?
- Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@Darrin Carey - Yeah I would like to learn as much as possible about buy and hold properties. I do have a pretty good understand of what property management companies do with reserve accounts because I manage USDA loans all day at work and we effectively manage the management companies over our properties. We have 50 year commercial loans out on hundreds of properties and I authorize reserve account expenditures every week. However I still have much to learn. I would like to come to the MeetUp group sometime but I am very busy. I'll be there one day though!
- Real Estate Investor · Dayton, OH · Member since 2015 · 31 posts · 6 votes10y
@John Lampertius - Looks like you have cashed out on that 401k in order to make a good investment. I know divorce is something I never want to experience but I have been around it a lot. Hope you are doing well and thanks for the advice
- Investor · Saint Paul, MN · Member since 2015 · 663 posts · 512 votes10yBrandon Cravens His question is legit. Your example should say both investors buy a 100k property value for 60k each. One uses 100% financing and the other 100% cash. Now you have a true comparison.
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