Certainly this is a personal preference/outlook thing but I think this argument gets tossed around under bad pretenses with improper assumptions. Tom mentions the possibilities are endless with no debt, I am not sure I agree nor even understand what a long list of alternates look like. I tend to think the list is extremely short if we truly compare apples to apples. I would like to know some of the items on this list. Remember, that using any type of seller finance, is debt. So I don't agree there is a limitless number of ways to buy a property if you don't have the capital.
To me this is simple:
1. Investor either has or does not have enough capital to purchase 100% of subject property.
a) If investor has total cash to afford purchase, the investor has an option to take on debt or be debt free.
b) Investor does not have 100% of the capital needed. In this case, unless 100% is raised, there is no transaction. How then is the money raised? Well in form of debt or equity.
2. The core issues still stems from the cost of said debt. Does the debt cost more, less or the same as equity? Well typically debt is cheaper. Today's prevailing rate is around 5%. You will struggle to find an equity investor willing to only take 5% for real estate investments. Equity will cost 8% or more. Equity also is usually a percent of the net income, which means increases in net income create increases in proportion to the investment. Debt does not ride on the back of the net income. So with debt, increases in net income, mean increases in bottom line.
3. Since we attempted to look into the future, let us also do that with debt. As interest starts to rise again, so will return demands on equity for investors. Today's acceptable equity returns at 8% will rise as interest rates rise. In the event, I go out and get a loan right now for 5% interest, 10 years from now, if prevailing rates are at 8% interest, I am hitting a homerun. I have outrun the cost of debt, by getting cheaper money when it was around.
In step with this idea, now is the greatest time ever to actually take some debt on so as rates rise, you lock in at the bottom.
4. The lack of combining debt with equity puts all the pressure on the equity return. And this argument, when posed in the other couple of threads seem to ignore the question, what is the cost of equity. I think this is an important question to address and has two ideas that go with it:
a) Either you have 100% of the capital or you don't.
b) If you have 100% of the capital, then you clearly do not need to raise more equity. You then create your own opinion on what level of equity return you desire and whether that is acceptable. Since this is a personal idea, we need to bring it back to reality a little bit with a comparison of other investments and returns. Certainly the investor who uses 100% of their own capital can ride the return to zero. However, in a market where returns are pushing say 10%, the investor starts loosing out on opportunity where the same capital can be making a better return. So while personal choice will allow the investor to ride to zero the realty is not a competitive advantage if we put a rule on that investor equity that must match the prevailing return on equity.
Another misstated line from above, "Do you own the real estate investment if there is a loan secured by the real estate?"
- Tom answered, "No"
- Tom, while I understand the point you are trying to make, you know the above statement and answer couldn't be farther from the truth. If I buy a property with a loan, I own the property not the bank. Does that bank have an interest in the property? Yes. But that is not the same or even close to the same as owning the property. A bank can not use the property the same way I can. A bank can not freely enter the property as I can. The enforcement of the security instrument and note for the loan can result in a foreclosure auction, where the bank still does not own the property but causes the property to be sold. The bank can not do this unilaterally. I as the real owner can sell the property (provided it pays the lien) to whoever I want. I can wake up one morning and paint the house pink with polka dots. Clearly, that statement is a massive misnomer and is really simply false.
Another point, the crisis didn't happen because of debt. Please stop kidding yourself that what the media tell us we should believe. The crisis happened because borrowers felt they no longer had to live up to their obligations, which meant paying the loan back. The crisis was not caused by putting the money out in loans, the crisis was caused by the money not coming back in as payments for the loans that were made. The root of many of the foreclosures were the borrowers not making payments not a thing which does not act nor causes action.
In step with the idea of defining the cost of equity is also the idea of growing the overall equity. If I invest 100%, my growth rate is limited the free cash flow. Against a property that cash flows, the growth rate of leveraged equity far out runs the unleveraged. If the property is $100k, the equity guy needs to make the next $100k from the property which could take years. With debt, the amount of equity as entry is far less. If debt services takes place, not only do I have a lower barrier of entry, but I can stand to earn more equity over time. The same $100k affords me 5 properties, which as payments are made across the portfolio will earn more equity faster than only equity.
I agree, this is a conversation of preference. I am still interested to hear what infinite options there are to debt.