I am currently the owner of 2 duplexes, 1 conversion and 1 side-by-side. The conversion was purchased using a down payment of 20% and cash flows $525/m. The side-by-side was purchased 100% LTV (zero percent down) and cash flows about $400/m. Obviously, this means my cash-on-cash return is infinity but I started with zero equity in the property and have to build it over the long term. The bank was willing to loan me 100% of the property value because my dad has built a very good relationship with them over the last 20 years through his construction business. I recently spoke to the loan officer and he said he would be willing to do this again.
Should I keep taking advantage of the 100% LTV and low-interest rates or is this "over-leveraging" too risky? Any advice would be appreciated.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
6y
@Nick Wilkinson it's not the LTV that poses the greatest risk in RE, it is a lack of liquidity. By example, if I owned 5 properties at 100%LTV worth $1M but had $1M cash in the bank then my risk is extremely low. This example is an exaggeration to make a point: being well capitalized is more important than your %LTV.
Los Angeles · Member since 2018 · 464 posts · 471 votes
6y
What's your equity position? I.e., if the market drops out from under you, what is your down-side risk? From what I hear from the experts here, they like to have at least a 30% equity position, so the market can drop that much and they can still sell out from under it without losing their shirts or any other articles of clothing.
What a fantastic position you are in. In my opinion anytime where the bank is willing to finance 100% that is a super awesome deal!! keep that great relationship going and I would definitely keep it going.
By the way, what part of the US is this? Ohio? I’m looking to invest in a new market and wanted to take a look at Ohio.
@Alvin Sylvain Although it has no equity to begin with, my plan is to hold the properties long term so I don’t think the equity piece is much of an issue. I will grow equity through improvements and principle pay down. The only real threat would be if the market gets so bad that tenants are unable to pay rent and/or rentals rates fall to where it does not cover my payments.
@Percy Matsunaga I’m investing in the Lincoln, Nebraska market. I’m a commercial real estate agent here as well.
Investor · Cincinnati, OH · Member since 2008 · 319 posts · 243 votes
6y
You are right to take caution about 100% LTV. Hopefully you have some liquidity outside of this deal. It is great you have such a solid relationship with the bank. You could look into doing some forced appreciation to these properties so you have some equity in the property and could sell if you wanted to.
@Tyler Weaver What if I am buying the properties for below market value and adding a little forced appreciation? Then would it make since? This way I have some equity from the initial purchase and add some more forced appreciation with improvements.
Investor · Cincinnati, OH · Member since 2008 · 319 posts · 243 votes
6y
So then you are talking about 100% LTC (Loan to Cost) and say 80 LTV? There is a much better margin of safety there. Basically the lower the LTV is, the bigger problem you could face and still be able to sell the property without bringing money to the closing table.
Entrepreneurial Life Coach/Investor · La Costa, CA · Member since 2015 · 18 posts · 8 votes
6y
Give strong consideration to the backlash from Covid-19. Underleveraged real estate investors are becoming victims in CA because state and local governments have put moratoriums on rent payments during the pandemic and landlords that aren't liquid are finding themselves looking at possible foreclosures on their rentals. If you were in CA instead of NE you might already be up to your waist in alligators. I would proceed with caution considering the cash flows you shared. I have always followed the rule of the thumb that a property should cash flow pretty close to two times its monthly gross rent revenue each month. It is much more joyful to cry over money you could have made as opposed to crying over money you have lost. Best of luck!
@Dean-Ross Schessler Thanks for hopping in on the topic. Yes, we have been pretty lucky in Nebraska as the pandemic has been fairly mild compared to other parts of the country. As far as I know, most investors have done well with their long term rentals over the last few months. I will say, as far as cash flow goes the numbers here are a lot different than they are in California (fundamentals remain the same.) The duplex that cash flows $400 was purchased for $169k and rents are $850 per side. Can you give me an example of what 2 times the monthly gross rent revenue would be?
Rental Property Investor · Jacksonville FL. · Member since 2019 · 2 posts · 1 vote
6y
Yes, I also could use clarification on what you mean by 2x monthly gross rent revenue. Are you saying the charged rent should double the mortgage payment? That seems very unlikely unless I/We are missing something
Investor · Colonial Heights, VA · Member since 2015 · 78 posts · 53 votes
6y
@Nick Wilkinson I believe @Dean-Ross Schessler rule of thumb for your example would be that you should cash flow at least $3400 a year or around $283 a month. I got the $3400 from multiplying your gross monthly rent by two to get $3400. Another common rule of thumb is making sure your gross monthly rent is at least 1% of your purchase price. If that is the cases then you should be able to cash flow regardless of where you purchase the property.
I also believe that you got a awesome deal with your bank since it seems like they gave you a low interest rate along with 100% LTV. The local community bank offered me 100% financing for investment properties but only 80% of it would be at their commercial property rate of 5% and the other 20% was basically a personal loan at a rate of 9.5%.
As others mentioned above there is risk of being over leveraged and that risk can be very high if you are taking out balloon loans and will need to get the property appraised again in a few years. If you plan on keeping the property long term, have fixed long term financing, and are currently cash flowing after taking into account reserves then I think your risk is only marginally higher than any other real estate investor.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
6y
@Nick Wilkinson it's not the LTV that poses the greatest risk in RE, it is a lack of liquidity. By example, if I owned 5 properties at 100%LTV worth $1M but had $1M cash in the bank then my risk is extremely low. This example is an exaggeration to make a point: being well capitalized is more important than your %LTV.
Rental Property Investor · Olympia, WA · Member since 2014 · 777 posts · 744 votes
6y
@Nick Wilkinson Nurture that awesome relationship by honoring what you have and making sure your future deals are solid. Use it but don’t abuse it!
I’ve bought several deals that were 100% financed. My last had a debt coverage ratio of 1:1. My lender gave me 12 mo interest only to make it work.
So I’m not as concerned about equity going in if I know I can get rents to market quickly which will ultimately drive the value. I refinanced this deal in 12 months for double the value (Current debt coverage including my cash out is 1.7)
What I want is cashflow. That is what covers the expenses. Equity doesn’t mean anything until you sell or refinance. If I have adequate cashflow I’ll create a reserve that will cover the downturns, vacancy, cap ex, etc...
Rental Property Investor · Hendersonville, NC · Member since 2016 · 446 posts · 412 votes
6y
That is an awesome opportunity to take advantage of, but also could be dangerous if you are not careful. I compare to the BRRRR strategy - If I am about to refinance and I know I can only get 75-80% LTV and I need my capital back for the next deal, the bank protects me from myself, forcing me to have equity in the deal when I'm done to get my money back.
With 100% LTV, you can easily get in trouble. I see two modes of "defense" in buying LTRs - cash flow and equity. cash flow keeps me safe if rents drop, equity keeps me safe if the market drops. I don't want to be upside down on either.
I would decide based on your risk tolerance how much equity you want to have and be firm on your criteria...otherwise, you can basically BRRRR without having to wait a seasoning period and really accelerate your investing!
Rental Property Investor · Member since 2019 · 304 posts · 462 votes
6y
If you can get 100% LTV, go for it. There is only two caveats. What is your reserve position? If you have sufficient reserves to weather any storm, you should be good. Secondly, what is the term of your financing? If you have 30 year fixed loans, then you should be good as well. However, if you have to refi in the next 5 years, that adds a big risk element.
Investor · Boulder, CO · Member since 2016 · 1k+ posts · 1k+ votes
6y
@Nick Wilkinson Clarification on the loan... Which value is the lender lending 100% on? If you are buying properties below value, is the lender loaning you 100% of purchase OR are they lending on ARV when you have completed your repairs?
If you are getting 100% purchase + rehab, then this is a function of how much value you can create on the rehab. I like this! If they are lending 100% ARV, then this is a function of your cashflow and reserves being able to sustain any hiccups with the asset. I think COVID has taught most investors that they need FAR more reserves and cashflow than they once thought.
@Sudhanshu Singha If that is the case, then both of these rules would be satisfied. I purchased the property for $169k (monthly rent is $1700) and my cash flow is about $400/month (400*12=$4800 per year). As far as the loan goes, it is not a balloon loan but, unfortunately, it is only fixed for 5 years. I have spoken to the bank extensively about getting a fixed rate but they are unable to do it as of now. They did say that once I am able to get at least 5 properties we would be able to rap all of the mortgages together and do a long-term fixed rate.
@Brian G. Thanks for jumping in. Yes, this makes sense. So if I was purchasing these properties with 100% financing but buying them below market value, would you consider that to be liquidity? Then if something happened I still have the ability to sell at the true value without completely losing my shirt. Also, I would do some work to the property in order to force some appreciation.
@Curtis Bidwell Thanks for the advice. So what your saying is as long as I am buying deals below market value that I know I can increase the value of (through rent increases or physical improvements) I should keep utilizing the financing?
@Ryan Howell Thanks, Ryan. How I see it, if I am able to find a property for $150K (and finance 100% of the purchase) and I know it is worth $180k after putting in a little work and raising rents, I am basically already doing the BRRRR strategy. The only difference would be that I don't have the opportunity to recoup my investment for the repairs like I would in the BRRRR strategy, although it can be difficult to achieve that anyway. Additionally, by financing at the $150k as opposed to the $180k my payments would be lower and cash flow would be higher.
@Dennis Cosgrave Hello Dennis. My reserves are certainly something that I should focus on more. I can't say that I have enough reserves to buy 5 properties at 100% LTV in the next year. Moving forward this is something I will consider before purchasing a deal using 100% financing. The 2 loans I currently have are 30 years but only fixed for 5 years. They are not balloons so I don't have to worry about a refinance in 5 years but I will likely see my interest rate go up. Like I mentioned previously, the bank has also said once I get 5+ properties they would want to combine the loans to get a long term fixed rate and amortization.
@Whitney Hutten Hi Whitney, glad you hopped in. Currently, they are lending on 100% of the purchase price. I have not thought about the possibility to have them loan on the purchase and rehab. This would allow me to create some equity without any cash investment while still keeping my payments relatively low and cash flow high. Maybe this is something I will talk to them about. This is why I almost like this strategy better than the BRRRR because instead of buying cash, creating value, then doing a cash-out refinance at a higher value (loan payments are higher), I never have to put my money in and my payments remain lower because the financing was given at the lower property value.
If that is the case, then both of these rules would be satisfied. I purchased the property for $169k (monthly rent is $1700) and my cash flow is about $400/month (400*12=$4800 per year).
Are you calcing cash flow by subtracting your PITI from gross rent? Make sure you allocate some funds to capex, vacancies, etc. monthly. What financing terms these 100% mortgages are on?
Entrepreneurial Life Coach/Investor · La Costa, CA · Member since 2015 · 18 posts · 8 votes
6y
@Nick Wilkinson sorry for any ambiguity @Sudhanshu Singha did an excellent clarification. I would add that $283 should be per unit ($566). My father referred to the 2x rule as his comfort buffer, when he was initially analyzing a deal in the conventional 20% down arena. Can't lose sight of how one calculates their own risk tolerance. Investors vary in the amount they maintain as cash-at-hand to compensates for vacancies, repairs, pandemics, etc. If one has a large nest egg they can afford to be more aggressive. I tend to be tight with my prebuying calculations to keep stress down and so I don't have to 'feed' a property, especially now that I'm older and find myself more conservative and will less recovery time. Your banking arrangement is indeed fortunate! Be cautious however in that I see the US economy as an over-inflated balloon. I personally don't think doing much before the election is especially prudent. I think the election will have an impact of some sort on the economy. Some of the economic pundits are rattling about the 'coming crash' will make 2007-08 look like an old joke and you're old enough to know many homeowners and investors were flipped upside down during that plummet.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
6y
@Nick Wilkinson no, liquidity is *cash in the bank or some equivalent* that you can *easily/quickly access* (cd, stocks, money market acct., etc.). RE is not considered liquid because it generally takes some time to sell. However, if you own one or more properties with *considerable equity* that does add a measure of safety as you can sell or do a cash out refi if/when you get in a bind. You generally need at least 30 days to refi or sell. Properties that sell in less than 30 days are going to be sold by a motivated seller and sold at a discount. If you get in a bind, you don’t want to become a motivated seller. Liquidity = cash reserves
Rental Property Investor · Redondo Beach, CA · Member since 2015 · 10 posts · 7 votes
6y
@Nick Wilkinson
Amazing opportunity if you have reserves to last a recession. If you are cash tight it is high risk. If you have other liquid assets like stocks, IRA's, Insurance ect then it's a golden opportunity IMO assuming you have underwritten the deal, the area, and believe it will stay at least where it's at or appreciate and you can rent it easily. Check that the turnover time in your market is healthy hopefully less than 30 day (how long does it take to rent out a unit)