Would you rather be leveraged 80% w/ low reserves or 100% w/ more

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Would you rather be leveraged 80% w/ low reserves or 100% w/ more

Shiloh LundahlPro Member
Rental Property Investor · Gilbert, AZ · Member since 2016 · 3k+ posts · 4k+ votes

Thanks to everyone who shared their opinion about whether they would rather have 10k monthly cash flow or 1,000,000. 

To keep the thought process going, I’d like to know, given the 2 different options, would you rather have a property worth 200k leveraged at 80% (mortgage of 160k) and have 2k in reserves or have the property leveraged at 100% (mortgage of 200k) with 42k in reserves? And why?

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Ola Dantis
Multifamily Syndicator · Houston, TX · Member since 2016 · 1k+ posts · 2k+ votes
5y

@Shiloh Lundahl Oh this is an interesting one! I'd go with the 200k Mortgage with 42k in reserves!

Being over-leveraged is never a good thing, especially when lenders look at one's portfolio but this is probably the one time I will go for the 100% leverage option. 

Think about it: The mortgage will be paid monthly by the tenant, so that's covered by the tenant while I have a good chunk of cash to weather any storm that comes with the property. 

More money, more problems?!! Nah, not this time lol. 

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  • Ola Dantis
    Multifamily Syndicator · Houston, TX · Member since 2016 · 1k+ posts · 2k+ votes
    5y

    @Shiloh Lundahl Oh this is an interesting one! I'd go with the 200k Mortgage with 42k in reserves!

    Being over-leveraged is never a good thing, especially when lenders look at one's portfolio but this is probably the one time I will go for the 100% leverage option. 

    Think about it: The mortgage will be paid monthly by the tenant, so that's covered by the tenant while I have a good chunk of cash to weather any storm that comes with the property. 

    More money, more problems?!! Nah, not this time lol. 

    5Reply
  • Nathan GesnerBusiness Member
    Moderator
    Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
    5y

    I'd rather be 80% leveraged with $2,000 in reserves. First, people with skin in the game are more likely to make it work. Second, I don't know anyone that built a successful investment business with 100% leverage but I know quite a few that lost everything by over-leveraging.

    There should be a third option: 80% leverage and $20,000 in the bank.

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  • Kyle J.
    Rental Property Investor · Northern, CA · Member since 2012 · 5k+ posts · 5k+ votes
    5y

    Just based on the information provided, I would definitely choose being 100% leveraged with 42k cash in reserves.

    That way I'd have enough money to cover any unexpected repairs/CapEx costs that came up. I've had to do re-roofs, whole house re-pipes, and replace HVAC units (sometimes multiple of those things in a single year). No way $2k in reserves would be enough to cover that.

    Not to mention that during this pandemic the landlords who have ended up in the most trouble are the ones who didn’t have proper reserves going in and then ended up with tenants who didn’t/aren’t paying. It’d be hard to weather that storm if all your money is trapped in the house and lenders are scaling back their lending.

    Plus, if everything went right, I’d have more money for future investing. :)

    If you asked the question another way, “Would you rather have all your money trapped in your house, or have a large chunk readily available to you?” I think the answer to the question becomes more clear. 

    3Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    5y

    If a conventional  30yr fixed mortgage at today's rates, I'd do 100% if I could.

    if I'm going to got through the pain and costs of a mortgage, I'll get the largest one I can. 

    If assumptions are changed and leverage means non GSE debt, my answer changes.  Not all leverage is the same. 

    4Reply
  • Tucker Cummings
    Investor · Raleigh, NC · Member since 2019 · 433 posts · 743 votes
    5y

    That's a real humdinger. It seems like if you're 100% leveraged, cash flow would be really low so you'd have to hope rents go up in the future. On the other hand, if you're 100% leveraged, any cash flow you get is an infinite ROI. I think I'd take the 100% leveraged route, but do either rent by room or put a lease option on it (get a 10k option fee, then get a little premium on the rent) that way you can protect yourself further and get a little more cash.

    1Reply
  • Steve Morris
    Real Estate Broker · Portland, OR · Member since 2019 · 4k+ posts · 2k+ votes
    5y

    Depends.

    1Reply
  • Damaso Bautista
    Rental Property Investor · Hawthorne, CA · Member since 2018 · 655 posts · 900 votes
    5y

    If 100% leveraged was possible, that is what I would do. It has nothing to do with reserves.  It has to to with someone else, mainly the bank or whoever is holding the note taking all the risk. 

    This is the answer to all of the posters "how can I get into real estate using other peoples money" question.

    This is the holy grail for them...and everyone else who wants to play because there is nothing to lose.

    0Reply
  • Matt M.
    Specialist · Easton, PA · Member since 2018 · 1k+ posts · 2k+ votes
    5y

    @Shiloh Lundahl

    Neither. My mortgages are small and I have decent reserves. I don’t ever want to be in a bad position financially. I like equity and small mortgages, this way if I do run into a life issue and need money, I can dump one cheap and still walk away with a decent amount, without ruining my credit.

    1Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    5y
    Originally posted by @Tucker Cummings:
    if you're 100% leveraged, any cash flow you get is an infinite ROI. 

    When you order your appraisal, you pay for that up front. 

    Other pre-paids like interest beyond 30 days, taxes and insurance are due at closing from you. Same with settlement costs and potentially your agent.  

    Fees like loan origination, lenders title insurance, survey, flood cert, doc prep etc aren't free either, but can often be lumped into the loan.

    So not an infinite ROI. Loans aren't free or frictionless. They are slow and often painful to obtain.

    But I do like the way you think generating higher revenue and offering a LO👍

    3Reply
  • Tucker Cummings
    Investor · Raleigh, NC · Member since 2019 · 433 posts · 743 votes
    5y

    @Steve Vaughan silly of me, forgot to add in the closing costs, and the other costs of doing business. 

    2Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    5y
    Originally posted by @Tucker Cummings:

    @Steve Vaughan silly of me, forgot to add in the closing costs, and the other costs of doing business. 

    No worries.  Your creativity is much more important than forgetting  about 1-2% in forgotten costs👍

    3Reply
  • Todd Rasmussen
    Rental Property Investor · Clarksville, TN · Member since 2016 · 1k+ posts · 1k+ votes
    5y

    @Shiloh Lundahl

    42K in reserves is the least of two evils. Nowhere to go with only 2k in the bank. At least 42K buys you some time to develop an exit if needed.

    2Reply
  • Brian G.
    Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
    5y

    @Shiloh Lundahl 100% leverage with $42k in the bank for sure mainly because my current investment niche of choice is the VR biz and there is more than enough cashflow to service the debt and still return a great profit. In addition, the extra $40k is liquid in the event something major happens, ie rather than equity trapped in the property that is harder to access. And most importantly, $40k puts me closer to buying my next property!

    1Reply
  • Matt W.
    Rental Property Investor · Member since 2018 · 157 posts · 83 votes
    5y

    @Shiloh Lundahl

    I’d go 100% with $42k, because you can always pay a lump sum of $40k toward the principal, but it would be much harder/impossible to pull out that $40k if you needed cash.

    2Reply
  • Guido Nunez
    Investor · Los Angeles, CA · Member since 2019 · 38 posts · 22 votes
    5y

    @Shiloh Lundahl leverage with reserves. Hands down.

    0Reply
  • Zachary Beach
    Specialist · Los Angeles, CA · Member since 2018 · 291 posts · 231 votes
    5y

    @Shiloh Lundahl

    100% leverage assuming the property has positive cash flows at TRUE COSTS and is in a market with positive Potential going forward. If not than neither I’m not trying to get any bad deals haha. Sometimes no deal is the best deal.

    2Reply
  • John Transue
    Evans, GA · Member since 2018 · 13 posts · 9 votes
    5y

    In this case the reserves is important. In the case with the 160k mortgage, no where near enough reserves for the mortgage or maintenance and thousand things wrong. Future borrowing also hurt as not seeing 3-6 months expenses.

    200k mortgage still has ample reserves- pay some down if you want. In either case, probably not much cash flow so also depends on which is more important.

    I did similar when starting. As I was in the military, did VA loans and lived in property while assigned there and then rented them out after I moved. Essentially a leverage of 90-95% when I turned from primary to rental. Took a while for the balance to go down and rent to go up, but now the annual returns on my $1 down and maintenance throughout the years is pretty good....

    JT

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  • Kevin Hunter
    Rental Property Investor · Carlisle, PA · Member since 2013 · 1k+ posts · 543 votes
    5y

    @Shiloh Lundahl, what is option C, because I don't like either of those.  Too much leverage is a lot of risk, but the cash reserves protects against that (only to a certain degree).  Do I have the will power to leave that 42k in reserves?  Yes I do, but that is why I would never need 100% leverage to have appropriate reserves.  80% leverage is better in my opinion, but only 2K in reserves is a recipe for disaster.  One roof, one driveway, one HVAC and its gone.... In this particular scenario in which I HAVE to choose one, leverage with the reserves is it.  However, for the record, I choose option C, 65% leverage with 12K of reserves.....

    0Reply
  • Josiah Patrick Zebarth
    Rental Property Investor · Denver, CO · Member since 2019 · 76 posts · 70 votes
    5y

    @Shiloh Lundahl

    Good question, Shiloh

    Personally I’m going 100% leveraged with the 42k reserves.

    Here are my reasons: First, Having a large amount of reserve cash is more important to me than a lower monthly rate from having a mortgage on less money.

    And also, I’m young and can still take a lot of risk without tons of expenses and responsibilities holding me back, so getting a riskier 100% rate would be totally cool.

    Best, Josiah

    1Reply
  • John PowellPro Member
    Real Estate Agent · Kennesaw, GA · Member since 2015 · 307 posts · 153 votes
    5y

    @Shiloh Lundahl in my opinion there are two theoretical safe equity positions the safest is 0 leverage the second safest is 100% leverage (no skin in the game). So if the first is not an option then the second it is. That being said I put down 25% on properties that I am Buying now. Typically the 100% leverage options have hidden cost like fees and higher interest or PMI appraisals ect that you have to factor in.

    0Reply
  • Erik W.
    Real Estate Investor · Springfield, MO · Member since 2017 · 1k+ posts · 2k+ votes
    5y

    I am assuming that the $2K in reserves here is the ONLY SOURCE of cash the person would have if something goes wrong.  Nothing else they can tap into, period.  If that is correct, then anyone who says $2K in reserves hasn't ever had a roof replacement and a furnace go out in the same month.  You both can and will go under if you're not prepare to pay when the SHTF, and trust me...it does!

    This month so far I've had a weather head get ripped off one house on new years day's due to an ice storm bringing down large tree branches, two tenants move out unexpectedly leaving damages, and had to replace a furnace.  Guarantee you that is costing me a heckuva lot more than $2K.  I carry significant reserves, so these are non-issues.  I fix stuff, write checks, and am finding new tenants.  

    A lot of investors on this site poo-poo Dave Ramsey for being unsophisticated and not understanding leverage.  To that I say there are far more investors who never acknowledge that leverage is a doubled edged sword that cuts both ways, and there have been far more people who have lost everything because things didn't work out as rosy as their spreadsheet projections.  Having a significant rainy day / emergency fund is one of Ramey's key teachings because it gives you margin and peace when other people are freaking out.  Being able to make calm, rational decisions without being forced to liquidate can save your fortune, you marriage, and possibly your life.  And that's all worth something.

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  • Marcus Johnson
    Investor · Saint Paul, MN · Member since 2015 · 663 posts · 512 votes
    5y

    @Shiloh Lundahl

    Neither. I've learned in the past three decades that some thing major happens every 10 years, and I don't want to be at high risk by being overleveraged. Back in May 2020, I sold a very successful Airbnb business because it was just way too much work. I'd rather have more time in my life to spend with my family and kids. I also refinanced our rental in Minneapolis to a 15 year term at 2.75%and the cash flow on the property is excellent, and I want the renters to pay it off, I'm at 40% LTV. I will conservatively save money up to put a 25% down payment on the next property at a 15 year term and cash flow. This is my risk adversity.

    0Reply
  • David Pere
    Rental Property Investor · Springfield, MO · Member since 2016 · 1k+ posts · 890 votes
    5y

    Reserves, 100%

    Leverage doesn't matter at all if you can float all of your expenses. 

    Meanwhile, having 80% LTV basically means your $40k is useless to help in the event of a big expense.

    0Reply
  • Noah Chappell
    Investor · Minneapolis, MN · Member since 2016 · 254 posts · 228 votes
    5y

    100% financed and 42k, a no brainer. What if someone came up to you and asked if you wanted 100% control of an asset at 0 expense? Even if it broke even for years due to high debt payments, you'd still have appreciation, tax benefits, loan pay down. 

    Another angle to take is that anyone who's ever house hacked would agree with above, given they've essentially fully leveraged the assent, putting down 3.5% 

    If anything goes wrong, you could essentially just walk away.. 

    But of course it would predicate 100% on the asset, if it was a wrecked 4 plex built in 1860 with years of pending cap ex then no.. this is assuming it would at least break even. 

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