Margin of safety is one of Benjamin Graham’s, who famously mentored Warren Buffett, major principles in stock investing. It is a difference between the intrinsic value of a stock and its market price. Having a large margin of safety protects the investors from poor decisions and downturns in the market.
So what about real estate?
The idea of margin of safety can be applied to this field as well. Buying at a good price will create a margin of safety that can protect you from further downturns in the real estate market or buying the wrong house. However, is it more important to have a margin of safety on your purchasing price of the house or subsequent payments you have to make?
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Margin of Safety in Real Estate
In most cases, I think real estate is a highly leveraged investment from the start. Not many investment opportunities allow you to put 20% down, or even 5% down at times, to acquire an asset. While buying a house at a great price is good, but that does matter at all if you cannot afford the payments?
The margin of safety therefore, I believe, lies more important with your ability to make payments. You can buy a house at the wrong price, but you could easily afford the payments, then you are in a much safer position. Your house may fall in value, but you could still afford it.
With that in mind, I do not recommend investors to pile on real estate investments without at least a large margin of safety in their monthly income. As most people on BiggerPockets seem to think that I invest somewhat hazardly by taking on a lot of real estate debt and even investing in homes that provide me with negative cash flow, I do have cash flowing properties that offset my negative cash flowing ones. I have a healthy margin of safety in both cash reserves and monthly cash flow to take on what I take on.
So I’d like to emphasize again that leveraged investments can be dangerous if not done correctly. How comfortable you feel with your margin of safety that is entirely up to you. Even if you own a lot of cash flowing positive properties, several vacancies at once can hit you real hard on your ability to service the debt. So the key is to find your margin of safety before expanding.