Is leverage safe or risky?

[Chase A.]

Is it safer to own a property free and clear rather than leveraging? If the real estate market crashes again like it did in 2007-2008 aren't people who are leveraging at a risk to loose everything?

[Joe Villeneuve]

Originally posted by @Austin Fruechting:

It all depends on your definition of safe and risky. 

I would personally feel safer with 4 properties of which I own 25% of than I would with 1 free and clear. 

Assume a $100k properties at 1.4%.  So $1400 in rent, 50% expenses leaves $700.  Free and clear you have $700 of income.  With leverage say your payment is $400, so now you have $300 of income... but you own 4 of them for $1200 total of income.  Now what if the worst case scenario happens at one of the properties such as THIS HERE - 5 years of BS from squatters and no income. If you have 1 property you, it's not that you just don't have the $700 in income, you also have ongoing expenses like insurance, taxes, etc.  So lets say instead of +$700, now you're (-$300).  If you had 4 properties with a mortgage you would still be +$500 a month ($1200 - $300/month loss - $400 mortgage payment on that property).   

 Thank you for clearing up the confusion of the power of Leverage used with cash...instead of either one alone.

[David Faulkner]

Originally posted by @Craig Curelop:

@Chase A.- Is having debt more risky than not having debt? Sure. Is it as risky as everyone says it is? I would argue no. 

If you buy a good buy & hold deal that cash flows you from the start, then you should not have to worry too much about a market crash. Rents do not fluctuate nearly as much as home values do. If you can hold on and collect rent to service your debt you will be fine. 

Where people get in trouble is when they HAVE to sell. Put yourself in a position where you don't have to sell and the market won't impact you nearly as much. 

You should always be prepared for (but not necessarily worried about) a market crash ... in a market crash, sure rents may not go down, but they very well may stop if your tenant gets laid off, etc.. You can get the cash flow restarted if/when it stops, but that takes time and money ... cash flow alone won't do it. In such circumstances, quality of cash flow is every bit as important as the quantity, since quality cash flow will not stop as often (or perhaps not at all) in a down turn and if it ever does it is much easier to restart. From experience, the things you need, in the order that you'll need them, to survive a market crash are:

1)High quality cash flow, to ride out the dip ... but if that fails, you'll need ...

2)Cash reserves ... to carry the property while you turn the unit and get another tenant to get it cash flowing again ... but if that runs out, you'll need ...

3)Equity in order to sell without short selling or getting foreclosed on ...

Leverage affects all 3. Every buy and hold investor from time to time goes through 1 on a single unit and has to tap 2 (or 1 from other units), but hopefully never 3 unless it is an intentional strategic move rather than a last resort. I think of them as 3 concentric moats around your investment castle ... 1 moat is just too dangerous, at least for me.

[Robbie Taylor]

1. @Joe Villeneuve How is owning a property free and clear like hiding money under a mattress?  You making 100% of the value back every 7-8 years (depending on how good your deals were and the mkt you live in).  Money under a mattress never makes anything.  I totally get how leverage expands your real estate portfolio faster ect. and the 4 ways of making money and all that jazz, I just didn't understand that statement.    

[Joe Villeneuve]

Money under a mattress makes whatever the inflationary rate is applied to money itself.

Money in equity makes whatever inflationary appreciation rate is applied to it based on REI.

Neither has more than the power of 1.  Neither is invested...just deposited in a safe place.

Money outside of the mattress is moving, compounding, and reinventing itself.  It has the benefit of both duplicating itself by reinvesting, and by that same inflationary appreciation the mattress effect was giving it...just many, many more times.