Why take less leverage?

[Michael K.]

When acquiring a property, is there any benefit to taking out less leverage on a property? Let's say you finance only 50% versus 70% of the acquisition price.

Why would anyone pay for a property with all cash or more cash than is necessary to achieve positive cash flow after debt service? After all, isn't leverage a major part of why real estate often proves to be so lucrative?

[Bryan Hancock]

The simple answer is that it doesn't make sense to put down any more than you need to obtain positive operating leverage. From a ROE standpoint you are better off being leveraged as long as you are getting positive cash flow.

However, as you acquire more properties the price of your debt will be higher if you are leveraged more. In theory, the higher debt pricing would cause there to be an optimal leverage point. In practice, I see lenders doing pretty much the same types of debt pricing even if your leverage ratio for your portfolio is high.

A frothier leverage ratio for your portfolio will cause you to start getting denied for loans later on, which means that additional leverage for your first few purchases has an opportunity cost.

Leverage cuts both ways too. Think of it as stepping on the accelerator if you increase your leverage. You will get where you want to go faster if you drive skillfully, but you will also crash and burn harder if you hit some road bumps. Less leverage provides MORE margin of safety in case things don't go as planned.