Leverage, debt, etc- how much are you comfortable with?

Question

Jim D. · Answer

In the scenario you described, you would be making much more money on the 10 properties. While the monthly cashflow is equal, with the 10 mortgaged properties you are also paying down principle on the loans every month. Secondly, assuming these properties are all equal in value, your appreciation over time is much higher the more properties you own. Assume each one is worth $100,000 and they appreciate 30% over 10 years. In the first scenario, you make $300,000. In the second, you make $120,000.

For anyone in the growth mode trying to maximize their total earnings, the critical question is this: by taking on $80,000 debt at 5% interest, can I invest that money elsewhere and earn more than 5% return? If so, you get to keep everything over 5%, so it makes sense to do it.

Smart investors do this when they are in growth mode. If they don't care so much about big growth anymore and just want to enjoy cashflow, that's often when people will pay down the debt and just let the cash ride in. Their total net worth won't grow as fast anymore, but they'll get to enjoy the cash, which for the majority of people is why they did it all in the first place.

Hope that helps.

Greg Scott · Answer

Rachel:

I will not answer your question but provide you the key to answer it yourself.

How much does the property cashflow?   Cashflow is key to success and survival in real estate.  You NEVER want to be forced to sell because of a problem.  That is when you lose.

Cashflow gives you money to live on and gives you the right to hang on to a property long-term even if you have unforeseen major repairs.

Many people like putting a huge amount down so they have high cashflow.  But, the more you put down, the slower your potential growth.

While the banks would never let you do this, what if you could borrow 125% of a homes value.  Would you?  What if I told you that after you borrowed ALL that money, it still cashflowed $1000 per month?  How fast could you grow, if you could buy 10 more houses just like that one?

Ron Flatt · Answer

@Rachel N-  4 properties cash flow $500 per month.   If someone moves out you just lost 1/4 of your income.  Also, 4 properties completely paid for, some one gets hurt they have lots to go after, no debt is on them, some folks see an easy paycheck, yes an umbrella policy will help some.  4 properties if in an appreciating market will grow slower than a larger number.

Now If you have leveraged those 4 paid for properties, you could have 16 properties-  if one goes vacant, the others will still make the mortgage and give you a check.  Some people will check, if the property is mortgaged they do not think they can get as much.  Here is the a comparison..

4 properties- valued at 40000 each  $160,000 equity        12 properties valued at $40,000 each is $480,000             Income --------------------------------------$2000 per month        Income..........................................................$6000 per month

24K/160k=   15% ROI before expenses.                               15 yr mortgage @ 6% mortgage $320K payment $2800.

(72K- $33,6K)  / 160K =  24% ROI before expenses

If they appreciate 3% per year                                              again the appreciate 3% per year

5 years later your 4 properties worth 46K each                 5 years later each property worth 46K X 12

total of $184K.                                                                          Total of 552K less debt of $300K=  $252K

This is oversimplified but you get the idea.

Some people over leverage- then something happens and they are in trouble.  However if you are buying good deals and keep them leveraged around below the 70% level and you manage properly you should be able to weather down turns.

You have to be comfortable with your debt load.  My twin sister wants all properties free and clear,  I like them carrying a little burden.  I do have some paid for, because I have begun to get portfolio loans instead of individual loans.  I pay down properties as per the schedule, but when I get 3 or 4 below the 60%, or if I have purchased an REO and had to pay cash   I bundle them together to pull out enough cash to make a better purchase.

There will be a time that I will start paying off completely, but I plan on continuing to build it out until I am 65, if I can.   These are my retirement, so I want a nice large safety net for my wife and myself.

Rachel N. · Answer

@James Marshall, that helps a lot. I was thinking more about total debt and had forgotten to consider the appreciation. And thanks for answering my question about when some people pay down the debt as well. Very useful information!

Rachel N. · Answer

@Greg Scott and @Ron Flatt, thank you for these insights.

I get that cashflow is crucial.  But if you had ten mortgages and ten properties cash flowing $200 per month, for a total of $2000, how is that different from owning outright four properties that cash flowed $500 per month? (since there is no mortgage). Are the ten properties better due to the tax benefits received from paying mortgage interest? What am I missing here?

I still am wondering, at what point do you decide to hold off acquiring more properties and pay down/pay off debt?  I read a lot on BP about people scaling up but not much about when anything gets paid off, so I just wanted to hear from  other investors about how they manage this.

Ron Flatt · Answer

@Greg Scott pointed out good points.

I have the perspective that the amount of mortgages do not bother me.  It is more along the line that it has to cashflow @ 80% occupancy.  When I only had one house and it was empty it hurt.  Now if one is vacant, I want to get it rented, but I can still cashflow easily.  There is some safety in numbers.

Make sure that you keep enough reserve to meet monthly challenges.  Then be able to make your debt load.

That is also the reason that I like smaller units, because you can get longer term fixed rates.  I hate ARM, which most of your commercial loans will be.  We are in low interest rates, which is below history's past.  The older folks on here will remember 20% mortgages, and the more common 9-11% rates.

Leverage, debt, etc- how much are you comfortable with?

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