Is it better to be over-leveraged or under-leveraged?

[Account Closed]

Hypothetically, would you be more comfortable being over-leveraged or under-leveraged in your investments? And what's your reasoning?

I'm thinking the most optimal position would be to have a lot of leverage, but with enough cash reserves so I can choose to bail myself out in case of emergency. I don't think I'd want to shovel my hard earned money into equity that may or may not lose value.

All thoughts and opinions are welcome! I'm just brainstorming over here.

[Dan Brewer]

Willa - 

I have two perspectives on leverage.  

1. Just like the stock market, leverage is good (and wise) when prices are rising.  It's like buying stocks on margin. Once you are satisfied with the increase in stock price, you sell, pay off the margin, and take your profits.  When stock prices are falling, leverage is bad.  Now you purchased on margin, anticipating higher prices, and the opposite occured.  Now you are losing money. And leverage only magnifies the losses (just as it magnifies the gains when prices are rising).  the key is to know when to get in, and when to get out. 

@Franklin Romine made a key point - what is your strategy?   Based on what I can gleen from your posts, sounds like you are a buy-and-hold investor.  Assuming this is true, then the declsion to use leverage changes.  You are not so much concerned about how the pricing of homes fluctuates.  You are more concerned about the cost of the funding, and (hopefully) the rate is fixed.  If the rate is not fixed, now its starting to get dicey.  Nobody thought interest rates in 1980 would hit 18%+. But they did.  Any rates that were indexed went through the roof.  Nobody thought what happened in 2007 would happen.  But it did.  The crash of 1980 hurt both fix-and-flip investors as well as buy-and-hold investors.  The 2007 crash primarily hurt the fix-and-flip investors.  Buy-and-hold investors actually saw interest rates drop over time, although getting loans on new acquisitions was pretty much impossible.  And when the markets crash like they did on 1980 and 2007, rental demand GOES UP.  Rental rates remain stable or increase.  However, rent volatility increases as well.  Renters lose jobs.  Their savings and income gets stretched.   So kind of a double edged sword.  

2. I have been on the capital side of the business for 21 years now, and have seen a lot.  My philosophy is that in general, the fix and flip market is fully matured. There is lots of competition for deals.  Supply is thin.  Prices are higher.  And the most forboding indicator - its taking longer to complete the flips.  That is a absolute sure-fire sign that its time to reduce risk.  Not everywhere, not with everyone.  But in general, its reality.  I think Atlanta is one of the bright spots.  I am sure there are a few other great markets as well.  But most are fully matured.   Therefore, those who leverage in the current fix-and-flip market are taking greater risk.  The lenders too.  

On the buy-and-hold side, leverage is OK (I emphasize OK) as long as you have low, fixed rates, your property is a mid-rental rate property in a highly desireable area, and you are not so overleveraged that it will be tough to cash flow with some hiccups in the economy.  And most of all, you still maintain very high cash reserves to help you weather any storm.  

I saw a lot of investors crash in 2007.  Just about anybody who was leveraged suffered.  That is why today I err on the side of caution.  As Warren Greenspan stated, irrational exuberance is a bad thing.