Investor · Philadelphia, PA · Member since 2017 · 20 posts · 2 votes
I enjoy thinking of the many benefits of owning rental properties that are free and clear of debt. However, I recently began considering some of the potential disadvantages of debt-free rental properties, especially for a beginner real estate investor who can use the equity to build the business. I also considered the potential risk associated with debt-free rentals. I reasoned that all investments have risk, and, for a real estate investor, the risk increases as the amount invested increases. Thus, if a rental property is owned debt-free, than 100% of the equity is exposed in terms of lawsuits, for example. This kind of exposure exists even if the property is owned by an LLC. Of course, one way to mitigate the risk is to properly insure the property.
Any comments on my thoughts about risk? Is my thinking correct?
Can anyone propose other potential risks in owning debt-free rentals?
If you agree that there are risks associated with owning debt-free rentals, are the risks offset by the benefit of higher cash-flows?
Both are correct. One solution is a solution for both...refinance.
Another solution is a variation of the first solution...with a twist. Have one of your own companies put a lien for a value equal to 80-100% of the value of the property. If there was a lawsuit, and you lost it, and the property with it, the winner would have to pay off the lien first...which is you.
I didn't really address the "dead equity" issue as much as I wanted to in the post, but indeed this is one of the biggest problems or considerations. More comments on this point will be greatly appreciated.
Both are correct. One solution is a solution for both...refinance.
Another solution is a variation of the first solution...with a twist. Have one of your own companies put a lien for a value equal to 80-100% of the value of the property. If there was a lawsuit, and you lost it, and the property with it, the winner would have to pay off the lien first...which is you.
This second solution, the variation, is very creative and I will keep it in mind. Thanks.
My main struggle with the refinancing solution is that the current cash flow serves a critical purpose - to fund monthly expenses while starting full-time flipping/rehabbing. Even still, from a(n) investor/business-owner perspective, the math seems to favor refinancing.
In our area a large % under 1 M investors do not bother with a mortgage. Sellers prefer to sell to cash buyers. Cash flow does not work in west coast well unless one puts a large down payment. Another factor is fear of not getting tenants. With no mortgage one can survive a few months without able to find good tenant. Getting good tenants is never that easy. Those putting 20-30 % down find the rent collected is still several K in the hole so they try to put down as much as they have.
Today someone in Nashville blasted at others that her short term tenants brings 3X more than long term tenants. Good for her. That is often not the case here even outside of FB, Google, Apple headquarters. Most investors carry additional insurance to avoid a lawsuit. Airbnb can be a source of lawsuit. Landlords avoid dealing with lawyers and we have 2500 in one town over.
Steven - your comment about proper insurance is something I want to comment on. I think one unexpected benefit of maintaining debt on a property is that the bank is involved as a 'partner' on the endeavor. Re: insurance, if a devastating event impacts your property, you will have much greater efficiency resolving insurance claims if you have the bank involved to a high degree - the bank wants its interests served and protected and their army of lawyers will ensure that the insurance company doesn't stall. If you own free and clear the insurance company's incentive for helping you individually is minimal - you're last on their priority list. Maybe others have a different take?
I own 7 houses with 5 of them being free and clear. I don't like debt, but understand that some debt is necessary to keep growing. I like laying down to sleep at night knowing I own my little cash cows free and clear. But to each his/her own.
@Steven Jones this is the lowest risk exposure you can have on a rental house. Anything different that sent free begins to add risk. Some dislike all of the equity, however I love being so well covered and able to weather any new conditional change of a market like that. I sleep better having zero debt.
@Steven Jones
So far this thread hasn’t become a long drawn out and boring talk about “dead equity” like every other thread about this topic on BP. Let’s keep it that way.
Aside from that, inherently owning anything without debt is less risky than anything with debt. That goes for real estate, cars, etc. so to answer your original question, no it’s not that risky.