When does overleverage get you in trouble?

[Benjamin Sussman]

I’ve heard that people lose everything when they’re overleveraged.

When would you say people lose their shirt in RE investing, when debt to equity ratios are to high or when their debt to cash reserve ratios are too high? Or is it a mix of both, or something else?

Just wondering if owning 10 properties with 5% equity in all of them is a dangerous thing or if that sort of portfolio structure is fine as long as the investor has sufficient cash reserves?

[Allan Smith]

I've done a lot of research on historical successes and failures and over Leverage is a very common denominator. I have come to the conclusion that anyone who went bankrupt or even lost a considerable amount of their net worth did not have enough cash reserves to service their debts.

there are many ways that people run out of cash  so each time that is different, but ultimately it's the first few Dominos that start to fall because  they could not pay their creditors.  Yes, a bank may call a loan due  but that is more rare if you have fixed terms . 

I will even go as far as to state that  your Equity position or loan-to-value position on your rental property does not matter.  If you are  Leverage leveraged to 105%, where you owe more than the property is worth, most people would say that is over-leveraged. However, the argument I would make is that that does not matter as long as you have cash on the side. Who cares if it's underwater? As long as you can keep making payments and keep the property kept up to have tenants pay you, in a way you are still not over leveraged.

almost every story I've heard of someone losing their shirt from over-over Leverage involved a hunger for growth that got them off balance. They did not have cash to dig themselves out, their cash was invested in multiple things to help them grow faster.

most recently I read the bubble in the sun book about the Florida land speculation boom in the 1920s. The four richest men in in the state died poor because they could not stop themselves from buying more and more land to develop even while the boom was crashing around them. They could not stop spending money. They would have large developments underway that they had put all their cash in and would need more cash from other investors to finish the development but since the economy had crashed nobody wanted to invest, and their development became worth pennies on what they had put into it because it wasn't finished. They had spent all their cash so they stopped making payments, the bank comes calling, and pretty soon all their assets come Crashing Down.

it's good to grow fast but your growth rate should gradually slow down over time to make you sure you keep what you earned. These guys would invest every penny back into the machine but never actually stop and slow down to make a profit.