Originally posted by Patrick G.:
Mathematically, the statement that you can have more debt and less risk is incorrect.
Really? Are you sure about that?
Which of the following situations has more debt? Which of the following has more risk (in your opinion):
1. $100,000 loan on a property worth $50K.
2. $100,001 loan on a property worth $1M?
Certainly, the debt is greater in #2.
And I find it hard to argue that the risk isn't much reduced in #2 as well.
In this situation, more debt, but less risk.
Do you disagree?
I understand the "Idea" of spreading 100k between 5 houses, so all my eggs are not in one basket. Now I'm diversified so I have less risk. That is mathematically wrong.
Actually, from a mathematical standpoint, risk and diversification are unrelated (orthogonal).
I am an engineer, and I have taken a few crazy math courses, but I am not going to pretend I can calculate out all the risks associated with having an mortgage and put a dollar amount on it. But I just want to say it is there.
I'm an engineer too. And I've taken all the same math courses. You (and I) don't have to calculate it. That's why we have actuaries. Though they don't calculate it either. They look at large samples and impute it. They then assign a risk factor in the form of a premium or interest rate.
If it were true that more debt necessarily means more risk, then lenders and insurance companies would necessarily charge higher premiums and/or higher rates for larger loans. But they don't.
So, either the statement that "more debt necessarily means more risk" is wrong, or banks and insurances companies don't understand risk. Which one do you think it is?
If you have an investment property that is Debt free, think about the risks involved in that property. It is almost zero! You need to pay taxes and you need insurance incase of fire, that's it. No debt free real estate investors ever go bankrupt. Tom will never get foreclosed on! How awesome is that!
This is a tangent to the discussion above (see my comment three paragraphs below this), but using that line or reasoning, shouldn't you be advocating for not buying property at all? Then your risk goes from "almost zero" to zero.
When you own property debt free, you can still lose your house if you don't pay taxes. But, if you don't own a house, you can't lose it at all! How awesome is that!
By that logic, it sounds like not owning any property is the panacea of real estate investing... :-)
Regardless, as I say above, this is a tangent to the discussion the OP started. In the real world, zero debt is an asymptotic case -- one penny of debt is infinitely more risky than no debt. So, discussing "no debt vs debt" in a discussion about "more debt is worse than less debt" is just a red herring.
In a strictly literal sense, that is true. But, in the real world, that's completely false. Donald Trump is living proof. Unless you don't believe he was really in debt or don't believe he's now out of debt. Otherwise, it's pretty hard to argue that he didn't borrow his way out of debt (again, with a couple real world steps in there as well).
Again, I'm not advocating lots of debt. I'm not necessarily advocating any debt.
All I'm saying is that the original post in this thread is overly simplistic, as are many of the comments above. If you look at debt as a scalar and think you and infer anything about risk, you don't have a very good understanding of some basic investing concepts.
I realize I'm not going to change anyone's mind on this forum, but I appreciate all the good conversations about debt-free investing versus borrowing. For me it solidifies my plans to have at least the first three properties free and clear before even considering a mortgage.
The OP wasn't discussing (as far as I could tell) debt-free investing versus borrowing. And he certainly wasn't talking about risk -- he was discussing competitiveness.
If his goal was to discuss debt-free investing versus borrowing, he probably should have said that... :-)