Lose Your Competitive Edge With Debt

Lose Your Competitive Edge With Debt

Real Estate Investor · Englewood, CO · Member since 2013 · 988 posts · 258 votes

Lose Your Competitive Edge With Debt

The more debt you have, the larger the loan on the property, the less competitive you are.

Is your goal to have as little money tied up in an investment property as possible? He who has the least debt is the most competitive.

Consider this:

In 2006, you buy a similar house next door to mine. We both own the properties as rental investments. I own mine free and clear. You aggressively sought a loan with the least down payment. Because the properties are the same, we both attract the same target market. Both houses rent for $1,000 per month.

Now, it is 2008. The target market is no willing or able to pay $1,000 per month. There are fewer people who qualify to rent your house because you rely on credit checks and I do not.

I lower my rental price to $850 per month and my property remains occupied. You cannot lower your rental price because you still have mortgage payments, overhead, and other debt payments. Your property will not cash flow below a rental payment of $1,000 per month. When you bought the house, you hoped to raise the rent the second year.

While my house has a tenant and is cash flowing at the $850, your house sits empty for more than a month. You are struggling to make the mortgage payment. You cannot find a buyer for the house. Finally, your savings are gone and you give up. The property goes into foreclosure, as many investors’ properties did 2008 and beyond.

Yes, my comments are completely contrary to the many books on the subject. They are based upon decades of experience and observation. My goal is to make deposits. I spend less time massaging numbers and never borrow money. It is very difficult to compete against me.

Just consider the options to determine what works best for you.

Your comments are welcomed and encouraged. We all learn from others ideas.

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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
13y
Originally posted by Tom Goans:

The more debt you have, the larger the loan on the property, the less competitive you are.

Is your goal to have as little money tied up in an investment property as possible? He who has the least debt is the most competitive.

Personally, I disagree with these statements...at least in some circumstances...

The first statement is mathematically incorrect. I can have more debt today than yesterday, but have it spread out across many more properties, each with a lower LTV. More overall debt, less overall risk.

In general, the absolute value of debt is meaningless without more information.

As for the second statement, I know some very competitive investors who are 100% debt laden. Many of the institutional investors who are buying up Atlanta (and other cities) right now are working off 100% debt and are tremendously competitive (if you define competitive to mean they have an acquisition advantage). While I'm not going to comment on their business models (they often make bad investments), they are extremely competitive because they have the ability to leverage large amounts of (borrowed) capital.

Donald Trump is another good example. Back in the early 90s at one point, he was $900M in personal debt. He borrowed about $3B at that time and was able to use it to dig himself out of debt and today he's doing okay for himself.

I'm not advocating large amounts of debt by any means (many people are bad with money and more debt equals more problems)...I'm just pointing out that blanket statements like "He who has the least debt is the most competitive" make absolutely no sense to me.

The bigger questions are how that debt affects your overall financial picture, how you use your debt, how you manage your debt, and what the risk associated with that debt is.

See this reply in the discussion

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  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    13y
    Originally posted by Tom Goans:

    The more debt you have, the larger the loan on the property, the less competitive you are.

    Is your goal to have as little money tied up in an investment property as possible? He who has the least debt is the most competitive.

    Personally, I disagree with these statements...at least in some circumstances...

    The first statement is mathematically incorrect. I can have more debt today than yesterday, but have it spread out across many more properties, each with a lower LTV. More overall debt, less overall risk.

    In general, the absolute value of debt is meaningless without more information.

    As for the second statement, I know some very competitive investors who are 100% debt laden. Many of the institutional investors who are buying up Atlanta (and other cities) right now are working off 100% debt and are tremendously competitive (if you define competitive to mean they have an acquisition advantage). While I'm not going to comment on their business models (they often make bad investments), they are extremely competitive because they have the ability to leverage large amounts of (borrowed) capital.

    Donald Trump is another good example. Back in the early 90s at one point, he was $900M in personal debt. He borrowed about $3B at that time and was able to use it to dig himself out of debt and today he's doing okay for himself.

    I'm not advocating large amounts of debt by any means (many people are bad with money and more debt equals more problems)...I'm just pointing out that blanket statements like "He who has the least debt is the most competitive" make absolutely no sense to me.

    The bigger questions are how that debt affects your overall financial picture, how you use your debt, how you manage your debt, and what the risk associated with that debt is.

  • Ontario, CA · Member since 2013 · 48 posts · 2 votes
    13y

    Lower your debt amount with possible solutions like timely saving and repayment in time. Loans on property will make you stressed and your creativity will hampered.

  • Investor · Cypress, TX · Member since 2013 · 403 posts · 59 votes
    13y

    And with most investors they don't really have a choice since not every has $100k-$300k to use to buy stuff outright.

  • Dawn AnastasiPro Member
    Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
    13y

    Tom Goans how many rental properties do you have? How many do you buy each year free and clear?

  • Abingdon, MD · Member since 2013 · 193 posts · 60 votes
    13y

    First the disclaimer, I'm a newb. But
    I agree with Tom 100%

    Originally posted by J Scott:

    The first statement is mathematically incorrect. I can have more debt today than yesterday, but have it spread out across many more properties, each with a lower LTV. More overall debt, less overall risk.

    Mathematically, the statement that you can have more debt and less risk is incorrect. Risk actually has a mathematically formulas attached to it, that I have not seen one Real Estate Investor ever even look into.

    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. Yes, you have reduced the risk associates with an individual house. Such as vacancy and repair. But having a loan introduces all new kinds of risks. A market variation is going to effect ALL the houses.

    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.

    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!

    Originally posted by J Scott:

    Donald Trump is another good example. Back in the early 90s at one point, he was $900M in personal debt. He borrowed about $3B at that time and was able to use it to dig himself out of debt and today he's doing okay for himself.

    You can't borrow your way out of debt. Trump hand many successful ventures that produced money for him. You could make the arguement that having the debt opened doors for him to get involved in those ventures, but the debt did not make him any money. This assumption is stating that Trump could not have made any succesful ventures had he operated debt free. Now I know Trump is a "good debt" individual, but had he changed his mind in the early 90's I'm sure he would of found a way to make some money without using debt.

    It boggles my mind how seasoned RE investors (and this is not in response to J Scott), but in general. But it boggles my mind how seasoned RE investors can advocate for debt, but then also talk about cash flow being the objective, and appreciation being "icing on the cake"

    If you assume some appreciation, that is when using debt mathematically KILLS debt free investing. But you never know what is going to happen, and if a RE investor finds himself in a situation where he needs to sell in a down market, then debt can bankrupt him.

    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.

  • Residential Real Estate Broker · Bremerton, WA · Member since 2013 · 494 posts · 142 votes
    13y

    I've given this a lot of thought and have been going through the numbers quite a bit lately. Only so much cash right now - but, I can buy up now. Pay down fast over the next few years.

    Not only is this a competitive point, as you stated, but low/no debt on REI is a hedge against unknown future circumstance...self-insurance. So is investing in different areas. I'm in a military area - if something happens to the military base, we're sunk. Fortunately we're one of the largest installations in the world and we have two unique features (a shipyard and nuclear subbase - one of only two or three in the U.S.). But nothing's for sure and RE is an investment when handled well. When handled poorly (thoughtlessly), it's gambling. I like to approach it like a game of chess. A checkmate would be great, but I think property taxes, surprise expenses and the unknown tenant prevent that. History does repeat itself, and to think there will always be people to rent is (who can afford to rent) is perhaps too optimistic. otoh, maybe there will be. Position your investments to protect them. I'm leaning towards fast to immediate payoff.

  • Abingdon, MD · Member since 2013 · 193 posts · 60 votes
    13y
    Originally posted by Ben Hughes:
    And with most investors they don't really have a choice since not every has $100k-$300k to use to buy stuff outright.

    I find myself in the same position. There are alternatives to debt.
    1) Start small, There are properties in every market well under $100k. I 'want' to invest in section 8 row homes, or mobile homes. But that is where I find myself and there is money in those types of properties. In my opinion a lot of investor write off these properties when they shouldn't.
    2) Find great deals and use a partner instead of debt. This definitely won't work for every deal. It's going to be hard to find a partner to invest $90k into your deal on a $100k house.
    3) Start with tax liens, notes or other investments that require smaller investments.

  • Investor · Arden, NC · Member since 2013 · 87 posts · 35 votes
    13y

    So where does this magic $100-300K come from? I haven't robbed any banks recently, so I don't have it. How the heck are you ever supposed to get started in investing if you don't take on some debt?

    EDIT:

    I see that Patrick posted while I was typing.

    Good options, but they all carry more risk than a good rental, and still require a substantial amount of cash.

  • Eric TaitPro Member
    Investor · Houston, TX · Member since 2013 · 314 posts · 146 votes
    13y

    Opportunities are unlimited capital is not, debt allows one more opportunities to be a part of. No one can mitigate all risk, but I would rather have a chance at being wealthy earlier in life using debt (its what the FED does, and no matter what you think about it, or how you think it is going to end, if they flame out, I could care less if you own you property free and clear we are all in deep doo doo).
    If you use debt to no more than 70-75% LTV, in todays market, we could still have a correction and you would have an equity cushion.
    But since the whole reason for investing in real estate is leverage (at least the best reason in my opinion), and cash flow. I am not worried about the underlying value of the asset if I have fixed rate 30 year debt.
    Now let's look at cash flows on rentals during the worst real estate market in US history, the cash flows went UP, I am making more money now and my ROI is WAY up, which allow me to do more deals and make more cash flow. It's an inverse relationship, if rents are going down (remember I am in Houston, good economy) it's because people are going to be buying houses again, which inflates the value of the holdings so we can sell if we need. If prices crash, more renters, higher cash flow, and there is always Section 8 to fall back on.
    But worst case scenario, I get foreclosed on because the economy went to pot, so will alot of others and I will be back.

  • Abingdon, MD · Member since 2013 · 193 posts · 60 votes
    13y
    Originally posted by Matt Rothwell:

    Good options, but they all carry more risk than a good rental, and still require a substantial amount of cash.

    Huh?

    I just bought a tax lien for $500. Well technically I have a partner, so I spent $250.

  • Residential Real Estate Broker · Bremerton, WA · Member since 2013 · 494 posts · 142 votes
    13y

    Matt Rothwell and Patrick G. To pay down my rentals, one of the plans I'm entertaining is saving all my profit from my rentals until there is enough to pay off the mortgage. I'm not going to pay "extra" every month, I want the cash in case it's needed for an unexpected CapEx. But, 5-10 yrs. down the line, there will be enough to pay some mtgs. off thx to my tenants. I can continue to buy additional properties with my own income.

  • Abingdon, MD · Member since 2013 · 193 posts · 60 votes
    13y
    Originally posted by Stephanie Dupuis:
    Matt Rothwell and Patrick G. To pay down my rentals, one of the plans I'm entertaining is saving all my profit from my rentals until there is enough to pay off the mortgage. I'm not going to pay "extra" every month, I want the cash in case it's needed for an unexpected CapEx. But, 5-10 yrs. down the line, there will be enough to pay some mtgs. off thx to my tenants. I can continue to buy additional properties with my own income.

    That's a good one. One thing we didn't discuss is the fact that having extra money set aside, offsets risk. Any risk, vacancy, damage, market risk, you name it. So if you add a little risk by having debt, you offset it by having some money.

  • Longview, TX · Member since 2012 · 368 posts · 131 votes
    13y

    The investor who puts 100% capital into the asset is more competitive against an investor who puts 20% in, no doubt. Is the 100% investor competitive when the 20% investor goes to buy investments, 2, 3, 4, and 5? If the time period is short and the 100% investor doesn't have a money tree in his backyard, it would appear to be no. Is a $5000 monthly income stream on $500K of leveraged property any better or worse than $1000 monthly income on free and clear? If the market turns down, sign me up for the latter; if it turns up, sign me up for the former.

    The "competitiveness" statement is made under a very specific set of investment and market conditions which favor the OP's point of reference. To me, risk management is more than just a matter of having or not having a mortgage.

  • Specialist · Memphis, TN · Member since 2012 · 1k+ posts · 1k+ votes
    13y

    Tom Goans having lived through the last 10 years as an investor in 3 countries I think you are 100% right. What many replies are missing is your main point which was if your income potential suffers you can ride it out much more easily than someone leveraged.
    I spent years trying to hang on to leveraged property so as to not crystallize my losses. The stress and eventual failure anyway I would not wish on my worst enemy.

    I invest in Memphis and occasionally borrow money for 30 to 90 days. Other than that I would never personally have a lot of debt ever again and this whole largely American idea of good debt has already proven itself to be a fallacy in the last few years.
    Make money and then put it to work earning you money. Get out of debt and stay out!!

  • Ned CareyPro Member
    Moderator
    Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes
    13y

    Virtually all discussions of debt put forth by those advocating no debt fail to include a key factor. The amount of debt vs equity or income. I can borrow at over 100% LTV and have less risk than someone who borrows @75%.

    How is that possible? Because I am buying a property that will rent for $1200 a month for $20K and Someone else could buy a property that rents for $1200 for $120K. Who has more risk, me who has borrowed $30K (150% LTV) with $1200 a month income or the investor who borrows $90K (75% LTV) with $1200 month income. I could do three deals for a total of $90K borrowed and still have less risk than the other investor.

    Of course borrowing to the max that lenders will give you is risky. Used conservatively by; borrowing at low LTVs, Buying dramatically below market, keeping low Debt to income ratios, and having cash reserves, all can mitigate most of the risk. - Ned

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    13y
    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... :-)

  • Ned CareyPro Member
    Moderator
    Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes
    13y
    Originally posted by J Scott:

    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.

    Well put J Scott and that was the point I was trying to make.

    Actually if owned in an LLC your liability goes up. If you have little equity and get sued they can only take the little equity the LLC has. If your properties are free and clear you have much more equity to take.

    As in many things in real estate, there are a lot of issues to consider and evaluate. - Ned

  • Investor · Arden, NC · Member since 2013 · 87 posts · 35 votes
    13y
    Originally posted by Patrick G.:
    Originally posted by Matt Rothwell:

    Good options, but they all carry more risk than a good rental, and still require a substantial amount of cash.

    Huh?

    I just bought a tax lien for $500. Well technically I have a partner, so I spent $250.

    What kind of monthly cashflow are you seeing from that tax lien? If I'm not going to have any monthly cashflow, I'd rather buy stocks and ETFs, at least then I can get my money out if I need it.

  • Roy N.Pro Member
    Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
    13y
    Originally posted by Patrick G.:
    There are properties in every market well under $100k.

    If only that were true Patrick. Around here, the only property - other than vacant land - for sale under $100K is either a dilapidated 2-bdrm "shack" on the outskirts of town (and it's listed at 89K) or an old house in a very rural setting.

    Even bank repo "Johnny Canuck" house {65 - 70 yr old, 1.5 story 2-3 bdrm houses built by/for returning soldiers after WWII} full of deferred maintenance are going for $135K {two in the last two weeks}.

    The 30-40K houses and 89-100K 4-plexes you read about on Bigger Pockets is what is enticing investors here to look south (sometimes even further south than the U.S.A).

    If I had enough cash-on-hand to be purchasing multiple 4 - 6 unit properties outright (at 250-500K a pop), I'd be in the private lending business and not the buy-and-hold business.

  • Dion DePaoliPro Member
    Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
    13y

    I like this discussion.

    I think an added point is the what we perceive as 'risk'. Is said risk really different for an asset when there is debt opposed to simply equity. Materially, no. The risk is lack of making a profit in either scenario. So the concept does not follow that putting debt on a property is a barrier to profit. It is not. Debt is a tool to make more profit as a percent of the actual cost basis of an asset.

    I agree with J. Scott, if debt was bad, we wouldn't have so much. So, I am not sure the statement can be found to be true. It can however speak to the idea of one less bill to pay from the cash from any given asset, if that is a problem. Certainly, over leverage is a bad thing but I don't think that is the debate.

    In an example where a house costs $100k and one person buys with straight equity and one with debt and equity (20/80) the debt stack will out run the equity stack. While the deal with debt stacked into the structure will distribute less in true dollars, the percentage or return can be greater. I invested less money, so I need less money to make a good return. Less money invested means a short time to pay the money back. Also means return can happen faster, so in that sense the equity investor loose out as a result of time value of money having to wait longer to get all of their capital back.

    Further, the argument seems to ignore the big elephant in the room. What is the cost of equity. This is a big deal and should not be overlooked. If debt costs 5% and equity costs 10%, which is better? Certainly, less expensive is better. This is the majority use concept of debt, frankly.

    Taking $100k and spreading it into 5 assets diversifies your risk of non-performance. One asset failing to cash flow or deliver any gain on sale is mitigated since you now have 5 assets which could deliver said cash. I don't think that is headed down a proper point to this discussion as it really deals with diversified versus not diversified risks. I think the question is, can the equity investor really outrun the guy with debt?

    No, not really. The debt investor only need to return $20k. The equity investor has to return the $100k. If we assume that all things are equal in the property including gross rents and costs, both deals get the same net cash number prior to debt service. Let's assume it is simply an additional $200 per period. So the equity investor gets $650 in free cash flow and the debt investor gets $220 in free cash flow. The debt investor only needs 68 periods to return the equity money. The equity investor needs 100 periods. So clearly, the debt stack can outrun the equity returning money faster and in many cases at a higher rate than equity.

    It seems to be that at the center of the OP, the real idea is since I am all equity, I simply have less headaches. That presupposes any investor using debt sees debt as some type of burden. It is really not a burden, it is really cheaper capital. Cheaper capital means higher returns.

    Adding debt does not change the risk in the asset at all. It changes how you paid and who you have to pay back for the asset. The risk is self contained in the asset itself. Either the asset has positive cash flow or it does not. In that sense, both investors are on equal footing in proration. A non-cash flowing asset for the equity investor means a zero the same as a non-cash flowing asset for the debt guy. Difference is how far from zero are they each? It is true, the equity investor can absorb more of a reduction than that of the debt guy but adversely and in proration to the amount invested, the debt guy doesn't need to make as much. A zero cash flow for the equity guy is a $100k loss and for the debt guy a $20k loss. So in that idea, the amount of loss for the equity is actually higher. The equity guy would have to recover $80k from the asset to even catch up to the debt guy.

    If we further reduce the free cash flow and keeping things equal in concept. The debt guy can go all the way down to around $110 per period and still outrun the equity guy. This would mean the equity guy gets $540 in free cash flow. It is going to be a similar return time of around 100 periods, if they both have the same ROR target.

    So moral of the story, I don't think the statement that an all equity investor is more competitive at all. In fact, I could probably make the argument the state is actually false. Since stacking equity with debt reduces the cost of capital allowing for higher returns.

  • Dallas, TX · Member since 2011 · 308 posts · 59 votes
    13y
    Originally posted by Patrick G.:
    It boggles my mind how seasoned RE investors (and this is not in response to J Scott), but in general. But it boggles my mind how seasoned RE investors can advocate for debt, but then also talk about cash flow being the objective, and appreciation being "icing on the cake"

    I think you have this wrong. Taking on debt will ALWAYS lower your cashflow. The reason to do it is to maximize your COCR, which will always be higher if debt is taken on smartly.

  • Abingdon, MD · Member since 2013 · 193 posts · 60 votes
    13y
    Originally posted by J Scott:
    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?

    With the above example I misunderstood your original statement. Clearly, Deal #2 has less risk because it has more equity.
    What I was going for would more accurately read “Mathematically you cannot have more debt as a percentage and less risk”
    Which directly goes against Ned Carey’s Post.
    However Ned, I think what your post is saying, is that you are getting extremely good deals. You are going into deals that have a really high ROI. Which I don't feel is apples to apples with the idea that statement that less debt is less risk. If you look at an individual deal you have done and compare doing that deal with and without debt, the deal without debt carries less risk. It may produce slightly less cashflow, but that is the cost of the risk. You're deals are just really good deals, because of your experience, relationships and other factors.

    Originally posted by J Scott:

    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?

    I agree 100%! Insurance companies are really the leaders in calculating risk (not really calculated, but data mined). I don't understand why you say that insurance companies don't charge higher rates for higher loans. They do! One of those forms of insurance is PMI (or MIP). If you don't have 20% down, an insurance company steps in and protects the lender from your default. The less your down payment, the higher your PMI. (More risk)

    Currently, I believe PMI is at around $100 per month per $100k borrowed. At least for someone around my credit level in my neck of the woods. So I thought about this in relation to my real estate investing. What if I ‘self-insured' of sorts and paid myself the $100 per month on a $100k REI? How does that effect cash flow? Apples to apples if I had 100k to invest fully in one property or invest $20k in five different $100k properties, if I paid myself PMI to ‘self-insure', Which scenario comes out better? Like you keep saying, it's a lot of variables to really nail down.

    But if an investor approaches every deal with the mindset of “How much would insurance cost to insure me against this deal going bad”, then it would be a good start and weighing the risk of debt into actual dollar figure of the deal.

    Touché. You are 100% right about that. Some times us ‘debt free’ thinking talk as if we have eliminated all risk, when in reality, we have only taken it down to a level that we feel comfortable with. Minimized. But generally more risk equals higher rewards potential, and for someone with a higher risk tolerance, the risk associated debt would still be within their comfort level.

    Originally posted by J Scott:

    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).

    We disagree on this one. The debt didn’t get Trump out of debt. Trump got himself out of debt. He happened to have used debt. I speculate he would be fine had he not used debt. The world will never know.

    Originally posted by J Scott:

    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.

    True, but it’s fun to discuss. If we were to attempt to work out all the details, it wouldn’t be much fun to discuss.

    Originally posted by J Scott:
    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... :-)

    I certainly wasn’t trying to high jack the thread, and I apologize to Tom if I did. Tom’s example was a borrowing versus debt free example, so I felt it was okay to contribute to the discussion as I did. I am not really qualified to elaborate on actual competitiveness of debt free versus leveraged, so I will leave that to the more experienced Investors. I honestly don’t think much about the competitiveness of investing. It is a competitive field, but for me it’s really just about doing the best I can do, with what I have.

  • Abingdon, MD · Member since 2013 · 193 posts · 60 votes
    13y
    Originally posted by Matt Rothwell:
    Originally posted by Patrick G.:
    Originally posted by Matt Rothwell:

    Good options, but they all carry more risk than a good rental, and still require a substantial amount of cash.

    Huh?

    I just bought a tax lien for $500. Well technically I have a partner, so I spent $250.

    What kind of monthly cashflow are you seeing from that tax lien? If I'm not going to have any monthly cashflow, I'd rather buy stocks and ETFs, at least then I can get my money out if I need it.

    It is 18% annually in Maryland. You do lose the ability to access the money.

  • Abingdon, MD · Member since 2013 · 193 posts · 60 votes
    13y
    Originally posted by Bryce Y.:
    Originally posted by Patrick G.:
    It boggles my mind how seasoned RE investors (and this is not in response to J Scott), but in general. But it boggles my mind how seasoned RE investors can advocate for debt, but then also talk about cash flow being the objective, and appreciation being "icing on the cake"

    I think you have this wrong. Taking on debt will ALWAYS lower your cashflow. The reason to do it is to maximize your COCR, which will always be higher if debt is taken on smartly.

    Yes, I understand that taking on debt may increase your Cash on Cash Return. (A little) My arguement is that it's not worth it becuase it increases risk.

    What I was trying to say in the sentence above was the increase in COCR is small, very small, especially if you look at the advantages of debt being used in an appreciating market. I am sure we are all familiar with the concept,
    If you invest $10k into a $100k house and in 10 years that house is worth $200k, then you can sell it, pay off the $90k loan and have $110k. The potential to make money is insanely high.

    For me, right now, I am 100% against debt. However in the future, after I am established. I may take up some leverage. I won't take on leverage for the COCR. I will take on leverage so I can earn equity on other peoples money.

  • Dion DePaoliPro Member
    Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
    13y

    I just want to go back one more time and hammer home my point related to the competitiveness of a debt investor versus an equity investor. Here is just another way to look at it, I suppose.

    Assume:

    Debt and Equity guy want to make a 10% annual return.
    Property is $100k
    Debt stacked 80/20

    Equity investor needs $833.33 per period
    Debt investor needs $166.67
    With debt Service, Debt investor needs $597

    Clearly, the debt guy is out running the equity guy here.

    So the idea, that the equity guy can take less cash flow and be more competitive really only boils down to a simpler idea. The equity guy can simply take less cash flow because he is the only guy he needs to pay back. As such, the equity guy can be willing to take 1% or 0% in return.

    While the debt guy has a floor of minimal acceptable cash flow. That floor, would be the debt level. So if the debt is 5%, then the debt guy can't drop below that since then proportionately the debt guy would have to inject more capital into the deal for debt service.

    I don't think that is a competitive edge as much as it is simply the capacity to take less of a return. That concept, I would agree, an all equity investor can run to zero in a better fashion than a debt guy. The debt guy can't really get to zero. If the equity guy get's to 1%, he still has the asset. If the debt guy get's to 1%, he either recapitalizes the debt service or losses the investment.

    Does that mean a competitive edge? I don't think so unless the competition is a challenge on who can tolerate more of a loss and more of a headache, which I don't think is the object of investing.

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