How much should I leverage? My personal debt thermometer.

[Richard Low]

Hey everyone, I haven't been on BP in a while, but recently I got my license, sold a home for a friend, and rented my own residence on a lease-purchase.  All good experiences!

I'm a big Dave Ramsey fan, so I've been struggling with how much debt I personally want to take on in Real Estate.   Right now I'm a 4th yr dental student and over my career I want Buy and Hold RE to be one of my primary investment/retirement vehicles but I know that I can get there with leverage faster than by saving up all cash.  I'm trying to develop a thought process/system that allows myself to step back and measure my current risk from leverage and compare that to the buy and hold opportunities in the market.

Here's my system that combines some of Dave's basic advice with my own thoughts on when to buy/deleverage/wait and see:

1. 1. Start from a spot of personal financial security (Dave Ramsey baby steps 1-3)
   1. a. No personal debt (credit cards, car payments, student loans)
   2. b. 6 month emergency fund
   3. c. Properly insured for your circumstances (Term life ins, home/auto ins, disability, etc)

For me, I'm not going to buy any investment properties until I'm past step 1.  There are too many ups and downs, random expenses, and illiquid assets in RE investing to be struggling with personal finance.

1. 2. Measure exposure vs income
   1. a. Instead of a debt to income ratio, I want to know my:
   2. Total Income - (PITIs + Costs + Family Budget) = Cash-Flow  
   3. b. In my mind, my financial stability is going to depend on my ability to my ability to pay my debt service and costs while surviving a dip in income.
   1. - This ratio alone isn't going to determine my decision to buy a property or deleverage, but it's helpful to keep in mind as I move to the next steps.
   2. - One hypothetical is a 50% rule.  If I lost 50% of my personal + rental income (vacancies, disability, recession, etc.), could I service my debt, costs, and put food on the table?  How long could I do this past my 6 month emergency funds?  
   3. - In addition to having a personal 6 month emergency fund, I plan on having a 6 mo fund for my dental practice and each property.  This buffer might seem excessive, but for me it's essential to be able to sleep at night and ride out the bumps while leveraging myself.
2. 3. Analyze the market
   1. a. Is the RE market down, inflated, or ambiguous?
      1. - In a down market it's time to increase my rate of acquisitions and tolerance for debt.
      2. - In an inflated or ambiguous market, it's time to slow my rate of acquisitions, look at de-leveraging by selling less desirable properties and paying off my personal mortgage followed by my properties with the best long term rental prospects.
3. 4. Analyze the deals
   1. a. Ultimately, if the cash-flow is good enough and the financing available, I would probably pull the trigger on any truly good deal.  And even if I'm relatively de-leveraged and in a down market, the deal still has to make sense.
   2. b. If there are no good deals in my market, it's time to partner up with someone on BP in a good buy-and-hold market.

Putting all of this together is how I'll make the decision to buy or de-leverage.   I know this is a lot of hypotheticals and many people would call me over-cautious, but it seems like many people underestimate the risks of leverage and get burned in RE when the market turns and they're in too deep.  

Please share if you have some real-life examples or any input!  What measures / metrics / systems do you use to make sure you're not over-leveraged?

Thanks!