How did you get crushed in 2008 due to overleverage ?

[Francisco Milan]

Hello

I have heard this over and over again from previous investors that lost it all in 2008 and I am starting to hear it right now again. How do these individuats loose everything due to being overleveraged?

[Nathan Gesner]

Quote from @Francisco Milan:

Hello

I have heard this over and over again from previous investors that lost it all in 2008 and I am starting to hear it right now again. How do these individuats loose everything due to being overleveraged?

Because they are over-leveraged. This means - unlike Bill or Joe - they bought property with 80% - 100% financing and the rent payment barely covered the mortgage, taxes, and insurance. They had nothing left over for other expenses like vacancy, maintenance, or capex. If a property is losing $100 a month and then the property value drops from $200,000 to $160,000 in less than a year, people panic and sell to cut their losses.

Why did some lose?

1. They didn't actually do the hard work and save up. As property values rose in the crazy market, people learned they had a lot of equity in their primary home. They thought they were wealthy and that real estate only goes up, so they cashed out their equity and bought investment property. Now they are leveraged on the investment and on their primary home.

2. They had no idea how to buy smart. They heard that real estate is a great investment, so they bought something without crunching the numbers, researching the location, etc.

3. After buying the property, they failed to learn how to manage it. They get bad tenants that don't pay rent or trash the property, they start bleeding money, and suddenly their golden egg turns out to be a lead weight they can't wait to unload.

Look at the recent market. The market went crazy and prices skyrocketed. A lot of homeowners suddenly realized they had a lot of equity in their primary home. They also saw a video that said they could buy a short-term rental in the Smokies or Florida and make $150,000 a year. Who wouldn't want that??? They cashed out their equity (bringing their mortgage payment higher than they want, but they can swing it with all the profit they'll be making) and they buy something for top dollar in a market they are unfamiliar with during a peak season. Eventually, they will learn that the property nets 1/3 what the YouTube guru told them it would, it's more work than they thought, and the shine will start to wear off. 

If the market turns, people in this situation will drop that property for a loss and run with their tail tucked just to stop the bleeding. Tens of thousands of new investors will follow suit. 

What could cause that panic? An economic depression. Prices rose astronomically and they could drop quite a ways to more reasonable values. War with China. Another COVID-like farce. There are many unknowns. Wise people flourish while the foolish lose.