Why You Shouldn't Leverage When Investing In Turnkey Rentals
Engelo RumoraBusiness Member
Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votesWhy You Shouldn't Leverage When Investing In Turnkey Rentals
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Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
8y@Engelo Rumora
I'm going to disagree with almost the entirely of your post. The key to leverage is moderate leverage. Don't buy everything at 95 LTV. Do 25-40 percent down payments.
The chances we see another GFC in our lifetime is unlikely. Keep in mind the events leading up to that recession took 30-40 years to materialize. (Thanks big short). So if history repeats itself we have another 20-30 years.
As far buying turnkey properties in cash, I think that’s also a bad idea. You likely won’t get an appraisal and you’ll likely overpay by a lot. When you finance the bank (with all that pesky paperwork) has a lot of build in things (like an appraisal) that limits your/their risk. Use high downpayments and your risk is even less.
Almost any turnkey company that only accepts cash purchases, throws off huge red flags in my mind as it likely means you’ll be overpaying by a lot. I know there are arguments to both sides of every coin but with the whole Morris invest debacle (who only accepted cash buys) it’s gonna be hard to override my opinion on this, especially if you’re dealing in sub 50k purchases
82 Replies
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Luke Sass:
@Engelo Rumora Engelo, Wouldn’t you say that real estate is the best chance for an average joe to take a shot. I like real estate because you win on so many levels. We’ve all heard the IDEAL metaphor.I-income from the rents D- Depreciation (ensures we pay little to no tax on the income) E-Equity as your renters pay off your loan A-appreciation in the right market your property should appreciate over time L-Leverage( the ability to gain a return on 3-5 times of my original investment)
Using leverage gives you the opportunity to diversify, instead of all my cash in one property I can spread that cash out on 3-5 properties which mitigates my risk. I also receive 3-5 the return which allows me to build my cash reserves faster allowing to absorb any sort of vacancy.
To your point about the current market I do think there are a lot of people buying clear blue sky and hoping appreciation is going to bail them out.
Thanks Luke,
My answer will be short, sharp and sweat lol
"Yes" to leverage but only when you know what you are doing.
I've done hundreds of deals, work 14hr days just on my real estate business and still loose money on the odd deal.
Now compare that to someone doing real estate as a par time investor and using a tonne of leverage from day 1 (It's a recipe for disaster)
Nothing comes easy and success in real estate takes hard work.
It also takes time to learn the industry so play it as safe as you can when you just start out.
Much success
ps. Please don't leverage to save on taxes. Real estate investing should be about making as much money as you can and not minimizing taxes from your 9-5.
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Luke Sass:
@Steve B. Well put which is why you should use leverage responsibility, stick to your numbers and underwrite so that your properties can withstand a significant market correction. I don’t necessarIly associate leverage wIth greedI think the distinction needs to be made between the residential properties and commercial multi families in commercial no matter how good an operator you are if your balloon payment comes due in the depths of a recession where capital markets have dried up your probably French Toast. Does this mean you were greedy? I don’t think it does...
A strategy that has worked well for me and that I always recommended to others is to build the foundation of your portfolio with as many cash properties as possible.
Yes, it will be a slow grueling and grind to build it.
But that foundation will save you in the long run when 5 out of your 10 properties become vacant, 2 tenants trash the place and you're stuck dealing with the repair cost, eviction fees and still having to pay the mortgage on the financed properties.
Thanks
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Jason D.:
@Engelo Rumora I think the assumption that you are borrowing at 5% to make 8-10% is the error in your thinking. Sure, the cash on cash return may be 10%, but what about the tax benefits? What about appreciation? What about asset protection? I Believe there is much more risk in cash purchases that using responsible leverage.Thanks Jason,
I would never invest in real estate for the tax benefits.
Investing in real estate should be about making as much money as possible and not saving on taxes.
Appreciation can't be predicted as nobody has a crystal ball so that calculation shouldn't be included when estimating ROI.
Leverage does help with asset protection but if that's what you're worried about and your serious about real estate, drop a pretty penny of $25,000 - $50,000 and I'm sure a competent attorney will set you up with an "unbreakable" trust structure where even you won't have access to that asset lol
Just my opinion.
Thanks again.
ps. I don't know of many investors that know how to use leverage responsibly. Just like many folks that can't use their credit cards responsibly.
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Jay Hinrichs:
Originally posted by @Luke Sass:
@Engelo Rumora Engelo, Wouldn’t you say that real estate is the best chance for an average joe to take a shot. I like real estate because you win on so many levels. We’ve all heard the IDEAL metaphor.I-income from the rents D- Depreciation (ensures we pay little to no tax on the income) E-Equity as your renters pay off your loan A-appreciation in the right market your property should appreciate over time L-Leverage( the ability to gain a return on 3-5 times of my original investment)
Using leverage gives you the opportunity to diversify, instead of all my cash in one property I can spread that cash out on 3-5 properties which mitigates my risk. I also receive 3-5 the return which allows me to build my cash reserves faster allowing to absorb any sort of vacancy.
To your point about the current market I do think there are a lot of people buying clear blue sky and hoping appreciation is going to bail them out.
Well I think what Engelo is alluding to.. is that max debt in a down turn can be unsustainable to some and lead to the loss of this dream
lets go back to 2002 when I started funding turn key companies in the mid west and really got into the rental side of things.. ( and this was regional) in 08 I had 465 investor loans out to mainly west coast folks who had bought in 10 states in the mid west and deep south.)
and here is how all those went.. I put up the HML to put them into title the buyer only needed 1k out of pocket and a 700 fico and my turn key providers and take out lenders would provide the homes. this was and is the BRRR strategy.. we were doing it way before it got coined on BP in fact I did well over 2,000 of them.. Anyway.. so now the buyer refinances and had 25% equity and cash out.. and none of their own money in the deal.. and they cash flowed 100 to 150 a door.. sounds great right exactly what everyone wants to do today.
well in 2010 by the time I was done foreclosing on all those west coast folks that could not refi ( because refi loans froze) and tenants stopped paying no income ) I ended up owning about 200 of these homes.. had they paid cash or had little debt they could have rode it through but no everyone had MAX debt and wanted as many doors as possible.. so many of these folks got crushed.. now granted it was the banks that took the huge loss and myself.. as they had little money into the deals.. but they lost their credit they had major stress.. divorces etc etc.. Am I predicting this again no.. and so what Engelo is saying is there Is moderation here and we are right back to those thinking that max debt is something to achieve with no history of what happens in a hiccup.. 25% equity in a property in a buyers market is NO equity its gone.. and if you put the cash up its a double whammy .. if your rental is vacant and you cant pay the mortgage.. your credit goes along with all your cash.. your recapture of depreciation and your threat of a 1099 C debt relief..
So obviously that was a doomsday event that happened and I live through personally... not predicting this.. but for me personally highly leveraged rentals there is some risk.. and again this is very regional.. in our area here we came through it OK in other areas were west coast folks are flocking to.. not so much..
Thanks Jay,
To my point in my other comments.
If only some of these folks held 30% of their portfolio unencumbered.
It would have saved a lot of heartache.
I'm for a 50/50 approach
50% cash owned and 50% leverage.
I think that would be a pretty safe long term play.
Thanks again
- Rental Property Investor · St. Petersburg, FL · Member since 2017 · 3k+ posts · 4k+ votes8y@Engelo Rumora you dont invest FOR tax benefits, but they are a benefit that you lose when paying cash. And if you want to make as much money as possible, paying cash is the slowest way to do that. My reference to asset protection is that the larger percentage of your total investment is in one asset, the more potential loss you can suffer and therefore there is more risk in "having all of your eggs in one basket" than in diversifying your portfolio as much as possible.
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Mike Dymski:
No value add, no leverage, little appreciation, actively owned investment, low return. What's the value proposition?
Safe and steady passive income
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Michael Patras:
@Engelo Rumora I think it depends on what people’s goals are. There is no one “right” way to do things. Some people have high risk tolerance and don’t mind taking on a lot of debt in order to scale faster. Maybe they are trying to retire from their job in a few years and would like to own a real estate empire. Maybe it works maybe it doesn’t, but those people need to be prepared if things turn for the worst.Others have lower risk tolerance or have differing goals and set a long time limit for retirement. Those folks may be a lot more prepared for a downturn, but at the cost of taking much longer for “financial freedom.”
I think it’s unfair to say everyone should do it one way or another. I understand your point, but what’s right for you may not be right for everyone. I like hearing the stories of those folks that were able to build a RE business and retire early for their financial independence and several of them did it in different ways.
Thanks for your post, I think it’s an important discussion.
Thanks for your comment Michael,
There are many ways to skin a cat as they say lol
I never claim to be right or wrong.
I like starting a conversation and sharing my opinion
Much success
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Jason D.:
@Engelo Rumora you dont invest FOR tax benefits, but they are a benefit that you lose when paying cash. And if you want to make as much money as possible, paying cash is the slowest way to do that. My reference to asset protection is that the larger percentage of your total investment is in one asset, the more potential loss you can suffer and therefore there is more risk in "having all of your eggs in one basket" than in diversifying your portfolio as much as possible.I wouldn't agree Jason,
There are many other tax benefits when paying with cash.
Turn you real estate investing into a business and you get to realize a tonne of tax benefits (Disclaimer, I'm not an accountant).
I also don't think that paying with cash is the slowest way because you will be able to get the best deal.
When using leverage you will most likely be paying top dollar for that property as otherwise the property won't qualify for a loan with decent terms.
You can still diversify and protect your assets when paying with cash by investing in various markets and different kinds of properties (Duplex, multifamily, commercial, etc...)
Set up numerous LLC's with your attorney being the statutory agent.
It will be very hard to find who the actual owner of the property/properties is.
That's my 0.02 Aussie cents on asset protection
Just my opinion mate
Thanks
- Honolulu, HI · Member since 2017 · 247 posts · 315 votes8y
Originally posted by @Sam Shueh:
The Big Short is about someone I know personally.
@sam shueh
what do they think about the current market?
- Rental Property Investor · The Woodlands, TX · Member since 2014 · 345 posts · 288 votes8y
since I will NEVER buy a turnkey property, I will leave that out of the equation and look at the comment "why you shouldn't leverage when investing"
- First - as you understand, Leverage is widely understood in the REI community as a HUGE benefit that (along with many other benefits that have also been mentioned) propels real estate above many other investing options. I agree with this .... the math is clear and you can't argue with the numbers. But we don't live in a perfect world - as has already been mentioned, an economic downturn, vacancies, property damage, and evictions can change that math quickly and when a new investor is walking a tightrope because they are highly leveraged, it is nothing more than a role of the dice if they succeed or fail.
- I began my investing career using leverage because I had no other option - as @Jay Hinrichs mentioned - as soon as I had $20,000 in my pocket, I went out and bought a rental property - My goal was financial freedom and Leverage was what allowed me to get the ball rolling....
- About five years later, I was able to resign from my career of 15 years - I had built a modest portfolio that paid my bills and replaced my salary -
- I recently decided that I would reduce my portfolio and sell a percentage of my property to get rid of ALL my debt-
- Now, I receive fewer rent checks, but I have fewer vacancies, turnovers, insurance premium checks to write - I receive fewer calls and have fewer headaches - and my net income actually went up - Of course I am missing out on the appreciation of the properties that I sold
- Why did I personally make the decision to reduce ... Because MY goal for MY real estate investing was never to build an empire - but only to keep as much of MY valuable TIME to use as I choose - (no 9-5 job)
I have "enough" - My income from investment property is enough to support my life and build in the future -
Leverage was a tool I used during my growth phase, but I feel much more comfortable now that my debt is gone .... (notice how the word is LEVERAGE when used in a positive context and DEBT when used in a more negative context)?
- The beauty of real estate investing (or investing in general I guess) is that even though my primary growth phase is over, I couldn't stop the growth if I tried - the investments have taken on a momentum that will continue - I still buy additional rental property if I find something I like - and I don't even bother running the numbers to see what the return will be -
Good conversation for the weekend - Thanks for starting it.
Good Luck and Happy Investing,
jeff
- Real Estate Broker · Oklahoma City, OK · Member since 2016 · 39 posts · 58 votes8y
Engelo:
In most markets a debt of 50% Loan to Cost would be prudent enough. In fact, you would be safer spreading the investment over two properties, as 90% of the time BOTH units would produce cash, 5% of the time, you would have one unit produce cash, and only 5% of the time have no cash. Having the investment spread over two units would be better than having "all your eggs in one basket" if something else went wrong.
Richard
- Real Estate Agent · Cupertino, CA · Member since 2016 · 4k+ posts · 1k+ votes8y
There is NO plan B. $500,000-600,000 interest tight up each year if keep these flips on the books or in inventory. It will have a domino effect if one or two do not sell. I am aware of half a dozen people doing the flips.
- San Antonio, TX · Member since 2018 · 103 posts · 31 votes8y@Jeff Wallace Woah! Jeff, I agree totally with your statement here. I'd say my 6 year goal goes very similarly in line with what you were able to achieve in 5 years. I'm saving up for my 20K (where did this magic # come from? Lol) to start my path towards first replacing my monthly expenses, to reaching my semi-financially free #. If you can share, did you start by buying rentals in the Texas market, close to where you live, or did you go out of state at all? I would very much appreciate your response! I am wrestling with what my Step C would look like, living in SoCal without a 6 figure income, but trading A LOT of hours for $$ to save up. Thanks-
- Rental Property Investor · The Woodlands, TX · Member since 2014 · 345 posts · 288 votes8y
Hey Alex,
I have only invested locally and now I only buy in my immediate local area - The woodlands, TX (which has an amazing hike/bike trail system- I can now ride my bike to all but one of my properties and never have to ride on the street)
but
I didn't really have much money when I started investing, so I would buy whatever I could afford as soon as I could afford it - which just happened to be in the worst areas of Houston (I do not advise doing this). Everything I bought needed rehab, so I was able to force appreciation - I moved from very low income and challenging areas to a slightly nicer locations and then to solid blue collar neighborhoods- always taking my equity from a sale and moving it to the next property (never taking profits from the sale for personal use) as I was able to invest in progressively nicer neighborhoods, I eventually moved my equity to class A and B neighborhoods.
After I had been buying rental property for about 5 years - and about the time I had moved most of my properties to solid blue collar neighborhoods, I was able to resign from my 9-5 career - However, the income I was able to create only accounted part of the equation that allowed me to leave a very good career with a great income and incredible benefits - The main reason I was able to walk away from a great job was because I had reduced my personal monthly expenses to a manageable monthly obligation - I lived well below my means and invested every penny that I could save over those 5 years.
Leaving the 9-5 allowed me the freedom to focus 100% on real estate and not worry if the electric bill would get paid and if there would be food on the table - we continued to acquire additional properties and we flip several houses a year - but most importantly, I spend every second of my valuable time doing whatever I want to do -
It just so happens that one thing I love spending my time doing (real estate) also creates amazing wealth building opportunities.
Good Luck and Happy Investing,
jeff
- Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes8y
What are the rates these days on non-recourse loans? Unless we are talking about something south of 5%, I don't see the point in leveraging turnkey. The key is to find a provider you can trust that is operating in a relatively untapped market and provides BEST in class PM services. Satisfy the above with no leverage and you'll have a property that provides some of the best long term risk adjusted returns.
- Specialist · Memphis, TN · Member since 2012 · 1k+ posts · 1k+ votes8y
So you don't mean never leverage when buying turnkey at all if I understand your subsequent posts.
You are saying don't pay over retail when buying from a turnkey and then leverage up on that inflated value.
I can't think of anybody who could fog a mirror who would disagree with that.......
- Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes8y
problem is good luck finding someone who can agree on what equals overpaying. You could say "retail" but as noted that figure can be a little misleading for numerous reasons.
Just because I like a good challenge with @Engelo Rumora I will jump in and disagree but only to an extent and only in certain situations. I think there are situations where it might make sense (this is not advice its just hypothetical):
1) The investor in question either has good asset protection or little in the way of assets/income to go after. In this scenario, the downside is what one puts in and the upside is high. The bet is that the cash flow plus the upside if the market goes up outweighs the risk of losing what was put in. Yes maybe there is a loss but most properties at least per property don't have that much in them.
2) You can invest the difference between the 5% or so being paid on the mortgage and the cash amount in something that earns money and is not necessarily dependent on the economy. Course this is a risk too but if it can be done even if the property doesn't cash flow much or is negative for a time.
3) The leverage is non-recourse and in an LLC with very little in the way of money in, either cause of BRRR or because that is the way they were bought
4) The investor is disciplined enough to have reserves. This is true with or without leverage but even more so with leverage.
Course this is not the case for most so its really more of a thought exercise.
Disclosure: This is not advice just my opinion.
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Jeff Wallace:
since I will NEVER buy a turnkey property, I will leave that out of the equation and look at the comment "why you shouldn't leverage when investing"
- First - as you understand, Leverage is widely understood in the REI community as a HUGE benefit that (along with many other benefits that have also been mentioned) propels real estate above many other investing options. I agree with this .... the math is clear and you can't argue with the numbers. But we don't live in a perfect world - as has already been mentioned, an economic downturn, vacancies, property damage, and evictions can change that math quickly and when a new investor is walking a tightrope because they are highly leveraged, it is nothing more than a role of the dice if they succeed or fail.
- I began my investing career using leverage because I had no other option - as @Jay Hinrichs mentioned - as soon as I had $20,000 in my pocket, I went out and bought a rental property - My goal was financial freedom and Leverage was what allowed me to get the ball rolling....
- About five years later, I was able to resign from my career of 15 years - I had built a modest portfolio that paid my bills and replaced my salary -
- I recently decided that I would reduce my portfolio and sell a percentage of my property to get rid of ALL my debt-
- Now, I receive fewer rent checks, but I have fewer vacancies, turnovers, insurance premium checks to write - I receive fewer calls and have fewer headaches - and my net income actually went up - Of course I am missing out on the appreciation of the properties that I sold
- Why did I personally make the decision to reduce ... Because MY goal for MY real estate investing was never to build an empire - but only to keep as much of MY valuable TIME to use as I choose - (no 9-5 job)
I have "enough" - My income from investment property is enough to support my life and build in the future -
Leverage was a tool I used during my growth phase, but I feel much more comfortable now that my debt is gone .... (notice how the word is LEVERAGE when used in a positive context and DEBT when used in a more negative context)?
- The beauty of real estate investing (or investing in general I guess) is that even though my primary growth phase is over, I couldn't stop the growth if I tried - the investments have taken on a momentum that will continue - I still buy additional rental property if I find something I like - and I don't even bother running the numbers to see what the return will be -
Good conversation for the weekend - Thanks for starting it.
Good Luck and Happy Investing,
jeff
Hi Jeff,
Thanks for your detailed comment and congratulations on your success.
Well done mate and my hats off :)
You have used leverage very well to get you to where you are today and the decision to sell a few properties and pay of debt is very wise.
Everyone else looking at using leverage when starting out should look up to your comment and implement a similar strategy.
Slow and steady wins the race.
Safety first.
Thanks again and much success
- Specialist · Memphis, TN · Member since 2012 · 1k+ posts · 1k+ votes8y
@Charles Worth, only people who shouldn't be investing would not know what the value is of what they are buying. And as had been discussed here ad nauseum is that turnkey is not all bad.But you have to understand you are paying at least 20K more than you need to in exchange for having a hopefully performing and passive investment.
Anybody who is investing should know that a property in this street is going to be worth around $XX,XXX. So they then know exactly what they are paying for peace of mind. The problem is that there are turnkeys and turnkeys. A company like @Chris Clothier,s produces a product without peer in Memphis and they stand behind everything they do.
But then some guy working out of his mums bedroom will sell the next door property for the same price, using Clothier's sale as comps, to an out of state investor. The rehab will be shoddy and he will be goneburger if any accountability is required. That's the problem in Memphis anyway. I even changed my company name because i realised I didn't want to be labelled as turnkey, I wanted to leave equity in for my buyers.
- Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes8y
Originally posted by @Account Closed:
Engelo:
In most markets a debt of 50% Loan to Cost would be prudent enough. In fact, you would be safer spreading the investment over two properties, as 90% of the time BOTH units would produce cash, 5% of the time, you would have one unit produce cash, and only 5% of the time have no cash. Having the investment spread over two units would be better than having "all your eggs in one basket" if something else went wrong.
Richard
Thanks for your comment Richard and good observation.
Safety does come in numbers.
Personally, I'd prefer to buy the first 3-4 properties with cash and then maybe look at financing the next 3-4, etc...
It's always good to hold a certain amount of property with ZERO debt.
Much success
- Contractor · Oxford, MA · Member since 2018 · 807 posts · 745 votes8y@Caleb Heimsoth my issue with your assessment of the recession not happening again any time soon is that it doesn't take into account if we fixed the problem. We passed laws and handed out a ton of cash, but the issue (the bad economy) was never fixed right. If a flipper comes into a house, sees a bunch of rot and puts new trim, sheetrock and paint over it and sells it, does that mean it was fixed? The government dumped over $4.5T in cash into the economy and continues to do so (at a slower rate that before, 10 years later) in a fake it till you make it strategy. Now most think we made it and have started spending like we did, but the cash still needs to be pulled back out, a disturbing percentage of people are collecting everything from food and housing to cash and health insurance from the government, most of which is being put onto credit cards. Personal credit card debt is at a record high. So has anyone really made it, or has the government lead by example and a ton of people followed? That system works, until it doesn't. If the fed put interest rates above the rate of inflation and took their "cash" back out of the system, would it crash? I think we all know the answer because they haven't done it and have said that not doing so leaves them with few options during the next downturn but we are not stable enough to do it now. When the only way we survive is from credit cards, record government debt and handouts all on government credit cards, I dont think we fixed anything from 08. I think the government kicked the can down the road one election after the next to make sure they would keep their jobs, power and their ability to conduct insider trading and get government contracts for themselves. They're all getting really rich, while making the tax payers really poor but people are too blind to see the real numbers. Most people I talk to these days keep saying this incredible economy will keep going for years, maybe another decade and you can't lose by putting money into the stock market or real estate. When everyone believes that, it is time to run and hide IMO.
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