Debt Sweet Spot on Rental Property

[Jake C.]

Hi All,

There seems to be 3 common approaches to financing rental properties:

1- Buy in cash. Hold in cash. Debt is bad. 

2- Buy with the absolute minimum necessary out of pocket for the longest possible term.

3- Somewhere in between 1 & 2. 

I am really interested in hearing from the people that have been utilizing the 3rd path. What is your sweet spot for debt?

Let's use the example of a turnkey deal that is 8 units (4 two unit buildings) at a purchase price of $300K and an NOI of about $50K, in an area that will see only very modest appreciation.

What kind of loan terms would you seek to really hit the sweet spot in terms of cash flow/risk/wealth creation?

Using the above example, one landlord told me that he would try to get a 50% loan for a 7 year term amortizing over 14 years. Assuming a 5.8% rate, his annual debt service would be $24K, leaving $26K in cash flow. His balloon payment would be $90K, so he will have paid off $60K of debt. As long as the properties are worth more than 80% of his current purchase price in 7 years, he should have no problem refinancing at his balloon. 

This seems to be a strong balance of cash flow/risk hedging/wealth creation.

Curious to hear your thoughts/approaches!

[Nathan Gesner]

@Jake C. I was trying to make the point that there is no "sweet spot" because it depends on your personal situation. It's like asking how much reserve a person should have. For a person living paycheck to paycheck, I would recommend a minimum reserve of 3-6 months rent. For someone with little debt, a six-figure income, and a $250,000 line of credit, a reserve fund is completely unnecessary.

How much debt you carry is personal and the key is to avoid overextending based on your personal situation and goals. I like to have 30% equity or more and strong cash flow. The market can go up and down but it doesn't matter because income and expenses remain pretty steady. How much equity I have really only matters when it's time to sell.

You increase leverage if you are trying to grow. You decrease leverage to reduce risk. The sweet spot depends on your situation and where you're trying to go (or stay).