How much leverage?

Question

Ok, so here is the question. How much do you leverage your portfolio? I have friends that are all over the map, I suppose it’s one of those “whatever is right for you” scenarios? I have some investor friends that are in the Dave Ramsey 100% down payment camp, then I have others that are throwing caution to the wind and grabbing up whatever they can, no matter what the cost. So I’m wondering is there a happy medium? How to the big players do it?

David Roberts · Answer

If something like that happens then we all have major problems, even people with paid off homes.  They still have to come up with taxes and insurance.  Those with fully paid off homes likely don't have large bank accounts because all of their money is trapped in the houses and at market risk.

Those who leveraged up and have cashed out their money have huge bank accounts, cash sitting safe and sound in an account, ready to buy 10 more houses at 25% of the value.  So while the PITI might be 5-600 a month, they have 300k in the bank to cover it for awhile.

The last time the housing market collapsed, what happened?  We had nothing but a record number of tenants (like we do now).  What you described is likely not to happen.  If it does, then like I said, that means the country is collapsing, and it won't matter what you're invested in at that point.  You're talking about a doomsday event.  Can't live like that man lol.

Person A buys a 60k home ARV 80k and leaves cash in.  Person B buys 60k home ARV 80k and refinances the cash back out after 1 year.

T/I = 3000/year, PITI = 6000/year.  Both homes rent for 12k/year (person A net cash flow = 9k, person B net cash flow = 6k after refi)

After 1 year, person A = -60k + 9k = -51k.  Person B = -60k+9k = -51k (at this point, the 75% refi happens)

After 2 year, person A = -60k + 9k + 9k = -42k.  Person B = 60k+9k+6k = 75k in hand (buying the 2nd one most likely but for the sake of argument, let's not)

After 3 year, person A = -60k + 9k+9k+9k = -33k.  Person B = 60k + 9k + 6k + 6k = 81k in hand

After 4 year, person A = -60k+9k+9k+9k+9k=-24k.  Person B = 60k+9k+6k+6k+6k = 87k in hand

After 5 year, person A = -60k+9k+9k+9k+9k+9k=-16k (you're almost whole, only 2 more years.  Person B = 60k+9k+6k+6k+6k+6k=93k

Who is at more risk?  This has been debated over and over and over but I cannot get my head around choosing person A.

If you don't need your money in the investment, then why would you have it there?  Now, if it's the tenant's money that pays off the mortgage, for example if you had 10 rentals each flowing 3k a year, that's 30k you can put into 1 rental to pay it down, fine.  But why put your own money in?  No way.  Use everyone else's money.  Pass yours through and get it back.

People dump money into 401ks every year ( me included) because that's what society tells them to do.  Hmm, who really makes out?  Let's see.  YOu give a fund all of your money, you take all the risk, you lose all the control, and oh by the way, you pay fees to the fund manager, and many times aren't even made aware you're paying the fees.  And oh yeah, the money is trapped until you're old. LOL  I WISH i would have realized how awesome real estate can be years ago.  It's the only investment I know that you can hold the investment with no money in it and get a 100% return.  Maybe that's why the biggest investors in the world are into real estate.

Andy Mirza · Answer

@Chris McDaniel I used to be in the "leverage to the hilt" camp until I had a deal go bad last year and I realized that I put my wife and 3 kids at financial risk. When you're single and it's easy to withstand financial shocks, it's easier to take risk.

You're right, the answer is "it depends." It depends on your day job (if you have/need one), your fixed overhead, your risk tolerance, your family's risk tolerance, your age, your reserves, and other factors. Can you sleep comfortably at night or do you stay awake with worry?

If you have large reserves, it's easier to say "yes" to higher leverage. If you don't you might be better off with less.

I need to refi my cash flowing rentals and lenders won't do more than 60-70% LTV. I'm comfortable with that level but I wouldn't go higher than 80% even if could. At 80% I have the option of selling easily if I need to. In 20 years, I'll be more comfortable staying at 60% LTV. It'll be the right balance of growth and security at that age.

Wilson Churchill · Answer

As long as the property has cash flow wit h100% (or higher) financing, why not finance every property and keep the money in the bank as a large reserve fund?

Chris McDaniel · Answer

@David Roberts  You're right, but i was just thinking of my ability to provide for my family. If I'm all leveraged up and say ExxonMobil reports that abiotic oil is real and the price of oil drops to .25¢ a barrel and most of my tenants get laid off (I'm in the Houston market), then my ability to provide for my family comes crashing down. If, on the other hand, I have houses that are paid for, i think weathering the storm would be much easier, my rents could easily be readjusted to $150/month if need be. I don't know what the right answer is?

David Roberts · Answer

Let the bank take all the risk.  Did you see the US treasury Friday?  The 10 year is at 1.65%.  It's going under 1, why?  Because every other safe haven country bond is at 0.5% or less.  The US treasury looks appealing at 1.65%.  Leverage up!

What do you suppose the bank does with your money?  Leverage it to the gills is what they do.