How Much Leverage is Overleveraged?

Question

As some people think a crash is coming alot of experienced investors who have been through crashes are saying "don't be over leveraged." But no one gives a percent of leverage that is healthy, or how much cash you should have if you have X properties etc. So, what's over leveraged mean for you?

JD Martin · Answer

It's a personal question with a personal answer. If you have a job making $10k per month clear and only need half of that to live, you could have $5k worth of mortgages on your rentals, maybe worth 80% of their value, and might be just fine with that percent because you can cover all the mortgages with your W2. On the other hand, if rental income is your only income, you might be uncomfortable with some/any leverage.

I am leveraged at about 28% of my total portfolio. I started off buying homes for cash only and never got around to harvesting the equity out of all of them, so I have a bunch of them without notes. I feel pretty comfortable at that level because I could have over 50% vacancy rate across all my properties and still be making money (not much!), and I have several sources of independent income outside of my rentals. I might be a little more conservative than most people on here, but if you listened to my podcast (in my signature) you'll know I also lost over $100k before, which can make you think about it if you come from a poor slob, blue-collar background like me.

Mike Dymski · Answer

Buy in locations where there is zero chance of extended periods of vacancy and you will never have to worry about leverage.

Jordan Moorhead · Answer

I try to be around 70% across my portfolio but IMO I'd rather have more reserves than less leverage. Low leverage won't pay the bills if the tenant stops.

Dwayne Poster · Answer

Your over leveraged if you can’t stop the demise of one deal from cascading into other deals.

Joe Scaparra · Answer

@Antonio Cucciniello, leverage can be a good thing but also can be very bad.  When I think of leverage, I think in terms of personal use and then the business or investment usage.

Personal side: most mortgage lenders, tell you that exceeding 35% debt to income starts highlighting concern.  On the personal side, wants and emotions drive decisions.  Business/Investment side should follow policy or logic and weed out wants and desires.  Since we are on a Real Estate Investing website, lets concentrate on the Investment side of things.

My rental portfolio consist mostly of duplexes. Leverage has NEVER been an issue as they have all cash flowed positive DAY ONE! Meaning that they are self-sufficient and can survive on their own regardless of my personal life. Because my duplexes are not demanding top tier rent then there is little risk to default from not being able to rent my units, which is the life blood of rental income......being able to consistently have occupied property, producing predictable, reliable, steady income.   Not requiring Top tier rent, meaning I am not having to do crazy innovations to make the property cash flow......like STR, or minimum 30 day rental or rent by the room.  Although these are GREAT strategies they carry far more risk during an economic downturn than say long term tenants paying $1500 per month here in Austin. In other words, If your duplex rents out for a $1 per month, then the economic environment matters not.  Somewhere between $1 and XX amount you should be able to find a renter in any economic environment.  For Austin, I would say the top amount is about $1500, but for Bryan College Station it would be more like $800 per month.

Lastly, as a guide ask yourself this question:  If I lost my job would my rental portfolio be in jeopardy.  If the answer is yes then you are overage leveraged.  That might be the case of your personal residence and in most cases that is the risk people are willing to assume, but for your rental portfolio you want to feel secure that in a downturn you are not coming out of pocket to keep your properties afloat.  The double whammy comes when you lose your personal job and that income was need for both personal and investment property.

This is one reason I LOVE duplex investing so much.  When bought right they sustain themselves.  What I am finding now is that a few smart first time investors are looking to buy duplexes over SFH.  I think that makes a lot of sense.  If you buy a duplex and lose your job or have to move to another city for a job you are not forced to sell your property.  Simply move out and rent the other side out.  A duplex has far better chance of covering expenses that a similar cost SFH.  Cheers.

Aaron Gordy · Answer

It depends upon risk tolerance. Each person will have their own risk tolerance and it varies widely. Personally, I like Warren Buffett's saying about risk tolerance "Only when the tide goes out do you discover who's been swimming naked".

John Morgan · Answer

I’m 50% leveraged. A couple rentals are paid off. If I need to lower rent $400/month per property, I can survive.

Marcus Auerbach · Answer

Between 50% and 75% is healthy, but with good properties in a good area 90% or more can still be okay.

If you drop below 50% you are underleveraged and your return on equity gets very low. You are resting on laurels.

If you are a corporation shareholders would demand to leverage more and invest more into growth/R&D/marketing to increase top and bottom line.

Larry Turowski · Answer

Do a projection with a likely worst case scenario. For me, when I had a job, likely worst case scenario was probably losing my job and 33% of assents not performing (people not paying, vacancy, whatever), and then some big bills—maybe a major repair needs to happen.  How long can you keep your head above water in that scenario?

Now, as @JD Martin said, it is largely depends on your personal risk tolerance.  Financial advisors recommend being able to pay your bills for six months after loss of income. That should also give you time to adjust your life if you see the situation is not going to improve, maybe sell some assets.

That last point is why I only like to buy properties at below market value. I don’t ever want to lose money if I have to or want to sell suddenly.

I flip as well as hold rentals. What I love about this business model is that I keep cash for flips, so not only do I have that working for me, but my worst case scenario is I have money tied up in free and clear flips, which, unless the sky is falling, in which case it doesn’t really matter, I could sell and have plenty of liquidity.

Antonio Cucciniello · Answer

I get what you are saying I think that will definitely minimize the downside but also price is a big factor in that location

How Much Leverage is Overleveraged?

Most Popular Reply