Impending Downturn: What is Safe LTV or Equity % on Rentals?

[Allan Smith]

Everyone who weathered the 2008 crisis knows it's very important at this time to make sure not to over-leverage on rental property. What is safe? I've heard 65% LTV should allow pretty much any investor to ride out the low point of the cycle. Does anyone have opinions on the matter?

This great thread about the next bubble burst inspired me to ask.

[Andrew Johnson]

@Allan Smith I think you might be asking a couple of different questions. If you have a commercial loan that might reset during a downturn period you have to worry about LTV. In some cases even if it's not resetting you have to send annual financials. I think @Jonathan Twombly hit it on the head when he talks about debt service.  I'd primarily focus on stress-test scenarios that revolve around a loss of collected rents.  I saw collected rents because it could come in the form of increased vacancy, a reduction in the rent itself, or both.  

Going back to the crash some of it was market dependent.  Orange County reacted differently than the Inland Empire.  They're not that far apart on a map, one was "hurt" the other was "decimated".  And even within Orange County (and this is anecdotal) you had issues where 1 bedroom/1 bathroom and 2 bedroom/1 bathroom apartments were still getting rented pretty easily.  However, those 3 bedroom/2 bathroom units were much harder to fill.  The family of four would just crunch themselves into a 2 bedroom/1 bathroom.  Consequently, it became hard to get the premium for a 3 bedroom/2 bathroom that you could 12-24 months earlier.  

So while I'm not trying to make everything fuzzy and cloud it with a bunch of "it depends" you really do have to look at your market (on a local level) during the time in history.  

But back to a high-level.  Start asking yourself what happens if collected rents drop by 10%, 20%, etc.  You'll hit thresholds along the way: make less money vs. break-even vs. lose money (but can handle it) vs. lose so much you can't make the mortgage payments.  

Yes, most of the time these do tie back to the LTVs but not all of the time. And, yes, if you're LTV is hurt your exit (i.e. ability to sell the property) options will diminish. On a side note, I'm pretty far away from 80/20 on the LTV side of things if I look across my portfolio. So I do have some "dead capital" but I also have to sleep at night.