What's a safe amount of leverage and reserves?

Question

Hey BP,

I have two questions I think would be important for me, as a real estate newb, to have a better understanding of. First, at what point would you consider a person Overleveraged? would you judge if a person is overleveraged by their income their bringing in and/or how much liquid assets they have in banks, mutual funds, etc.? Secondly, I would like to know how much I should keep in reserves? For example, I have a duplex. How do I calculate the amount of reserves I need? I understand the answer is probably subjective, but I think this is an important topic, as it keeps your portfolio in a safe position.

Noah McPherson · Answer

@Steve Vaughan @Jay Hinrichs Thanks for the feedback guys. I see the importance of avoiding debt on things that aren't cash flowing assets, and I'll make sure I fully understand the terms of my leverage also. As for the 3 months of debt service plus a a years Capex and repairs, that was exactly what I was looking for. I'll make sure to implement that into my management strategy.

Steve Vaughan · Answer

As far as consumer debt goes, I don't play with cars or cc' s or any of that.  No cattle hacking, rewards, miles, etc.  Tedious and too much hassle.

For rentals, I consider the type of leverage more almost than the LTV.  I'd rather have an 80% LTV 30yr fixed conventional than a 50% LTV HML or toxic neg am, commercial, private or seller-financing not conveyed to you properly.

Reserves, in general I carry 3 months debt service plus estimated repairs and cap ex for the year.  As you get into the dozens of units space, I just use an absolute amount like $30k or $50k.  I've had a couple $28k ish outflow months and a few in the teens so I generally keep 30.

Jay Hinrichs · Answer

To me over leveraged means you have big car notes  your CC are close to or are maxed out and your only making minimum payments you go buy furniture and you finance it.. you buy real estate with the least amount possible down at market prices.

And your cash reserves would only last you a few months to service all the debt.

So no retail debt pay cash for anything you consume or use  OTHER Than a vehicle

and decent amount of TRUE equity in your real estate no FO equity IE refi appraisal but you know the home would never ever sell for that on the open market.

bascially follow Dave Ramsy and

@Steve Vaughan  over the years on BP has written some really good comments on how to build an empire while balancing family life and fiscal safety..   My self i blew it in my 20s like so many do and did..  had fun but financially speaking was not the greatest use of my purchasing power vis a vi my income in those days.  But one thing I did and continued to do over the years was to make sure I owned a home on the SF peninsula Massive tax free appreciation can make up for some boneheaded 20s financial decisions  LOL

Jay Hinrichs · Answer

good your asking now before you become to over leveraged.

from my point of view and ONLY mine..  after seeing this black swan event of Covid and rent moratoriums that were out of the investors control.. If you have debt on your rentals  does not really matter but if you have monthly obligations that if they are not made your going to run into fico score degradation.   In my mind U need to have enough cash on hand to weather a protracted dry spell of no income. Tax's dont hurt your fico  UTLS might but in most states you have years to catch up on prop tax's if you need to.

Although the overwhelming majority on BP from what I have seen did not get affected by the moratoriums or those that did never post.

HOwever you can also have issue with long evictions so U need to know.. Hey if I have a bummer tenant can I get them out in 3 to 6 months or is it going to be a year.. and what happens when they do 5k worth of damage i have to pay for to re rent.  Now granted depending on Asset class this may not be an issue but it our trolling in the C D high yeild rentals this will be an issue.

so in my mind figure out what you need to have to back stop you if you have either of those events  Black Swan or bad tenant. then put funds aside accordingly and its not exponential the more doors U have the less per door you need.

What's a safe amount of leverage and reserves?

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