Originally posted by @Alison Robinson:
Great subject! I don’t have the experience of many of the responders but I have spent many hours considering how much debt I should carry. To grow my business I am prepared to leverage savings and a strong credit score but on the flip side I've worked 25 years in a corporate job, following the most basic rules for retirement savings from age 24. Establishing an emergency fund, then contributing to a 401k, saving at least the minimum amount to get the company match, continuing to increase contributions until reaching the government maximum allowance. Continuing to diversify savings through other vehicles over the years. I went through the 90s where 10-15% returns were easy to come by and through the major losses in 2001& 2008, then the no growth years and now the slow recovery. I'm absolutely thrilled to be investing in real estate but I'm not willing to risk what took 25 years to build.
Here is my approach:
Consider a worst-case scenario - I accumulate a portfolio of rental properties. Assume both the rental market and the housing market tank. Property values drop 50% and rental vacancies hit 50%. How do I survive without losing everything? In other words what debt can I take on and recover from without declaring bankruptcy and without drastically impacting my standard of living. For me that number is $200,000.
Liquidation Option: Sell all assets at a 50% loss, proceeds would only be sufficient to pay down a portion of the business debt, the rest would need to be covered with personal savings or income. I could cover $200,000 and not dramatically impact my current life style
Liquidation Formula: (Total Assets / 2) - Total Debt =< $200,000
Temporary Survival Option: Property vacancies are running 50%. Gross Income is insufficient to cover monthly expenses. Additional personal income would be needed to cover business expenses. I could defer $1500 in personal monthly income to supplement business expenses and still cover my monthly living expenses for an extended period of time assuming I did not lose my job.
Monthly Negative Cash Flow Formula: (Gross Income /2) – Total Property Expenses – Total Debt Payments =< $1,500
My approach will likely change as we purchase more properties but this lets me sleep at night.
If your max debt loss tolerance is $200k (the amount that you can cover) that wouldn't get you a whole lot of property. Assuming going off your usual 80% LTV, a $600k building is $120k down with the remaining $480k financed. In your worst case scenario, your $600k building will drop to being worth $300k and then sold. So you will lose the $120k and then have $300k proceeds to go to pay down your $480k loan... Leaving around ~$180k in loan costs for you to personally cover (easily your $200k number).
So you are kind of pegging yourself at that level with your more standard buy and hold financed strategy
But property values (generally go up and down) so I would focus more on your monthly income loss mitigation strategy then just liquidation. Rents and vacancies are going to be a lot more stable then property values. Focus on buying good cash flowing properties
