Wow, there are some EXCELLENT posts on here, I have voted for a couple of them. I like the Table Saw analogy. When people ask me, I use the "Water and Fire" analogy. Water and Fire are NEEDED for our very existence. With water we grow food, take a shower, cook and a lot more. Too much water and we have Katrina, the India Ocean Tsunami and the greatest loss of life ever in nature in the flooding of the Yellow River in China. With fire, we heat our homes, run our cars, cook our food and make smores at the beach. Too much fire and we burn down our homes, burn up our cars, destroy thousands of acres of forests and bring down the World Trade Center.
Debt is like Water and Fire. Used wisely, and we have a great life. Used unwisely, it can destroy everything (I have watched my personal residence burn to the ground so I know it all too well).
There are NO RULES when it comes to Debt/Leverage. But there are GUIDELINES. I have seen my personal leverage fluctuate between 25% and 75% LTV, with the same properties and my monthly cash flow changed very little. For example, a house I owned in Orange County reached a top value of $700,000 in 2007, and I owed around $200,000 on it and it rented for $2,000.00 a month. That house dropped to around $400,000 in value in 2010 and I stilled owed around $200,000 on it and it still rented for $2,000 a month. Today, that house is worth around $550,000, I owe about $190,000 on it (Principal pay down) and it now rents for around $2,500 a month. My NET WORTH is bouncing all over the place, but my monthly cash flow is affected very little. (As an aside, I paid $90,000 for the house back in 1985 and it rented for $1,200 a month) The reason I do not sell it now is that I see upside potential to $800,000 in five years and that is appreciation I don't want to miss.
The one thing I have NOT read in this thread is the AVAILABILITY of financing. In todays market, finding financing is like pulling teeth. For instance, last year, I wanted to go 33% down on a rental in TX that I was buying at about 90% of value. I have a credit score of over 800, I had DOUBLE the amount in the bank that I was borrowing and the rent was THREE TIMES the amount the PI payment. But the lender said I did not qualify since I did not have any W2 income. I told the lender to take a hike and I paid ALL CASH for the house. I got a CMA this week and the house has gone up $40,000 in value, so if I could have financed it, I would have doubled my money. But going all cash, I ONLY made 25% cash on cash return. Also, if it was financed, I would be out the $500 a month for the Mortgage payment. So, financing it would have been PREFERRED, it creates a better return, but WHERE DO I GET IT?
So I have some GUIDELINES that I use (remember, there are NO RULES)
1. Never go into debt on a Non Appreciating Asset. (My exception here is when there is little or zero percent interest rate. My last car loan was at 2.79% so instead of paying cash, I bought a rental for cash where the rent makes my car payment. A 10% asset paying a 2.79% loan.)
2. Never have a PI payment of more than 50% of the rent on a rental. If the rent is $1,000 a month, the PI should NOT be over $500.
3. For those starting out, always have some 'skin in the game.' My first investment was No MONEY DOWN (seller carried 100%), but I put some of my own funds in immediately for refurbishing the property. Having some of your own hard earned cash in an investment creates a psychological incentive to work hard to make it succeed.
4. Create liquidity ASAP. Even with Free and Clear properties, have the ability to pull money out immediately. I carry two HELOC's on two properties with the ability to pull out $200,000.00 if I need it.
5. When the rent drops to 0.5% of the value of the property, time to consider redeploying that equity if everything else is 'equal.' This may be refinancing, selling and buying, trading, or other ways to increase your asset base. There are exceptions like expected appreciation, sentimental value, future plans of the city like redevelopment that may increase your value, etc... Let me give a real life example. My cousin is a very successful investor. Years ago he bought some raw land and built a self storage facility. He paid $275,000 for the land and spent about $1,000,000 building the self storage lot. It was a nice cash flow and then a large company wanted to buy his land and offered him $20M for it. He turned it down knowing that the company would want it even more in the future. He sold it to that company two years ago for $39M. He knew the upside was much stronger than the original offer from that company.
So like I said, THERE ARE NO RULES, only guidelines when it comes to Leverage, Rents, when to buy and when to sell. What are you comfortable with as an investor? How much risk causes you to lose sleep? Are you willing to put in some of your own money? Currently, I am at about 30-35% LTV on all my investments. I would like to get it to around 50% but am having a tough time with lenders right now. That is MY comfort zone, yours may be different!
