Originally posted by @Joe Villeneuve:
Originally posted by @Michael Masters:
I don’t believe the biggest risk going forward is a drop in property values but rather an increase in interest rates. If you have adjustable rate mortgages you could see your expenses spike in the next few years.
On a $250,000 mortgage your annual payments will be $12,650 if you have a 3% interest rate and 30 year amortization. If rates rise to 6%, those annual payments will rise to $18,000.
For this reason I keep a balanced view on leverage. I tend to run at 40-45% equity in my properties. This keeps me safe and also gets me cheaper interest rates. I’ve also locked in as long as I can on my properties (although because they are commercial multis it’s difficult finding loans that lock in for more than 10 years).
For me, these are an investment not a job. I hire property managers and basically sit back and collect the checks. If I were more involved with my properties I might be willing to take more risk, but at this point I need to focus on my day job.
"I don’t believe the biggest risk going forward is a drop in property values but rather an increase in interest rates. If you have adjustable rate mortgages you could see your expenses spike in the next few years"
Why would you have an adjustable rate in the first place. That's a very definite example of risk. If you have a fixed rate mortgage, as you should, an increase in interest rate has no impact on anything with a hold property.
"I tend to run at 40-45% equity in my properties..."
You mean you tend to "buy" 40-45% equity in your properties.
"...This keeps me safe..."
Keeps you safe from what?
"...and also gets me cheaper interest rates."
...and in the end you are "spending a dollar to save a dime".
OK Joe I’ll bite. I assume you posted this more because you didn’t like my response to your comment saying many investors on this forum don’t have basic math skills (and I assume you put me in this group as I like to have equity). However, I’ll put that aside and respond to your comments on my more recent post.
Before I start, let me apologize for the length of this response. I have a long journey on my daily commute in and out of Manhattan, I figured I’d try to explain how someone can still be good at math even though they don’t use your method of real estate investment. It might not be a productive use of my time but it will be more entertaining than listening to the same old boring news and/or sports radio. I’d be surprised if anyone actually reads the whole thing.
First let me say this, whatever your approach is to making money in real estate, I’m sure you’re much better at that specific approach than I am. I have an intense day job with a long commute which doesn’t give me a lot of free time to spend on my properties. I leave home before 7 and get home around 8 (I’m actually writing this during my long train commute home). Any remaining time is valuable family time that I don’t want to spend putting up drywall or painting walls or chasing delinquent rent. For this reason I buy apartment buildings which are in major metro areas, which rent to stable professionals, which need no immediate capital investments, which have low vacancy rates, and which are easily handled by property managers. I’d assume my “hands off” approach is much different from yours, although correct me if I’m wrong.
Secondly, I’m sure the returns you make on your investments are much better than mine. For me this is an investment and not a job. My goal is to have a safe hands-off investment to balance against my stock market investments. Basically a safe investment which outperforms the bond market. My most recent real estate investments in 2017 & 2018 give me returns of about 13%. Not phenomenal, but pretty good given I do almost nothing post-purchase except collect profits from the property manager. I’m sure you’re doing better as are many others within the BiggerPockets community.
Having said the above, let me provide responses to your post:
Agreed, I said it because I was trying to warn those who use ARMs. This is why I understand what you are saying about low-risk because you are insulated using long-term mortgages. I tend to go for mortgages on the longer end of the available spectrum too, but as I mentioned in my prior post getting a 30-year fixed rate on large commercial multi-unit properties is difficult to impossible. Freddie Mac won’t give anything fixed longer then 10-years. I have mortgages which are fixed from between 7 and 10 years which gives me some insulation, but it is a financial impact I must model in my long-term view. I hope those with 3 or 5 year ARMs are prepared for their upcoming rate adjustments.
I’m not sure why you felt it important to correct this statement, but I don’t actually “buy” with 40-45% equity. I tend to buy with 30-35% equity and increase equity as I pay it off. Commercial mortgages force you to put more down as equity, at least 20-25%. My properties all vary in % equity but average out to about that 40-45% which is what I call my run-rate. Certainly not how I buy it. If I missed your point, please better help me understand.
OK this is the hardest to answer, especially since several others have tried to explain why they are more comfortable with more equity in their properties but their reasons aren’t making sense to you. I’ll do my best to explain my situation.
My investment style is what I call “buy-and-die”. I call it this for two reasons. First, it’s a way of avoiding capital gains taxes and sales commissions by never selling (although I have 1031’ed in the past). Secondly, and more important for this response, it’s a way of making sure my family has steady income even if I get hit by a bus tomorrow. It needs to be easy enough that my wife isn’t overwhelmed with maintaining it as she’s trying to raise our young children by herself. Something VERY easy should the worst happen. With this investment style I need to have decent equity in the property in order to not have all the cash flow go to the mortgages. I’m sure if I operated in riskier markets and had a higher cap rate return I could achieve this while using higher leverage, but that’s not my approach or my goal.
I’m sure in your approach you can make good cash flow even on highly leveraged properties. I’m glad that works for you, it doesn’t work for me.
Ahhh here’s a small math dig, albeit in a much nicer tone this time for which I thank you.
Because we like math, here were the choices I had for mortgages on my upcoming June 1st purchase:
$3,635,000 mortgage at 4.50% (annual interest of $163,575)
$3,900,000 mortgage at 5.25% (annual interest of $204,750)
So the cost of taking an extra $265,000 in mortgage is an extra $41,175 in interest. That’s actually 411,750 dimes per year. It’s a little more than $10K above the median personal income of an American*. Most importantly, that’s a 15.5% interest rate on the extra mortgage (41,175/265,000). I opted to put in more equity rather than pay the 15.5% marginal interest rate.
For 28 years I’ve worked in a job where it is my duty to evaluate risk & reward. In other words, I’m ok when it comes to math. Please trust that I would never “spend a dollar to save a dime”. The only times I am stupid with money is when I tip.
In fact, the most important thing I’ve learned over 28 years in the working world is not to think you are smarter than the next guy. There’s more than one way to skin a cat so the approach that works best for you might not work best for the next guy. Hopefully this brings you a little closer to understanding why we all don’t operate using maximum leverage.
The American real estate business is very diverse and we all invest in our own unique ways. Best of luck to you all in your own Big Pocket aspirations however you aspire to achieve them. To those who had the stamina to read this whole post you certainly have the energy to succeed in any endeavor!
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