All Forum Posts by: Ron Thomas

@Larry Turowski Thanks for the kind words.  Hopefully your radical notion of leverage carrying risk doesn't provoke such backlash as it did for Dave and I.

@Cliff Mccue Great points, I really have no retort for any of them.  It sounds like you know what you are talking about.

Thanks for the insight @Larry Turowski  I've heard the stock market is expected to grow a bit slower in the future than in the past, say 8% per year on average as opposed to 10%.  Have you heard the same, and if so do you think population is a main driver of that?

@Account Closed

This quote below from you is entirely based on the wrongful assumption that my writing of the word 'interest rate' is referring, basically, to the fed rate and not the market rate of interest an investor would expect a given asset to return unlevered.

"So if Value=NOI/interest rate then

since interest interest rates are pretty much uniform across the country, let's say 4% then if you were looking at $50,000 NOI then value=$50,000/4%. $1,250,000=$50,000/4%. Basically he seems to be saying cap rate = interest rate. So there would be little range of cap rates. Makes no sense!"

No one who actually thought that through would think NOI, factored for a rate of interest set by central bank to influence the macroeconomy, would be the prudent way someone would go about figuring the present value of a stream of future cash flows for a given asset. If you really thought that was what I meant then I have this funny feeling your misinterpretation was based on a mere desire to argue.

Anyway, back to the point about leverage being risk free. In simple terms so the rest of us can comprehend, can you please explain the existence of PMI if leverage is, in fact, as you vehemently profess, risk free?

@David Nolan  Thanks for the insightful posts.  I wouldn't put to much thought into Bob's writings.  Apparently faulty logic and abrasive, off-putting character transcends national boarders because you took away the same things from him that I did.

Cheers!  I look forward to reading more of what you write.   

@Account Closed For your sake, I hope you are just messing with everyone to entertain yourself.  Good luck with things.

@Account Closed David had no luck getting the point about leverage across, even though he went as far as quoting the World Bank, so I have no real expectation that these points will persuade you but it doesn't hurt to try!  Truthfully, I'm surprised an investor would even argue about this point.

Numerically - 

You buy a $100,000 property. 

Option A - No Leverage.  The market moves 10% down (it moved 40% or so in America in the crisis).  You lose $10,000, AKA experience a 10% loss on the capital you put forth.

Option B - Same property but this time you leverage $90,000 of its cost and only contribute $10,000 down.  Same property, as I said, so its subject to the same market forces at Option A and the market falls 10%.  You lose $10,000, AKA experience a 100% loss on the capital you put forth.

100% > 10% = risk amplified by leverage.

Option C (bonus option) - You have $100,000 to invest but buying in cash doesnt suit your style because leverage, in your mind, is 'riskless'.  So you basically do Option B on 10 different properties all at once.  Again, market moves 10% against you and poof, $100k, or 100% of your capital, gone.  Now scale it, lets say you did Option C but had $1,000,000 in cash so you bought them all unlevered.  Again, this scenario would have resulted in a 10% loss of your capital.

In Practice - 

How often, during the crash, did you hear about assets being foreclosed for being under leveraged?  

If leverage isn't risky, why won't banks finance 100% of any property without a second thought?

If leverage isn't risky explain PMI.

I assume you agree with the statement 'Higher risk merits higher reward'?  Assuming that, why does a first mortgage with lower leverage limitations accept a lower return on their money than investors or partners that are willing to fund in positions second to said mortgage?  A higher leverage position puts the mezzanine financier in a place of greater risk so a greater return is demanded.  

You'd be wise to think about much of what @David Nolan said.  I use leverage to invest as well, though I am borderline a 'newbie' and not scared to admit it, but when I use leverage I do so with a scalpel as opposed to a chainsaw, because I respect its risks.

A final thought about 'Higher risks merits higher rewards'.  If you dont believe that statement then you have a fundamental misunderstanding of investing basics.  If you do believe that, on the other hand, yet continue to believe that leverage produces higher rewards with no commensurate shift in risk, then you are contradicting yourself.

Good post @David Nolan!  

Everyone thats read a book understands that Price=NOI/Cap Rate

Dare I say that I think very few people understand that what that equation really means is that the present value of a given stream of infinite cashflows = that cashflow divided by the current rate of interest.  That was one of the few great points I picked up from what you wrote.  

Another is the point about leverage and the magnification of losses.  It seems like too often people think 'bigger return, great!'.  I think 'bigger return, great!....but what is the risk that merits this return and can I mitigate it?'.  Knowledge seems to be the one thing that actually mitigates risk.

Land being in virtual constant supply, with the exception of maybe urban sprawl, is another great point.  Depreciation being a legitimate expense and not just a tax benefit, and what I inferred as the normally underfunded cap ex line item is yet another great point. 

Are you a real estate fund manager in Australia?

@Detric Moton

From one relative novice to another, take my advice for what its worth.  I have not bought an apartment building yet, although I am currently preparing to enter this market.  The main difference between commercial real estate, which is what an apartment building is considered, and residential real estate is that residential real estate is purchased to live in and commercial is purchased for the value of its cash flow.  Every thing about each genre stems from this fact.

For example, the price of a given piece of commercial real estate is calculated by the income it produces and the market rate or return an investor expects for putting their capital to work in that market. Value=NOI/Cap Rate. A residential piece of real estate, on the other hand, is valued based on what other homeowners have recently paid.

Thus, financing for commercial real estate is based less on the individual borrowers ability to pay and more on reasonably expected cashflows from the deal.  

My single biggest piece of advice, if you are really interested in buying an apartment building of any sort, is to take the time to really, and I mean really, educate yourself ahead of time.  You will invariably need to use a lot of other peoples money, whether from banks, investors, equity partners, or any other sources, and you owe it to them to be knowledgeable before you put capital at risk.  

@Stephen Chittenden Good point about wage growth not necessarily mirroring inflation

@Nathan Paisley  I enjoy writing.  Thanks for wasting your life on a comment