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@Joe Villeneuve that's a different way to look at it! I thought I was on the right track when @Chris Seveney validated my point, but everything can be seen multiple ways which is what makes these things so tricky. I feel all-cash is less risk because unless the market goes way down I can still likely get most if not all my principal back, even in a half done rehab(?).
As you see it, the lender is taking some of your risk away, but how does that work if there is a loss on the project? The lender takes the title and you lose your down payment and rehab costs? And you end up with a credit record that prevents you from taking out (decent) loans for the next many years? That sounds like more of a nightmare scenario than losing some principal, but I don't think I'm as educated on what this would look like and why you think it would be a better scenario. Can you say more?
If the project loses value, the it doesn't matter unless you have to sell the property. IF the property still cash flows, you can ride it out until the property regains its loss.
Risk is based on 3 parts:
1 - What is at risk. This is ALWAYS the cash that was put into the deal.
2 - Who is at risk. See above. This is the person that put in the cash. When you buy all cash, you are taking on 100% of the risk. When you put 20% down, you are only taking 20% of the risk, and the lender is taking 80%.
3 - Who is the risk. this is the person/entity that is responsible for keeping the investment a good investment. This is the REI. This means the person who is AT risk the most, is the person that put the most cash into the deal, and they are relying on the person who is THE risk to keep their cash safe. So, the person who puts the least amount of risk (cash) into the deal, is the person sho has the least amount of risk.
While I see the point you are trying to make, I couldn't disagree more. You can't measure risk in dollar amounts only. If you default on a loan, you will suffer much more than just dollars lost. Reputation carries a hefty value; you can't just loose investor/bank money and wash your hands of it. You can't just go to the next deal. Your investment career is likely over, especially if it's a loan from a bank. I take that risk very seriously and operate a low LTV because of it.
Fear and lack of risk controls are not the way to invest. Of course foreclosure is going to damage you. One foreclosure isn't going to damage you. There are too many ways to get financing to get hurt by it. Legal action, from things having nothing to do with the property directly, is always there. Foreclosure risk isn't if you set the deal up properly and it's based on accurate analysis.
On the other hand, the greatest risk will always be what you have to risk...which is your cash in any deal. You are either risking the small DP, or all cash. This also impacts legal action. A property with 100% equity is a target, one with 20% isn't,...or is at least a very small target.
On top of that, the cash you put into a positive cash flow property is what the REI pays for that property. When you put up 20%, that's what you are paying for it. When you pay 100% cash, then you are paying full price.
Plus, 20% down means you are buying 5 times as much value compared to paying full price in cash. So, a 5% appreciation generates 5 times the equity increase as well,...and that's exponentially gained on future appreciations.
Using debt responsibly is a good strategy and necessary in most cases if you want to scale. However, debt can be the silver bullet to an investor if not done responsibly. When I was an underwriter and lender, a foreclosure killed the deal. Those are very hard to overcome and would require you going off market for financing for at least 5-10 years before any financial institution would look at you again. Of course, debt allows an investor to scale quicker and take advantage of appreciation on a larger scale but running a risk analysis on who's making loan payments when the SHTF is a useful exercise.
While your assessment of debt vs no debt risk holds water when it comes to litigation, an LLC with an insurance policy and an umbrella sets up a good defense. As well as being in a state with charging order protection.
LLC, insurance (doesn't stop litigation), doesn't stop litigation. They can help you win, but not stop it. Debt stops it in its tracks since the only prize of winning is a limited equity, which is sucked up by the lawyer.
As I stated above. Foreclosures delay traditional financing, until the REI can show a positive track record after the foreclosure. There are many more ways to finance properties, not involving traditional financing, where a foreclosure shouldn't impact it negatively. These other ways will show positive results to a lender, and help to stop the foreclosure from stopping traditional financing.
Apologies if you misunderstood what I said above, “an
LLC with an insurance policy and an umbrella sets up a good defense.” Nothing stops litigation, including debt.
While there are many ways to obtain financing other than obtaining from traditional sources, avoiding a foreclosure should be a top priority. Arguing that foreclosures only “delay” traditional investor financing seems to mean that non traditional lenders care nothing about past foreclosures. I would argue that even private lenders do due diligence on the borrower.
