Leverage: A good strategy or a slippery slope?

[ButGregSaid]

Hey everyone -

I was thinking about getting into real estate myself and the great debate on starting off seems to be centered on the use of 'leverage'. When I say 'leverage' I'm referring to an up front loan. My dad's a Real Estate Broker himself and swears by the benefits of leverage. Naturally the benefits of leverage show up when you make the 'right' purchase. But the wrong purchase can dig you a pretty deep hole. Perspectives of people like Dave Ramsey don't help my dilemma much either. Wanted to see what the consensus was on these forums, what is your take on leverage and what was your strategy when you started off?

Thanks for your input!

 

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[EvanOkanagan]

If you want to grow at a snails pace, then don't use leverage. Otherwise, you need to take calculated risks to see the rewards.

 

[lowtek]

It depends on what you are going to buy and for what purpose.

Do you have a specific deal in mind? Or are you pontificating on the values of leverage in general? I'm guessing you're talking about buying property to rent out, since if you're flipping you almost certainly have to pay cash or get hard money.

Suppose you have 300k to invest... you could buy a 300k property outright that nets you 1500 a month

or you could leverage to buy a 1m property that nets you 5000 a month

In the former, you are guaranteed to make a small amount of money... but you're also not likely to be worried about market downturns. You're likely buying a smaller property, so vacancy rates are a bigger consideration, as is the impact of a bad tenant ruining the property.

In the latter, you're probably getting a commercial loan and have to worry about paying it off or refinancing it at year 10 - or selling it before then. In which case, you're more sensitive to market conditions. But then again, you're certain to make more money right off the bat. This is money you can use to roll into another property to increase your cash flow further. It's also probably more units, so vacancy rates aren't as big an issue.

I would almost always opt for the latter... until such time as I could buy the $1m property outright - then I would.

 

[EvanOkanagan]

I'll elaborate on my post a bit with my own personal experience. I buy cash-flow producing rental properties and have been a Realtor as long as I have been investing in properties.

I got my license and started investing in Real Estate about 4 1/2 years ago. At that time, I had literally no assets and 20k in a retirement account.

With that 20k, I used leverage (a mortgage) to buy my first property. It was one of the scariest & exciting financial moments I've had, as that was only 5% down on the property I bought. Before purchasing, I worked out the numbers--and if you leave yourself enough room for error in RE investing it's hard to lose (talking about cashflow rental properties).

Now I had some good cashflow coming in every month from that property I bought--so I banked every penny of it, as well as continued saving any extra money I had from the J.O.B (Realtor in this case). A while later I bought a couple more properties (with a partner this time) and came up with the cashf from the extra money I was saving (again leveraged).

Then it really started to snowball. Adding more properties would add to my savings, helping to grow at an exponential rate. Not only that, but after a certain time with renters paying down the mortgages and seeing some appreciation in the properties, I didn't have to use my savings anymore for the properties and was able to take out equity from the properties (again, leverage).

Now fast-forward to 4.5 years after my first property. I have a portfolio worth over 3m-- and over 1m in equity with these properties. I've also been making cashflow from the properties for 4.5 years (more than enough to pay for all my expenses now), and have paid down a substantial amount of principal over those years as well.

Where would I be had I not used leverage and instead kept saving from my initial 20k (that took me a year to save..)? How much money would have been lost over the years (via cashflow and mtg paydown) had I just waited to buy without using leverage?

Bottom line: If you're just starting out, leverage is an amazing tool to help you grow. If you've already amassed large sums of money and you're just looking for a safe place with good returns for your money, then you might not need to use leverage.

TL;DR: Went from 20k to over 1m in net worth in a short time using leverage. Unless you have large sums of money just sitting in the bank, use leverage to help exponentially grow

 

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[jon.a]

7 years ago leverage was good.
Today not so much.
For most people.

 

[Paul Thomas]

I'll elaborate on my post a bit with my own personal experience. I buy cash-flow producing rental properties and have been a Realtor as long as I have been investing in properties.

I got my license and started investing in Real Estate about 4 1/2 years ago. At that time, I had literally no assets and 20k in a retirement account.

With that 20k, I used leverage (a mortgage) to buy my first property. It was one of the scariest & exciting financial moments I've had, as that was only 5% down on the property I bought. Before purchasing, I worked out the numbers--and if you leave yourself enough room for error in RE investing it's hard to lose (talking about cashflow rental properties).

Now I had some good cashflow coming in every month from that property I bought--so I banked every penny of it, as well as continued saving any extra money I had from the J.O.B (Realtor in this case). A while later I bought a couple more properties (with a partner this time) and came up with the cashf from the extra money I was saving (again leveraged).

Then it really started to snowball. Adding more properties would add to my savings, helping to grow at an exponential rate. Not only that, but after a certain time with renters paying down the mortgages and seeing some appreciation in the properties, I didn't have to use my savings anymore for the properties and was able to take out equity from the properties (again, leverage).

Now fast-forward to 4.5 years after my first property. I have a portfolio worth over 3m-- and over 1m in equity with these properties. I've also been making cashflow from the properties for 4.5 years (more than enough to pay for all my expenses now), and have paid down a substantial amount of principal over those years as well.

Where would I be had I not used leverage and instead kept saving from my initial 20k (that took me a year to save..)? How much money would have been lost over the years (via cashflow and mtg paydown) had I just waited to buy without using leverage?

Bottom line: If you're just starting out, leverage is an amazing tool to help you grow. If you've already amassed large sums of money and you're just looking for a safe place with good returns for your money, then you might not need to use leverage.

TL;DR: Went from 20k to over 1m in net worth in a short time using leverage. Unless you have large sums of money just sitting in the bank, use leverage to help exponentially grow

Loved this post, thanks!

When you were at the 20k point and had not yet invested in your property what books/resources did you use to get ready to make that first investment in a cashflowing property? Additionally, did you live in the first property?

Thanks!

 

[MattR82]

What % leverage though..

Stacking up a house of cards on 5% loan to value ratio is different to having a nice healthy LVR with a bit of breathing space (although in Australia those days seem long gone anyway with lending restrictions).

 

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[garyjsmith]

+Rep. Thank you for sharing that

 

[EvanOkanagan]

Loved this post, thanks!

When you were at the 20k point and had not yet invested in your property what books/resources did you use to get ready to make that first investment in a cashflowing property? Additionally, did you live in the first property?

The best thing I did was joining a group of like-minded investors at a Real Estate brokerage (as a Realtor). One of them there mentored me to pull the trigger on my first one. I was reading books years prior but never actually put pen to paper--so I'd say joining a local investment group or becoming close with Investor/Realtors in your town would be the best first move.

My first place was a house that I used as student housing (rented out per-room). I had one room reserved for myself but shortly moved out to a condo I rented. Good idea though if you're paying high rents to live in part of the house if you can and rent out the rest.

What % leverage though..

Stacking up a house of cards on 5% loan to value ratio is different to having a nice healthy LVR with a bit of breathing space (although in Australia those days seem long gone anyway with lending restrictions).

^^ Truth. Though I did 5% for my first property, that was the highest I've ever leveraged a property. I'm sitting at about 35-40% loan-to-value right now for my portfolio

 

[garyjsmith]

After reading through -- both the thread and JScott's link -- I'm seeing a lot of parallels to Options

 

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[MattR82]

The best thing I did was joining a group of like-minded investors at a Real Estate brokerage (as a Realtor). One of them there mentored me to pull the trigger on my first one. I was reading books years prior but never actually put pen to paper--so I'd say joining a local investment group or becoming close with Investor/Realtors in your town would be the best first move.

My first place was a house that I used as student housing (rented out per-room). I had one room reserved for myself but shortly moved out to a condo I rented. Good idea though if you're paying high rents to live in part of the house if you can and rent out the rest.



^^ Truth. Though I did 5% for my first property, that was the highest I've ever leveraged a property. I'm sitting at about 35-40% loan-to-value right now for my portfolio

Nice!

 

[Striver]

I would almost always opt for the latter... until such time as I could buy the $1m property outright - then I would.

Using your own method and advice as a prompt for my question, why not use the $1m to leverage a $3m property?

 

[lowtek]

Using your own method and advice as a prompt for my question, why not use the $1m to leverage a $3m property?

You can, for sure. It really just depends on your goals, risk appetite, and ability to secure financing. A loan that large is going to be commercial and is going to come due in 10 years. If you think you can make that $2m or sell the property at a profit in the next 10 years, lever up. If there's doubt, then you may want to just go for the sure bet and own the $1m property outright. And of course, the bank can always make the decision for you

 

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[MJ DeMarco]

I'm seeing a lot of parallels to Options

There are. Both assets can leverage time as an asset (make $ as time passes) and both require less money output to get control.

But only one is liquid.

I think leverage is great.

But I don't like leverage combined with illiquidity.

 

[BrandonS85]

There's alot of pros, a few cons with leverage.

Pros

• Increases your buying power
• Lets you borrow money for TOMORROW's projects at TODAY's rates (Inflation is awesome!)
• Helps you scale quicker
• Can make deals profitable that without it would be impossible

Cons

• You're a slave to the lien-holder (Can be mitigate via contract, but still)
• Can decrease your businesswide cashflow

I deal with many people who have been in real estate for a very long time. They TEND to frown on leverage as they've seen a few people who have lost it all via acceleration/calls on their debt from banks during down times. One guy just lost it all because his mining company started to have a rough stage and a local bank called all his loans. Everything was auctioned off, both his mining company and his real estate company and the results were pretty terrible for him.

On the other end of the spectrum, the one I make to people who have been in it for a long time is that it's VERY hard to scale to a reasonable business size without leverage. In my case I try to do partnerships, private money loans and traditional bank loans and equal it all out. I FEEL that it provides a good mix while increasing my monthly bottom line.