Author Topic: Case Study - Too Much Leverage?  (Read 4053 times)

FIRE_HELP!

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Case Study - Too Much Leverage?
« on: May 09, 2014, 11:07:54 AM »
Hi everyone.  Just looking for some general feedback on whether we have too much leverage/debt.

We live in a very high COL area outside of New York City.  Luckily our income justifies living here - stable jobs with high salaries (although not a lot of upside potential).  We own our home and 2 other rental properties in the area that we have accumulated over the last 8 years.  We are in our early to mid 30s with 3 kids.  Here are some general figures:

Total Combined Property Value: $2.0mm
Total Outstanding Mortgages: $1.5mm
Combined After-Tax Annual Income: $270k (including rental income net of expenses).
Annual Expenses: $135k (including rental properties does not include principal payments for any of the properties).
Highest outstanding Mortgage Rate is 4.125%.  All mortgages are fixed and were initially 30yr terms.
No other debt.
$255k in investments and retirement accounts.

Given our life situation, current combined income and annual expenses, do we have too much leverage, just right, or not enough?  After maxing-out 401ks, would you prioritize paying down mortgage debt with the balance of annual savings or should we look to invest (either in stocks or additional rental properties)? 

Our thinking has been that the fixed rates seem very attractive as long-term debt and, while paying them down is a guaranteed return and would decrease leverage, if rates keep going up we may someday regret having aggressively paid down principal.

Thanks in advance!
« Last Edit: May 09, 2014, 11:24:47 AM by FIRE_HELP! »

DOPOLI

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Re: Case Study - Too Much Leverage?
« Reply #1 on: May 09, 2014, 11:42:27 AM »
Definitely recommend staying away from real estate w/ any new investments and go for a more balanced portfolio outside of real estate (stocks, bonds, etc).

I can't say if you're too leveraged. It depends on how you feel about it. Are you freaking out about having 1.5M-2M in real estate debt? Then maybe it's not worth it.

FIRE_HELP!

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Re: Case Study - Too Much Leverage?
« Reply #2 on: May 09, 2014, 12:13:25 PM »
Definitely recommend staying away from real estate w/ any new investments and go for a more balanced portfolio outside of real estate (stocks, bonds, etc).

I can't say if you're too leveraged. It depends on how you feel about it. Are you freaking out about having 1.5M-2M in real estate debt? Then maybe it's not worth it.
Debt level doesn't bother us per se, as the cost of owning or renting a single family home in this area is really high and that's what is driving the big asset/liability lines.

We think real estate is probably a better bet in the long run (we may never see rates this low again?) but just want to make sure we aren't in over our heads vs generally accepted levels of leverage.

DOPOLI

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Re: Case Study - Too Much Leverage?
« Reply #3 on: May 09, 2014, 12:18:45 PM »
It seems fine if:
- you know that you aren't going to sell for 15+ years
- you can deal with the possible psychological shock of real estate values going down in the near-term if interest rates rise
- you are satisfied with your rental returns
- everything else is stable.

jasman18

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Re: Case Study - Too Much Leverage?
« Reply #4 on: May 09, 2014, 02:08:39 PM »
One thing to remember: Rental income does not compound like Equities do.
Being that unbalanced could be a detriment to long term growth.

TomTX

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Re: Case Study - Too Much Leverage?
« Reply #5 on: May 09, 2014, 03:02:48 PM »
If you are in a stable situation with no plans to move - the leverage seems reasonable, even if the figures are large ;)


Tyler

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Re: Case Study - Too Much Leverage?
« Reply #6 on: May 09, 2014, 04:00:12 PM »
So your debt to liquid (non-retirement) savings ratio is what -- 10:1?  That's personally pretty steep for my tastes.  You're fine if your situation is steady-state, but the real world will always find ways to surprise you.  Job losses, real estate market changes, etc. can sneak up faster than you realize, and the high leverage may not allow you the luxury of waiting out the correction.  I know several very smart people who went bankrupt in the Bay Area like this. 

I'd personally be a lot more comfortable selling one rental and shifting that money into liquid stocks/bonds.  Then again, I've never been much of a rental buff myself so others here may have a different perspective.

totoro

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Re: Case Study - Too Much Leverage?
« Reply #7 on: May 09, 2014, 04:23:20 PM »
Your leverage is not a problem if you have properties that pay for themselves, long-term low rates on your mortgage, a goodly amount of other savings/investments (you do), and high incomes (you do). 

Are your rental properties cash flow positive when you factor in all expenses including the full mortgage payment (not just the interest)?  This provides a safety net. 

Are your mortgages set for a longer term?  Have you planned for a scenario of mortgage renewal when rates rise and/or one of you loses their job and/or you have vacancy?

Mr. Frugalwoods

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Re: Case Study - Too Much Leverage?
« Reply #8 on: May 09, 2014, 04:52:25 PM »
Hard to say without knowing what sort of return you are getting on those rental properties.  If you aren't making at least 8% cash on cash, then it might be a good idea to redeploy at least some of that to better performing assets.

It sure seems you could be overweight on real estate in terms of a balanced and diversified portfolio.  Not super concerned about the leverage in particular, and those rates are excellent as I'm sure you know.

Emg03063

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Re: Case Study - Too Much Leverage?
« Reply #9 on: May 10, 2014, 03:15:47 PM »
I would consider how your cash flow is impacted by the loss of one or more of your income streams.  It sounds like everything is ok at the moment, if you're comfortable, but you seem a bit cash light for my comfort if one of your investment properties stops performing and you have to support it.  I wouldn't necessarily look to sell, but I would work on deleveraging by adding more to my paper investments as time goes on.  I wouldn't be looking to add more real estate until my paper assets were about 50% of my debt, but that's my personal comfort level.  Real estate offers potential rewards to those who can appropriately manage the liquidity risk.