Author Topic: real estate for portflio diversity - Paying Cash vs Using Leverage to Purchase  (Read 910 times)

bthewalls

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Have been watching 'moris invest' on you tube (Paying Cash vs Using Leverage to Purchase Investments). https://youtu.be/js34q_Zt1jw

I'm a bit lost......at 8.42 mins on this you tube he discusses how to start the purchase process.  He compares the benefit of completely buying the first rental with cash and then refinancing to buy a second and repeating the process over and over (obviously buying destressed/under value property that can be leveraged...which is easy in northern ireland, where I live).

Would love to hear what people think of this, I had assumed the only way was to just put up repeat mortgage desposits as apposed to leveraging.  any links or reading suggestions would be a great...thanks guys.

Barry


Freedomin5

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It can work, but it can also be a house of cards.

Letís say I buy a property and pay off the mortgage. I can take $100,000 out of property A, so I do that and buy a $500,000 ($100k or 20% downpayment). I now have to make monthly payments on the $100k lien of credit and the $400k mortgage Letís say I get good renters and after a year, my line of credit is paid off and I can take out another $100k line of credit on Property B. So I take out $100k on property A and $100k on property B as a $200k downpayment and buy a $1M property C (20% downpayment).

Itís all fine as long as I have renters in all the properties. However, if life happens and Iím not able to rent Property C, then I canít make the mortgage payment and the line of credit payment on C. Since C borrowed from B, Iím not able to make the line of credit payment on B. So eventually I lose C, which leads to me losing B. If I lose B, I canít make the line of credit payment on A, and I lose A as well.

Obviously, thatís an extreme case. If itís used in moderation and you have another way to make payments (other sources of income), then the risk is not quite so great. So for example, weíve taken out line of credits on paid off properties with a solid rental track record to provide downpayments in new properties. We also continue working so if ever one of the units are vacant, we can still make the mortgage payments.

SwordGuy

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The house of cards analogy is very apt.

If things go well, extreme leveraging will multiply the gains.

Example, let's say inflation is 3% per year and housing value goes up with inflation.  That's all.

If I buy a house for 25% down, I get 3% added to the value but I only paid for 1/4th of that gain.    In effect, it magnifies my gains by a factor of 4!   
Pretty awesome, eh?

If I have $100,000 and buy 4 properties at 25% down, I'm getting 3% of $400,000 worth of appreciation but I only paid for $100,000 of it.  My tenants are paying the cost of the rest of the appreciation.   That's awesome.   

Same principle applies to rents increasing over time.   I'm getting 4 times the rent appreciation for the same money.  Good times!

And, of course, if there aren't good times, it's worse.

With a $100,000 paid for house, if it doesn't rent for a goodly while my carrying costs in my area are pretty low.  Maybe $2500 a year if I mow it myself.  $3000 if I hire someone for the yard work.  It's not fun to shell out money for no return but it's certainly doable.

But if I have $400,000 worth of bank loans and those properties aren't renting out, lordy, am I hurting!  I have 4 times the property taxes and 4 times the insurance and 4 times the number of yards to mow AND I have 4 mortgages to pay down!     If I get laid off those extra expenses will eat into my emergency fund pretty fast.

Had an out of town supervisor who but in 30 bids on $100k properties and got 5 accepted.  He bought all 5 at once.   Gonna make a mint!

Right after he closed a big factory shut down and people were leaving town instead on clamoring to buy from him.   Housing values plumetted so he was underwater on all 5 houses.    He had to rent them out for a pittance because that's the best he could do.

My first rental at $45,000 total cost (purchase + renovation) that rented out at $750 was producing more profit than his 5 houses for a tiny smackerel of the risk.   Bad stuff happens and it often clusters together with other bad things.


An in-between position is to buy a house for cash, repair it to get a bump in value, then borrow against it to buy another house for cash.    This way, you're only ever on the hook for 1 mortgage but you have two potential sources if income to cover it.   If only one house is rented you're still treading water instead of sinking in more and more debt.   You would have a 1-1 ration of paid for to mortgaged properties.   

A slightly more agressive one would be to do the above and do another mortgage with another downpayment.  This would give you a ratio of 1 paid for to 2 mortgaged properties.   If a cluster of bad things happen the bad effects could be softened somewhat by the paid for house.

The time to leverage is when the market is starting up, not when the market is stalling at the top.   Not that anyone knows exactly when that is, of course.   But the indicators are easier to monitor in a local real estate market than they are for the global stock market.

bthewalls

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Thanks for your explaination..food for thought

macmoneysaver

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Not sure if it is the same Morris, but one got into trouble for some sort of scam over the past couple years--be careful if you are engaging for more than just info.

@SwordGuy is spot on.

For more info on his description of the hybrid approach, google the BRRRR method or listen to BiggerPockets podcasts.

Bigger pockets website also has a couple free real estate investing books. (They are big on the BRRRR method and buying with no/low money down).  I personally think they overplay the leverage part, and it can get you into trouble if the housing and job markets go south.

Another option is to buy one with cash and two with 25% down.  This way, your overall portfolio is only 50% leveraged--easier to handle economic downturns.  Both the risk and reward are intermediate between the two extremes.

bthewalls

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Thanks...yes makes sense