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Leverage understanding and execution

I’m not a conceptual fan of leverage.

 

But the more I read. It grows on me.

 

 

I’m fully aware that statistically real estate has generated wealth like virtually no other asset class (see stocks) in the last 100 years. The reasoning behind both single and multifamily makes sense, no matter what apple creates or where technology takes us… You have to live somewhere, we all do.

 

The need shouldn’t go away with time.

 

It’s easy to make the case for sticks and bricks, even though they bring generally much more labor/headache than the equity markets (this is assuming you don’t get headaches during times of beat/volatility). What they also usually come with is leverage, and with historically low rates this is a good thing.

 

I think.

 

I’m not usually a comfortable guy with debt, which is ironic considering virtually every other successful person I know loves it. The more I get into real estate the more I have to try and increase my comfort level with debt, which is easier said than done in my case. The main issue with debt in real estate is that it is largely illiquid. If you need to take cash out of a property in a bad economy when banks are tight, you just can’t do anything about that. Not so with stocks, though if you pull out of the stock market in a down market that little caveat just enables poor financial behavior.

 

Real Estate is not “marked to the market”

 

That is one of the best things I’ve ever heard said out loud for making sense of why real estate investors tend to do better than stock investors over long periods of time (amateur investors in both categories). It just makes so much sense to me, and after these bullet points it should to you as well.

 

  • Stocks trade every day at fluctuating prices, you can go pull that information anytime and let it impact your decision making.
  • Real Estate values tend to change very slowly, and unless you have a formal appraisal done the “value” of your asset is just based on what you think it’s worth.
  • I’m confident in saying that if your home or apartment complex was “marked to the market” you would have a much harder time seeing that investment through for 15 or 30 years. Because….. EMOTIONS.

 

 

Obviously, leverage works when you buy a cash flowing property and allow the rent revenue to service the debt while still creating cash flow, which would hopefully be a reasonable “cash on cash” return. If you do the math well and factor in maintenance/repairs/vacancy this can be a tremendous wealth generator.

 

But what if you do the math incorrectly?

 

That is why I’m scared of leverage, well… one of the reasons why. Because if you have more vacancy than expected, the bank doesn’t care. If you have more repairs than expected… The bank doesn’t care. Your payment is set, and you absolutely must service that debt in order to maintain the property and ultimately generate a long term return.

 

 

 

With all that said, leverage when correctly applied can hands down accelerate the wealth building journey. It’s a risk/reward scenario and knowing that I’m ok with taking a little calculated risk to win bigger long term.

 

How do you fell about leverage? Let us know in the comments below.

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