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How much is too much?

David9205

ergoCentric Dave
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Jul 17, 2016
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Hello,
I'm off to what I think is a good start, however have seen many people be cautioned about being over-leveraged. What is a safe amount of equity I should carry as a % of my entire portfolio?
Thanks!
 

DanW

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Sep 18, 2007
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Equity in the property or cash? I don't keep much aside. I invest cash into buying more properties as well as updates to my current units.
People thought I was nuts until they saw the results. My security is monthly cash flow. I am not in a super heated market and I buy at depressed prices so it works well. It may not work in other markets.
 

David9205

ergoCentric Dave
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Jul 17, 2016
Messages
16
Equity in the property or cash? I don't keep much aside. I invest cash into buying more properties as well as updates to my current units.
People thought I was nuts until they saw the results. My security is monthly cash flow. I am not in a super heated market and I buy at depressed prices so it works well. It may not work in other markets.

Hi Dan,
Equity. Before I started investing and because of the market in BC I had built up a fair bit of equity in my primary residence. I'm now using a HELOC secured by my primary residence for the down payment on new cash flowing property. Just wondering at what point do I become over leveraged? For example if my total portfolio is worth $2M, should I have $400,000 equity (20%) and finance the other $1.6M (80%), should it be 33% equity/66% financing, 50% / 50%, etc?
 

DanW

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Well, I just have 20%, but I can't say what you should have. If prices go down for me it won't be nice, but it won't hurt me since the cash flow is good.
 

Rickson9

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Although I carry no debt, I think I would be comfortable with 25% leverage (ie 75% equity).

It's all a matter of your personality.
 

Thomas Beyer

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You need a reserve. A rule of thumb is to be able to cover three months vacancy, or six if you are more cautious. If you are in a falling market like AB you need more than in a rising tight vacancy market like GTA or BC. We used to budget 10% lower rents at 10% vacancy as reserves and that proved to be too small for AB. Cash buffer is vital in falling markets. Many 2012-2014 buyers are now upside down in AB (but they tend not to blog here and admit their mistake).
 
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Matt Crowley

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A good rule of thumb is that your DCR is the amount that your gross rents can come down and you can still break even. So with a DCR of 1.2, your rents can come down 20% and you will break even on cash flow.

There are two totally different budgets running at the same time when you buy a property and manage it:
1. Operating budget: property taxes, small maintenance repairs, property management, insurance, marketing, bookkeeping, legal, utilities.
2. Capital budget: these are the big ticket cyclical expenses. Roof replacement, driveway, windows, furnace, fence, exterior, mechanical upgrades. Unless your property is brand new you are going to need a capital budget.
The right amount of cash in your account could be $0 if you are comfortable providing cash calls to your property. I don't really see any rigorous discussion on this forum regarding capital budgets. All I seem to see is regarding before tax cash flow = NOI - debt service.

My over leverage evaluation starts with a robust budget exercise:
1. Operating budget: even if I am providing my own PM, I charge out the fees to the property when performing a financial analysis on it. Operating budgets need to be based on actuals and should be a line by line build-up budget. Maintenance line is not going to be 5% of gross revenue, it is going to be determined by the upcoming small maintenance items for the property. From there I take a look at the before tax cash flow of my portfolio.
2. Capital budget: I update my inventory of cyclical repairs. I code each one: U=urgent, N=needed, R=recommended, W=wanted. Some cyclical expenses need to be done (furnace) while some can wait a year until there is more cash available (windows). Other enhancements may provide an enhanced tenant profile and help to protect the investment longer term (going from low quality laminate to luxury vinyl tile).
Before talking about leverage you need to really understand your numbers. 20% equity minimum before you know what you are doing is a pretty safe starting point. If you are the investor-owner, you need to look at the actual cash in account after tax and after cyclicals / capital budget and ask, "when do I get my money back?" Personally, I think it is really amateurish to have a portfolio that constantly needs cash calls, but that may be some investor's preference.
 

Sherilynn

Real Estate Maven
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Oct 22, 2007
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Minimum amount of equity can also depend a bit on the market.

We got started by buying properties with low money down, living in them, renovating the secondary suite, buying another property, and then renting out the first property. We bought with 5% down but this was in the 2006 boom in Alberta, so between the boom and the renovations, we quickly had plenty of equity. And because suited houses cashflow well, we were easily able to weather the downturn.

But we used a very cautious approach to this. We took on one project at a time and focused on suited houses because of the high cashflow and because they hold their value well. And we never used high-interest financing.

I saw other investors buy condos with high-interest renovation mortgages and take on too many projects at once. Then the market collapsed before the renovations were done and they couldn't refinance to cover the high loans. They lost it all.

For me, being conservative in your plans and budgets, and having a reserve fund to weather the storm is more important than your LTV at any given time. Values will rise and fall, but that only matters if you are forced to sell at a depressed price because you have negative cashflow and no reserve.
 
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