"Good Debt" - Posted by Tony Colella

Real Estate Investing Single-Family Homes
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Posted by Tarheel T on March 21, 2011 at 05:20:31:

Bernd you are my hero!! What you write here is the truth although certainally unpopular.

The bible says something to the effect of “if you don’t work you don’t eat”. Today we see a certain % of the population carrying those who will not work or even if they will work, they refuse to save any of their wages and so they fall back into public support just as soon as they hit the first speed bump. There was a local real estate investor who wrote a weekly column in my local newspaper on personal finance. In one of his pieces he professed that anyone who does not save at least 10% of their income is living beyond their means. His column was soon dropped.

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“Good Debt” - Posted by Tony Colella

Posted by Tony Colella on March 20, 2011 at 12:40:35:

Ryan wrote the following quote in his candid post about the current state of his business.

“There is NO good debt. (yes others will argue this but I’m living the reality of “good debt” gone bad right now)”

Now Ryan knows that I have not and will not kick him while he is down. His wording indicates he expected some disagreement.

This post is not about how Ryan used debt but rather debt itself.

Ryan indicates, just as many others I have spoken to that have been hard hit by the economy, that they expect to return to the investment game.

Folks, unless we weather the storm with assets intact and fairly liquid assets at that, debt will be a fact of life. It is wonderful to believe that a business will rise from the ashes and do so without debt but if the business fails or simply scrapes by, there won’t be cash to buy new deals no matter how good they are.

Think of Lonnie’s model. We were able to buy 3 bedroom mobile homes for next to nothing because we had cash. Cash to buy, cash to hold and cash to fix up if necessary. The reason that the end users didn’t buy for next to nothing was (in addition to Lonnie’s knowledge) that they did not have the cash. They could only buy if someone would finance them (namely us).

We cannot tell ourselves we will not use debt and expect to start with nothing and create something in a reasonable period of time.

How we handle that debt and how much we expose ourselves to is a personal decision. Much like Ryan I don’t want more debt but perhaps “better debt” would be more appropriate. For me this would mean fewer properties with less debt as I don’t need a huge income but I do need less exposure to risk.

For others like Rick Ewens less debt in this economy would be crazy in light of the deals he may find through the “better use” of debt.

I am due to close on a property tomorrow that will use “debt” but in such a friendly manner that it represents very little risk to me. This is a unique property to me and me alone because it adjoins my property. To accomplish my desires to expand upon my property and the plans I have for it, I needed debt. If the debt had not been so friendly I would have had to pass but would any of us pass on a good deal, safe loan terms that allows us to advance our interests simply because debt was necessary?

If we needed a car to go to work and had no cash due to losses in business would we not borrow money to buy a car to get us to a job that provides us with income to not only pay for the car but also provide for our families? Is this really any different for the investor who makes his living with real estate as their vehicle?

I know many of us have here have been burned by debt and in some cases we are to blame and in others it was outside forces entirely but the reality of business is that money is necessary to start, to hold, to improve and expand. That money has to come from somewhere and if we don’t have the money we must turn to debt, albeit with a great new respect for it.

Tony

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Re: “Good Debt” - Posted by Chris in FL

Posted by Chris in FL on May 22, 2011 at 02:56:01:

There is good debt and bad debt, now as there has always been. Way too many people got swept away with real estate and borrowing near the market peak, and got burned. Now many of them will overcorrect, and “no debt ever” will be their mantra (ala Dave Ramsey). Their loss. Far before the bubble burst, it was very easy to see that lending got out of control, and there would be a lot of fallout (I saw people able to buy property with 100% bank financing if they could sign their name stating their income was xxxx amount - HELLO!!!). I saw fixer uppers selling for prices so high that, for the cost of the house plus repairs, you could buy the house next door that was already all fixed up - HELLO!!! Plus, way too many people were buying anything they could any way they could just because they could - and thought it was ‘good debt’ because real estate only goes up in value - HELLO!

Those with a cautious buy and hold strategy, using good debt, with reasonable cash flow above their debts, and reserves, rode it out okay. I do SFR, but let me share this. I started buy and hold SFR in 1998. I bought often with 80% debt, and it worked well for me. By comparison, today I can buy the same houses cheaper, and the rents today are 50% higher. Plus, my cash flow and reserves are better today than they were in 1998. Can anyone really think borrowing the same 80% today would be a bad thing? Really? Deals that required 15 year and 30 year amortizations (80% LTV) to break even in 1998, I can do today and break even with a 6 year amortization and 100% LTV. It is okay, though, that so many hate debt right now -it makes it easier for those who recognize opportunity to make the most of it!

A Robert Allen take on it - ‘a million in debt is a million in net’. If you borrow a million dollars against income producing assets that will carry the debt, and you make the payments, eventually you will have a million dollars in net worth.

Just my two cents worth.

Best wishes,
Chris in FL

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Re: “Good Debt” - Posted by shawn sisco

Posted by shawn sisco on March 20, 2011 at 17:12:44:

Tony, the three legged stool analogy comes to mind when
I ponder these things. Were an investor to keep all
three legs (short term $$) (Long term) (mid range with
lump sum payments) more or less in balance, the deals
we would be involved in would be much more diverse and
our ability to weather a downturn would be much
greater. I know this from my own experience, I have
been getting along without an income stream that once
leveled out the valleys, and by relying chiefly on the
monthly rent income stream without the land sales
providing some lump sum payouts that would have been
re-invested into other deals with other people thereby
expanding my list of contacts to network with- who in
turn produce other referrals that feed other facets of
my business. By my ?hunkering down? and focusing on my
MHP operation I have without a doubt limited my
opportunities. Ironically, I did so to focus on
becoming debt-free.
While I agree that the use of debt to acquire assets
can be most useful, and is commonplace. I think that
investors do themselves a great disservice, by never
really getting in the game, or later on after having
accumulated assets, by keeping those assets at risk by
keeping properties indebted.
The ?game? as I see it is acquiring assets by using
strategies other than straight purchases for long term
holds. Buying packages of properties from retiring
landlords and dealing them off, trading with other
investors, and of course the option strategies that you
so aptly mentioned come to mind.
Steve WA reposted below this week about a couple of
MH?s that he ?acquired? with precious little cash but a
lot of specialized knowledge and a great relationship
with a park manager. These two little deals should
increase his income by $600+ per month which is about
all that he has invested out of his pocket.
These little deals impress me so much because I can do
these; you can, as can everyone reading this forum. I
can probably improve my short term income as much by
doing this sort of stuff as I can with $300,000 of
financed inventory for sale. So what am I waiting for?
I feel that I have grown complacent, and I sense that
other posters here have too.
It is time to buy some doughnuts and visit some MHP
managers, and transporters.

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Re: “Good Debt” - Posted by JeffB (MI)

Posted by JeffB (MI) on March 20, 2011 at 15:07:41:

I have a great many thoughts to share on debt but at the present moment, want to keep it short and say I mostly agree with what Tony is saying.

Debt itself is not bad. It’s being illiquid or insolvent that is bad. You can have all the debt in the world, but if you have assets, cash flow, and/or significant equity in the property you can use it safely every single time. What I am trying to say, admittedly not very eloquently, is that debt is not cause of failure, it’s the application of that debt to one’s business in a manner that does not provide sufficient liquidity and multiple exit strategies that will inflict damage down the road.

Jeff

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Re: “Good Debt” - Posted by Tony Colella

Posted by Tony Colella on March 20, 2011 at 15:15:30:

If we could pay all cash for a handful of properties many of us now would (after the economic crisis). Previously many of us would have leveraged that cash reserve into more and more deals.

When we consider a scenario of NO CASH to start with, we are left with the use of debt.

Sure, lease/option type scenario’s can limit the amount of debt necessary (provided the state gov’ts don’t outlaw them too) but you will still need cash reserves and investment capital of some sort to improve the property.

Some time back I wrote a series of posts suggesting people don’t quit their day job. My theory is that if you can live off of the income from your job and you poor the income from the investment properties into the property and to pay down/off the mortgage early then you may not need as much cash in hand.

If you can do one or two of these per year I believe you could have a very tiddy retirement plan created in a matter of 10-15 years that would provide for a family outside of any pension (few jobs still offer pensions) and 401k type investments. If you have those then you are even better off.

Tony

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Re: “Good Debt” - Posted by Bernd Hanak

Posted by Bernd Hanak on March 20, 2011 at 19:00:15:

Savings precede investment. Savings is the simple difference between production and consumption. Risking no savings, or an insignificant amount relative to the price of an investment, is not investing, is not even a speculation, but is like purchasing a lottery ticket or pure Las Vegas-type gambling. Could one exemplify a unique situation which seems to be contrary to the laws of successful investing? Of course, the possibility exists, especially during the recent credit and housing bubble. However, the bubble has burst, and reality is reasserting itself. Only savings can serve as investment capital. The debts of the mismanaged ?too big to fail? banks, which we and our children are allegedly responsible for, were not caused by the banks? prudent investing of our savings, but by the fractional reserve system and the elimination of established legal safeguards. With the blessings of government, these banksters pretended to invest our savings with a thirty- to- one leverage. This is like buying on margin when one ?plays? the stock market. When the margin call comes, it is time to pay the piper. Whether the amounts of money are in the trillions or in the thousands, the principles of investing are the same. If recent history doesn?t teach us that debt is like fire and can easily kill us if not conservatively managed with respect, then we have to suffer a bit longer. I am of the unpopular belief that a person?s ?need? without having savings simply means that the person does not have a ?need?. In fact, I believe that an able- bodied person who refuses to produce has no right to food or shelter. Savings were the foundation that made human progress possible through the ages. Our American society has evolved, along with plastic and its twin, easy credit, into a nation of next to no savings which thinks that the credit card is an expanded bank account. We forgot that nature has built-in checks and balances, and so does any flourishing society. Get away from that, and everything collapses.

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Re: “Good Debt” - Posted by Shawn Sisco

Posted by Shawn Sisco on March 22, 2011 at 09:40:22:

Great Post Bernd! I think many have missed the wisdom of Lonnie’s advice to buy MH lots (or other long term investments) when you can no longer keep all of your money working in higher yielding, short term deals.