Friday, January 25, 2013

Rental Property Investing - Cautions in Leveraging

Based on our prior blogs on Leverage, the opportunity to increase returns is clearly a prudent strategy for many. But it should be applied on the right properties and primarily those with the right circumstances. A realistic understanding of the risk involved should be foremost in your decision making.                                                 

Let’s look at the following ‘Cautions’:
  1. Mortgage Payments Change When Interest Rates Rise – if the payment is manageable in the intial term (say 3 years), what happens if the rate rises 2-3% in a subsequent term. Does the return disappear? – Can the payment be covered?
  2. Maximum Leverage vs. Poor Real Estate – the best leverage deal does not improve a bad investment . You can also lose focus on value, lack opportunity for appreciation, and easily be ‘underwater’ at some later stage. Lucrative financing can often be a trap!
  3. Cash Flow is Key – Is the current cash flow sustainable? Are current rents in fact market rents?  Status of expiring leases?  All are key parts to this exercise.  Buy and Hold strategies very much depend on sustainable cash flows and lack of price appreciation is much less of an issue as a result. 
  4. Over Estimating Price Appreciation – being too optimistic in this area is a major downfall for many and results in negative returns. Best practice here is to be conservative and have this part of the risk analysis be of least importance – meaning future value appreciation, is not key to your decision in acquiring the property.
  5. Risks of Overleveraging with Personal Liability – the consequences can be catastrophic on a personal level if your portfolio of properties underperform and end up selling below the initial investment. Personal guarantees (known as convenants) are pretty common in the market today, so you need to understand the risks they present and factor that into your decision making.
A sound leverage strategy is worth implementing – but keeping the above points ‘top of mind’ as you execute your plan. As always, consult a experienced commercial realtor in your area, to assist in implementing your plan.

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