To leverage, or not to leverage… is that the question? Not really. It is more of an investment philosophy that you answer on your own in alignment with your goals and tolerances. What is leverage? Leverage, as defined by Investopedia, is:

1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.
2. The amount of debt used to finance a firm’s assets. A firm with significantly more debt than equity is considered to be highly leveraged.

Basically, leverage is using Other Peoples’ Money (OPM) to help finance your investment. In real estate, this is usually done by getting a mortgage from a bank. Is this a good thing? As with all things, it depends. There are many different reasons why you may want to use or avoid leverage.

Reasons to avoid leverage:

1. Cash flow – If there is no debt to service, your cash flow is much higher per property even though the ROI is smaller
2. Time and Energy – Without leverage, you can only go so far as your existing capital, which means you may only have involvement with 1 property for every 2 or 3 that you would acquire with leverage
3. Exit strategies – You should always have multiple strategies to exit your investments. If you own the property free and clear, it doesn’t matter what the sale value is, you won’t be underwater
4. Peace of mind – All properties have surprises. If you do not have operating capital and a major problem occurs that is not covered by insurance (i.e. foundation problem), it is usually simple to tap into the stored capital in the property to cover those expenses

Reasons to use leverage:

1. Increased returns – By using leverage, you can put less cash in any one deal. The ROI goes down because you now have a debt to service, but you have only spent (let’s say) 20% of your capital. If you fully deployed your capital, you would control 5x the property. At the lower individual ROI, you are still making considerably more ROI than you would with a cash purchase of a single property because your lesser ROI x 5 is more than your single, higher ROI
2. Diversity – By leveraging, you can increase the number of doors you own. If one unit goes vacant, floods, or the neighborhood takes a dive, you are more likely to be able to offset the vacancy or reduced rent of the one with the income from the others. It is less likely that they will all be vacant at the same time
3. Taxes – One of the dimensions of real estate is the tax incentive that the government provides for those who provide housing to others. Even with only 20% of your own capital, you gain 100% of the depreciation which means you can save on taxes. I guarantee I can make my money work smarter than the government can, so tax reduction is a big win
4. Inflation becomes your friend – If a property that you have 20% invested in increases in value 10% over a few years, that gain is all yours, not 20% yours. That means your investment is now worth 50% more in cash terms to you! Inflation is now on your side, and inflation is a guarantee; the government openly states that they want inflation, and they own the printing press
5. Potential law suit reduction – Let’s face it, there are people that live to game the system, and there are more of them every day. If their attorney is working based on profit and they see that you are leveraged, you become less attractive because they may not be able to collect much from a win. Obviously, this does not preclude a legitimate suit. Don’t be that guy
6. Crash protection – “If housing values plummet, leverage can be very bad. You now own the entire loss.” That is not true. Many property owners let the bank take the property back. Does it destroy credit? For a time. At that point, you only lost your initial investment. This is called strategic default. I don’t necessarily advocate doing this, but leverage is actually protection in a crash. “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.” – J. Paul Getty

What is my strategy? My strategy is to be more aggressive at a younger age, and taper to more security at older. Use more leverage while I am young and then start transitioning to less stressful amounts. I am currently at an age where I want to expand my holdings and income to help change my lifestyle, so I am heavily leveraged in my properties. As I get older, I will likely taper that down to give me less stress and maintain my lifestyle. I plan to always have some leverage in place. That is the plan today and it will almost certainly change in the future. Life teaches lessons and only a fool doesn’t learn from them. I recommend reviewing and assessing your strategy regularly to see if it still fits your vision.