Commercial Real Estate Investing – How Comfortable Should You Be With Debt?
“He who wishes to be rich in a day will be hanged in a year.” — Leonardo da Vinci
I just received an email from a beginning investor that has a question, and somewhat of a dilemma…
He wants to purchase a commercial real estate property, but does not like the thought of all of the debt that is involved. He has worked hard to achieve a great credit score, has some money to put down on a property, but does not like the idea of having a large loan over his head.
What should he do?
First, many of you reading this know that there is a difference between good and bad debt. When you get a loan to buy a $500,000 property and there is sufficient cash flow to pay the loan – and pay you a nice cash flow, that is positive debt. That is good debt that not only covers the cost of the loan, but also gives you cash flow every year.
This positive leverage allows you to buy a $500,000 without using all $500,000 cash. You have your tenants making the payments AND your appreciation and value is based on the debt you have used – NOT just the cash you put into the property. So, if you put $100,000 into your down payment and the property appreciates, say 3%, or $15,000 you have just made a 15% return on your down payment…..using leverage.
This is not to mention the positive cash flow you will receive from the property – above all of the expenses involved. It really comes down to being comfortable knowing that debt used constructively will give you higher returns on your investment. It is just a tool, nothing more.
And when you sell the property the debt will be paid off, too.
If this still makes you squeamish then you want to focus on all cash deals, or deals where you have your cash in, but no leverage. You will sacrifice return, you will sacrifice the number of deals available to you, and you may even sacrifice the quality of deals that you get involved in. If it makes you sleep at night, that is OK, but know the trade-offs.
I have found that a well-located investment should be a no-brainer for a new loan, a new ‘tool’ to get the most return and cash flow that you can. If you cannot sleep at night, then go the cash route understanding that you are leaving extra cash flow and return on the table for peace of mind. It is a trade, and quite honestly, there are no right or wrong answers – just preferences.
