How to avoid Overleveraging Real Estate

Hey YouTube, this is Cody. I've got Christian back for this week's video of Corporate vs Entrepreneur. Today's video topic, we are going to be talking about leverage, using debt as a tool, and then really focusing and hitting hard on the concept of overleveraging. We're going to be explaining what that is. There's some misconceptions out there on what overleverage means. Before we jump into that, we need to explain and address what Corporate vs Entrepreneur is. Christian took the corporate route. He has spent nearly a decade, because he's about a decade older than me, in the, the corporate path, and he's uncovered a lot of different experiences that have given him a different perception on how he views everything in the business space, in real estate, just general day-to-day. And since I dropped out of college a few years ago, I've accumulated different perspective than him. And so Corporate vs Entrepreneur is not us just butting heads, but it is really a collaboration of things we agree on, disagree on, and it is designed to give you guys, the viewers, a different perspective from both sides of the table on how we treat debt, how we treat real estate, business decisions, investments, and how we're going to both scale up and how you can do it too. That said, today, leverage, over-leverage.

Over-leverage, that is the first thing that I did not learn in college about this actually, was it's not about the amount. I think that's the first thing a lot of people are gonna jump to is, is $50,000 of debt too much debt? Is $5 million? Dave Ramsey would tell you any debt is too much debt. Over-leverage, to me, and I know Cody agrees with this, is how much debt can you take on that's not paid for out of cash flow? In rental real estate, for us, that's our tenant's rent needs to be able to more than cover the debt. If you're doing it that way, the number should be infinite. You can have $100 million of debt if that debt is more than servicing itself. I think a big place where a lot of people get stuck as well is they'll take an asset, real estate, heck, it could be gold, but you'll take an asset that is based on appreciation. You'll buy something that's like, oh, it doesn't quite cash flow, but in 5 years I know it's gonna be worth this. It's gonna be an excellent investment. My crystal ball isn't any better than yours. I don't know where they're gonna be. We call that speculation. And I think that is another huge piece where people can get overleveraged. When you owe stuff that depends on future events that have not happened, that you don't know will happen, that is over-leverage.

Right. And when you're getting started, big numbers are scary. I understand that. I got started, my first deal put me $1.1 million in debt. I get that the numbers are scary, but that's not a reason not to do this. If it cash flows or cash burns, that should be your decision maker. You need to account for risk though. And your risk is really going to underlie in number one, the market.. But on this overleveraged topic, you're going to have to look at your balloons. If you have short-term debt that you have to pay off next year, you're at higher risk than if it's due in 30 years and it'll pay itself off. An example of this, if you go and buy a house on a 30-year fixed-rate mortgage or a duplex on a 30-year fixed-rate mortgage, at the end of that 30 years, if you don't refinance and all you do is let your tenants make that monthly payment, you will own it outright in 30 years guaranteed. As long as you don't change the debt. If you start doing short-term debt, maybe you borrow hard money or you do a personal loan that's due in a year or 2 years or 3 years, you're probably going to have a balloon. It's probably not amortized, meaning it will be paid off completely at the end of that term. Meaning you got to write a check, either by writing a check out of your bank account, meaning you got to earn that money in a short amount of time. You're going to have to refinance it with new debt. Or you're gonna have to sell whatever you backed it with. Now, with real estate, I don't like to sell. I want to keep stuff forever, so I don't want to do short-term debt because I know when I'm borrowing big amounts of money, if it's due next year, I can get in trouble. So the balloons are something that can really quantify being overleveraged. If you have a whole bunch of fix-and-flip properties, I just did one, I could not handle more than the one I just did. I would I'd lose a lot of stuff. I could not cash flow a whole bunch of cash flow negative assets. And so that was a 1-year balloon, meaning that if I held the property in 1 year, I'd have to write them a check for $221,000. Guarantee you, I would not be in a position at that time, based on everything else I'm doing, to write that check, and I would lose that property if I couldn't refinance or if I couldn't sell, if the economy went down. So Above and beyond that, one way that you can quantify being overleveraged is having short-term debt.

Yes, short-term debt. I see with a lot of flippers. I also did my rental project in Moses Lake where we bought a duplex. Duplex was vacant. I had to completely turn it. So every month, that's a cash burn. It was in 1-year debt. It was a little painful when expenses come up and no new money's coming in. You hurt a little bit. Now, I had cash reserves for this, and those reserves protect you from over-leverage. I can write the check for what I need to do, or I can offload the property in time if I absolutely had to. I had an escape. Flippers, where you're doing 5, 6 different projects all on 6-month to 1-year balloons where you need to refinance, you are relying on, one, appraisers. That's really difficult. Sometimes you get a low valuation, even when it's wrong, you're stuck. The economy turns and people aren't lending money. You likely can't cover 6, 7 projects at the same time. So like you were saying, another form of over-leverage, if you have too many assets, you're buying on too much speculation, be it flipping, be it betting on inflation, or appreciation, You can over-leverage using those, and you want to avoid that at all costs. Always, always buy on cash flow, and you cannot over-leverage.

So that being said, just to sum up this video, our 3 main points here are: if you're starting out or if you've been doing this for a while, do not focus on the dollar amount. The dollar amount is really irrelevant, and as long as you are structuring long-term debt that's not going to be called due anytime soon, and you're building this around cash flow, you're not buying liabilities that are going to be a cash burn on your portfolio, you're not going to find yourself overleveraged or at much risk as those who are leveraging things that don't bring in money. They're buying things with short-term debt with variable interest rates. As long as you follow these general guidelines and you don't get stuck on the numbers, you're going to be able to scale your portfolio faster than those who are scared of the dollar amount. And you're not gonna have as many hiccups as those who are buying and borrowing on short-term debt with high interest rates. Yes, you may need to use short-term debt to get into the game, but make sure that you're not building your whole portfolio around it, because then it becomes a house of cards. It can all fall down, it can crumble to the ground. So that's this week's video of corporate versus entrepreneur. Let us know what you think in the comments below. Like and subscribe if you haven't already, and I will see you guys next week.