The lender, bank, or private money could be your biggest partner in a real estate investment. You want to make sure to choose the right partner and the right product. When buying real estate, you can buy with all cash or use debt as leverage. Today I’m going to talk about using debt. Let me break this down for you.
An example of debt would be a 33% down payment (this is called equity in the commercial real estate world) with 66% debt. This would be a 66 LTV – or loan to value. The lender of the debt will hold a mortgage against the asset. The 33% down allows you to purchase the property, cashflow, and control the asset. For the sake of easy math, I will round the numbers and say that you are using one of your dollars to control three dollars’ worth of an asset, or $1M to control $3M of an asset. This is called leverage.
Leverage is one of the most powerful tools in real estate investing that can exponentially move your net worth, equity, and cashflow. Let’s say you buy a property for $3M and it’s worth $3.2M the day you close. You used $1M as a down payment and turned your down payment into $1.2 the day you close on the property. That’s a 20% return on investment (ROI) on your money on day one. Who doesn’t like that? With leveraging debt, you can get 2-3X the size of the asset for your dollar, and 100% of the upside. The lender may have a mortgage of 66% of your properties value, but in this example on day one now they only have 62.5%. You get all the upside, the lender or debt partner does not.
With investing in the stock market, if you invest $100k you get $100k worth of stock. If you invest in commercial real estate, you can use that same $100k and leverage it to control $300k worth of equity in the asset, and you get 100% of the upside. Banks won’t loan you money to buy stock, but they will gladly loan you money to buy real estate. What does that tell you? Banks trust real assets that have stood the test of time, they can be insured, and they produce income. Banks love loaning money for commercial real estate. They trust the asset (assuming it is a quality asset) to make money, and you make even more.
Now that you understand the basics of how debt works in real estate, I will show you the best type of debt. Fixed rate long term financing. That is the only debt I recommend. A lot of commercial real estate deals – we’re talking billions right now in 2024 – are failing due to variable rate loans. The loans were great at 2.5% interest, but at 8.5% they are not producing cashflow and are forced to sell the asset at a discount to pay the investors back some of their money. The biggest reason commercial real estate deals fail, is not being able to cover the debt service. By underwriting a fixed rate debt scenario for the asset, you know it won’t change.
I recommend 5+ years – 10 if you can get it – fixed rate debt when you purchase an asset. Real estate investing is a long-term play, not a get rich quick scheme. Before you invest in a property, find out what type of debt is being used. That can save you a lot of problems down the road. It’s not unrealistic to get commercial loans with 15-30 year fixed rate debt as well.
We know rents have always increased over time. Knowing that the debt payment will not increase ensures that cashflow will go up – assuming it’s a good quality asset – but your debt service will not. This is the time in our lives where variable rate debt is getting hammered in the market and billions of commercial real estate deals are being traded at a major discount. You want to be able to control the major variables when you buy real estate, and this is one of the most important ones after you have picked the right quality and size of asset. Get a great debt partner for leverage with fixed rate long term financing and pair that with conservative underwriting. Low interest with variable rates may seem like a good idea, until it’s not. If your rate goes up 6% (which we are seeing right now with this type of variable financing), you may crash and burn. This will save you from headaches in the long run when buying real estate. We want you to invest smart and be in it for the long haul
to create cashflow and wealth.
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