From a real estate overview, we focus on homes in which we believe we can get a 1% per month rental rate. After vacancies, maintenance, evictions, property management, taxes and insurance, our 12% shrinks to 7 to 8%. Any loan interest shrinks this another 5 to 7% for commercial residential loans. This results in tight cash flow on borrowed money. We do acknowledge and consider that there is another 3% returned via appreciation. But our belief is that using traditional real estate loans allows a company to become much larger but the return is diminished greatly.
Yes, the ROI, when 20% is put down, may increase the returns incrementally on the 20%. Mostly the hope for the incremental return is that the property appreciates; thereby, providing a return on the borrowed money. Without this appreciation, it’s doubtful the borrowed money would contribute much of a return. The appreciation, at times, can be a long wait.
Let’s also not forget that the risk is increased proportional to the leverage used. Additionally, the larger portfolio opens the door to easier mistakes made during growth. The larger portfolio also means that more labor is needed causing traditionally leveraged REITS to have to work much much harder for the same dollar return.
We take an inverse approach to leverage. For example, we carry little to no debt on our real estate, open lines of credit against those assets and sale Puts against dividend paying value stocks in the market. This approach allows us to pay 0% interest on real estate and collect Put premiums; thereby, utilizing leverage without an associated cost.
If stock values drop, we collect dividends and Call premiums to offset any LOC interest charges. During those times, it is not expected to need rental income to cover LOC costs. Of course, dividends can be halted in dire times (ie: GM during 2020 COVID), so rental income is our amazing fail safe.
Although we mostly avoid margin usage in the market and choose instead to use LOC’s as our source of funds, should it become attractive, we do carry a Portfolio Margin account providing us access to 6x leverage opposed to the standard T-Reg margin providing 2x leverage. The view here is that it’s better to have more access to funds than less when the sky inevitably falls.
The old saying goes, when the tide goes out, you see who’s swimming naked. Our stance is that we would rather walk out to the tide, take off our sandals and go for a swim while the tide comes back in.
