The decision to remain debt-free or take on leverage in real estate investing is a complex one that depends on various factors and individual preferences. It’s important to consider both the advantages and potential risks associated with leverage.
Leverage, when used strategically, can provide financial and tax advantages in real estate investment. Similar to acquiring stocks using a margin account, leveraging allows investors to amplify their purchasing power and acquire properties with a higher value than their cash equity investment. The annual master lease payments in a DST are typically presented as a percentage of the equity invested, offering a cash-on-cash return expectation. It’s important to note that investing in a DST involves acquiring a fractional ownership in the entire property, including both the equity and debt portions of the capital stack. By utilizing leverage, investors can benefit from potential appreciation growth on the full value of the real estate, potentially increasing the overall internal rate of return (IRR) or annual average return as a percentage of equity invested, especially in an appreciating market.
However, it’s crucial to consider the potential downsides of leveraging in real estate. In a down market, leveraging can amplify the decrease in property value as a percentage of the invested equity. Additionally, if there is a decrease in cash flow, there is a risk of not having sufficient funds to service the monthly debt payments. It’s important to carefully assess the ability to handle debt obligations and the potential impact of market fluctuations on the investment.
As highlighted in every Private Placement Memorandum (PPM), leveraging any real estate investment, including DST properties, carries the risk of losing the entire investment in the worst-case scenario. It’s essential for investors to thoroughly analyze their risk tolerance, cash flow projections, and market conditions before deciding whether to take on leverage or remain debt-free.
The decision to remain debt-free or take on leverage in real estate investing ultimately depends on your individual circumstances, risk tolerance, and investment goals. Here are some key points to consider:
Increased purchasing power: By using leverage, you can acquire real estate with a higher value than your cash equity investment, potentially allowing you to invest in larger or more valuable properties.
Potential for higher returns: Leverage can amplify your overall return on investment (ROI) by allowing you to benefit from potential appreciation growth on the full value of the property.
Tax advantages: Leveraged real estate investments can provide tax benefits, such as deductible mortgage interest and depreciation expenses.
Market downturns: In a down market, leverage can multiply the decrease in property value as a percentage of your invested equity, potentially leading to significant losses.
Cash flow challenges: If there is a decrease in cash flow from the property, you may face difficulties in servicing the monthly debt payments, potentially leading to financial strain.
Full investment loss: There is always a risk of losing your entire investment when taking on leverage, especially if the worst-case scenario occurs and the property fails to generate sufficient returns to cover the debt obligations.
Risk tolerance: Evaluate your comfort level with taking on debt and the potential risks involved. Consider your financial stability, ability to handle market fluctuations, and willingness to accept potential losses.
Cash flow projections: Analyze the property’s potential cash flow and ensure that it is sufficient to cover the debt obligations, even during challenging economic conditions.
Market conditions: Consider the current state of the real estate market and the potential for future appreciation or depreciation. This can impact the overall returns and risks associated with leveraging.
Loan structure: Understand the terms of the loan, including amortization schedules and whether it is interest-only or includes principal payments. Different loan structures can impact cash flow and overall returns.
It is advisable to review with your Cornerstone Real Estate Investment Services representative who can assess your specific situation and provide guidance based on your individual goals and risk tolerance. It is important for all investors to evaluate the pros and cons of leverage and determine the most suitable approach for their real estate investment strategy.