I got a great question from a reader recently about how I avoid over-leveraging and never lost money on a deal.
Because I’m in real estate to create financial SECURITY, I always encourage my students to learn how to plan for the worst-case scenario when buying deals.
So read on to find out how.
How did you keep your financial statements from becoming over-leveraged with all the deals you do? Keeping ratios in line to be exact. Did you ever have issues with that? – Jesse B.
Hey Jesse, I play the real estate game because I want to sleep well at night… and not worry about my money.
I’m NOT interested in taking risks.
I’m not interested in SPECULATING on the profitability of my deals.
After all, I have my family, my employees, my tenants, and my businesses to take care of.
So today I’m going to show you why I’ve never lost money on a deal.
See, many of my buddies lost everything they’d worked years for when the 2008 housing crisis happened.
Several apartment building owners next to mine went belly up when the economy tanked.
But I didn’t.
Why?
First, let’s talk about the holy grail of not just real estate, but all businesses.
The most important thing to know is that cash flow is king.
I prioritize cash flow above all else, because of my rule #1 of investing:
I don’t want to lose money.
Make sure you remember this every single time you take action on a deal.
When I invest in a deal, there needs to be positive cash flow.
With positive cash flow, I know I can weather any major shift in the housing market and any economic downturns.
I know I can take care of my properties and use the income to take care of my family.
Here’s how you calculate cash flow.
Note: This number should always be POSITIVE in your calculations.
So if my Effective Gross Income = $2 million…
And if my property’s Operating Expenses = $1.2 million…
And my property’s Debt = $500,000…
Then this is how I determine my total Cash Flow for the year:
Cash Flow = $2,000,000 – $1,200,000 – $500,000 = $300,000
So how do I ensure I always have cash flow left over – after loan payments and setting aside money to fix the property?
I lean on my bank to help me.
A lot of investors think the bank is the bad guy.
But I think of the debt, the bank, and the lender as my partners.
The bank is there to help me because they’ll NEVER let me over-leverage or over-borrow on the property.
They will not lend me any money unless they’re sure there’s cash flow in my deal.
And all this is determined by a very important number:
Debt Service Coverage Ratio (DSCR).
If you understand this number WELL, it could keep you from getting in a lot of trouble with your deals.
Your DSCR measures how much cash flow your investment can generate and pay off your debt from the bank.
Here’s how you calculate your DSCR:
DSCR = Net Operating Income (NOI) ÷ Debt
Your NOI should be 25% greater than your debt load, creating a typical DSCR of 1.25.
So if you need to pay off a loan of $100,000 a year, your NOI needs to be $125,000 to create a DSCR of 1.25, which typically meets the bank’s requirements.
DSCR = $125,000 ÷ $100,000 = 1.25
In a down economy, this number can determine whether or not you lose your property.
It also determines if you can continue to manage the property and stay afloat.
And it determines if you and your fellow investors can continue to enjoy monthly passive income.
So, Jesse, this is how I’ve never over-leveraged a deal, and have never lost money on a deal.
(I have an ENTIRE lesson on this in my Real Estate Success System course, which comes with a Home Study Manual workbook so you can follow along.)
LET’S KEEP THE CONVERSATION GOING
I’ve been receiving lots of questions lately, and I promise I’ll get to yours if it’s a REALLY good one about real estate investing.
Be Great,
Grant Cardone
Disclaimer: This content is intended to be used for educational and informational purposes only. Before investing, you should always do your own analysis based on your own financial and personal circumstances before making any investment. Grant Cardone is an industry expert who has been investing for over 30 years and his opinion is based solely on his own personal experience and circumstances. Individual results may vary. You should perform your own due diligence and seek the advice from a professional to verify any information on our website or materials that you are relying upon if you choose to make an investment. Investment involves great risk and there is no guarantee of performance or results.
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