Is it better to have debt than own free and clear?

[Terri B.]

I heard an investor on a call say it's best to have some debt on properties for protection. There wasn't time to discuss in detail so I'm asking you all fellow investors about this. What's your perspective and why? I was thinking perhaps from a legal perspective any suits would also involve the lender and thus have greater "protection." ??? What do you think, what advice have you taken or what are you doing on this?

[Jonathan Bock]

@Terri B.

As always, "it depends" truly case by case 

I'm assuming the speaker was harping on equity stripping for asset protection 

[Chris Seveney]

Quote from @Terri B.:

I heard an investor on a call say it's best to have some debt on properties for protection. There wasn't time to discuss in detail so I'm asking you all fellow investors about this. What's your perspective and why? I was thinking perhaps from a legal perspective any suits would also involve the lender and thus have greater "protection." ??? What do you think, what advice have you taken or what are you doing on this?

Personal preference, to me a lot of these asset protection schemes are like wearing a covid mask when driving alone.  Oh some scrupulous attorney will not sue you because you have debt and they will go after properties that are free and clear. In order for them to do that, you have to have some pretty serious negligence. Ask them what possibly could they be sued for that insurance would not cover you on? 

If you want true asset protection, hire a property manager and make sure your attorney reviews that contract and get proper insurance. 

[Michael Smythe]

@Terri B. it's typically overkill to try to protect an asset by leveraging it this way. 

Just have enough liability insurance!

[Tim J.]

Of all the nonsense I have heard about real estate investing, using the notion of "protecting assets" as a reason for leverage is one of the dumbest. 

[Terri B.]

Meaning refinancing or gettling a line of credit on a free and clear property?Quote from @Jonathan Bock:

@Terri B.

As always, "it depends" truly case by case 

I'm assuming the speaker was harping on equity stripping for asset protection 

[Terri B.]

I don't understand how can debt be considered protection in the first place.

Quote from @Michael Smythe:

@Terri B. it's typically overkill to try to protect an asset by leveraging it this way. 

Just have enough liability insurance!

[Terri B.]

Yes I don't get how debt protects. 
Quote from @Tim J.:
Of all the nonsense I have heard about real estate investing, using the notion of "protecting assets" as a reason for leverage is one of the dumbest. 

[Allan C.]

@Terri B. If you don't have any equity then there's nothing to sue for. But that assumes you have minimal equity within a LLC and you've operated the entity in a fashion that cannot be pierced. That also assumes that you have a fair amount of equity in the first place, which most people thinking about this scheme don't have.

As others have said, if you want asset protection then be intentional about it. The primary reason to leverage the asset is to increase your returns, or diversify your holdings. Anything less than those drivers is a distraction.

[Jeff S.]

Allan C.

• Rental Property Investor

@Terri B. If you don't have any equity then there's nothing to sue for. But that assumes you have minimal equity within a LLC and you've operated the entity in a fashion that cannot be pierced. That also assumes that you have a fair amount of equity in the first place, which most people thinking about this scheme don't have.

As others have said, if you want asset protection then be intentional about it. The primary reason to leverage the asset is to increase your returns, or diversify your holdings. Anything less than those drivers is a distraction.

Exactly.

[Terri B.]

Got it, thank you! So if there's not much equity no liquidity to sue. Free and clear mean all that equity could accessible to a Plaintiff. Wow ok
Quote from @Allan C.:

@Terri B. If you don't have any equity then there's nothing to sue for. But that assumes you have minimal equity within a LLC and you've operated the entity in a fashion that cannot be pierced. That also assumes that you have a fair amount of equity in the first place, which most people thinking about this scheme don't have.

As others have said, if you want asset protection then be intentional about it. The primary reason to leverage the asset is to increase your returns, or diversify your holdings. Anything less than those drivers is a distraction.

[Adam Bartomeo]

It is almost always better to have leverage than it is to own cash. 

With leverage you are using the houses money to gamble and not yours. You can use funds to buy other properties. If things go sideways you will only lose the funds you have invested. The tenant pays all of the expenses while you invest your money other places. You invest 20% but keep 100% or the profit and appreciation. The list goes on and on.

Some of the above is true for cash but the biggest issue is not being able to invest the cash into another investment.

[Benjamin Aaker]

Don't forget that from a liability standpoint, you have more risk exposure than just the equity in a property. If you are negligent they may go after your other assets, even though you might be in a LLC.

[Bud Gaffney]

@Terri B. Depends on your situation. How wealthy do you want to be? Leverage and have others pay the debts. Rinse and repeat!

[Bud Gaffney]

@Terri B. Clear + free is dumb if you can get more properties that other people are paying all your bills :)))))

[Bud Gaffney]

@Terri B. 100% better to have debt! That means you’re making more $ ! In the long run

[James Murphy]

@Terri B.

To increase your Cash on Cash return on investment, it may be beneficial to use debt to obtain income and asset appreciation with less cash expenditure. However, it is important to note that the absolute profit per month will be higher without debt. The decision to use debt or not ultimately depends on one's priorities.

Regardless of your choice, it is crucial to maintain the property in good working order and have sufficient insurance coverage as a defense against liability claims. Some people also suggest forming LLCs to contain liability in certain circumstances.  It's a good idea to consult a lawyer and/or insurance company for professional advice on these specific matters.

[Terri B.]

Thank you for this, very well explained.
Quote from @James Murphy:

@Terri B.

To increase your Cash on Cash return on investment, it may be beneficial to use debt to obtain income and asset appreciation with less cash expenditure. However, it is important to note that the absolute profit per month will be higher without debt. The decision to use debt or not ultimately depends on one's priorities.

Regardless of your choice, it is crucial to maintain the property in good working order and have sufficient insurance coverage as a defense against liability claims. Some people also suggest forming LLCs to contain liability in certain circumstances.  It's a good idea to consult a lawyer and/or insurance company for professional advice on these specific matters.

[Terri B.]

Makes sense that it's best to put the money to work.
Quote from @Bud Gaffney:

@Terri B. Depends on your situation. How wealthy do you want to be? Leverage and have others pay the debts. Rinse and repeat!

[Sam Shueh]

Your credit score will suffer if you have debt. Often it is based on how well you pay back history.

[Marcus Auerbach]

I had a post once here on BP to ask people about their LLC and asset protection stories, or something that "happened to a friend" - it had a huge amount of replies, but no good stories.

Don't be negligent, use solid leases and maintain good liability insurance.