“Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.” – Archimedes
Though I don’t know that Archimedes would have approved of triple-levered SPY ETFs, the concept of leverage is absolutely revolutionary. Ancient Mesopotamians used early forms of promissory notes to purchase cattle and tools with debt, allowing these earliest entrepreneurs to use borrowed money to get access to goods. Goldsmiths, being already safekeepers of large amounts of gold, found it convenient (and lucrative) to issue notes against the gold which they held in their safes at an interest premium. The amounts which these proto-bankers lent often exceeded the amount in their safekeeping; however, this allowed businesses freer access to capital, positively encouraging growth and investment in new and growing enterprises.
While WCI founder Dr. Jim Dahle is fond of saying that nobody ever went broke without owing money, I’d like to suggest the counterpoint that leverage is one of the strongest tools in your financial toolbox. In fact, many of you readers at least implicitly agree with me, given that most of you, at one point or another, took on debt to finance the purchase of something you deem valuable: an education, a practice, or a home—in other words, an investment.
I’m going to share with you my experience with a fairly aggressive amount of leverage, which is probably more than most of you gentle readers are comfortable with—even if humans have been doing this for thousands of years.
How Much Do I Owe?
Let’s skip to the good part and go right for the tally!
- Home: $117,000
- Single-family home investment properties: $44,500, $77,000, $195,000, and $154,000. The first two are jointly owned in a multi-member LLC, and my wife and I own about 55% of them. So, we owe about $67,000
- Commercial real estate: $975,000
- Wife’s car: $67,000
- Speculative loan to private equity: $250,000
- Grand total: $1.825 million
What about the corresponding assets?
- Home value: $600,000
- Single-family home investment properties: $105,000, $145,000, $240,000, and $205,000. Given the same 55% ownership of the first two, that equals $137,500
- Commercial real estate: $1.25 million
- Wife’s car: Probably $60,000 according to Kelly Blue Book
- Speculative loan to private equity: Variable
- Grand total: $2.492 million, plus the return on the PE investment
That’s leverage of around 73.2% on the assets, not counting the PE return. If I get the $250,000 back, the leverage will fall to around 66.5% against our assets. I’m totally comfortable with this, by the way. I’m like the gambler who always thinks the next hand is a winner.
Why Am I Doing This?
Clearly, I’m a fairly risk-inclined person. You might be asking yourself why I have taken so much risk in my financial life? I’ll detail below and then go into some juicy details regarding my gambit.
First, I’m an unrepentant maximizer. While WCI columnist Alaina Trivax has a job for every dollar she and her spouse make, I like mine to have, statistically, 1.73 jobs. Similarly, I work multiple jobs, and I expect my money to work as hard for my family and me as I do—and then some! While burning the candle at both ends may increase my burnout one day, it’s also a hedge against my next reason.
Second, I’m concerned with the direction physician pay is heading. Jim and I disagree about the trajectory of physician pay. He believes we are mostly stable, if not somewhat improved, as a group of earners. However, I see headlines like this, “Medicare physician pay has plummeted since 2001. Find out why,” and I have seen colleagues and my own after-inflation pay trending negatively. I believe it’s due to the consolidation of physicians under large hospital groups and private equity (both of which have been associated with lower quality of care) and the burgeoning class of administrative, non-revenue-producing bureaucrats embedded into every level of patient care.
Third, I just enjoy the game of making money. I know, I know. Filthy lucre soils the hands that touch it, but very few of you would work for free if you didn’t have to do so. From a philosophical point of view, if my dollars can provide or facilitate the production of a good or service useful to other people, then why is that such a bad thing? From a personal standpoint, the earning of money feels like a game in which I have a distinct edge: a large and fairly stable income. It seems absurd to not make use of the tremendous advantage that I’ve worked hard to procure. After all, who buys a Porsche 911 and doesn’t mash the pedal to the floor every once in a while?
More information here:
The Best Ways to Leverage Debt to Your Advantage
10 Reasons You’re Not Stupid for Paying Off Your Debt
How Fast Can You Get Out of Debt?
Details Please!
OK, enough of the reasons for doing it. Let’s get into the dirty details of my domineeringly dense debt. While I didn't nab one of the mouth-wateringly low interest rates some of you enjoy (sub 3% interest rates!), I locked in a fairly reasonable long-term 5% rate for the mortgage. While 5% isn’t nothing, it’s lower than my investments have returned, and it costs me about $1,100 per month, due to a sizable down payment from the sale of a previous home. This is fixed-rate, low-rate, and non-callable debt. Unless I get into arrears on the payments, the mortgagee can’t call for the balance of the loan, unlike investing on margin where the dreaded Margin Call can upend your plans in an instant.
The single-family rentals, while representing a sizable amount of debt, are all stable, cash-flowing investments at rates of 4.5%, 5.25%, 6.5%, and 6.25%, respectively. While there’s some risk of another eviction moratorium (I’m watching you, bird flu) or a massive crash in housing prices and thus rents, these are fairly safe bets. I’ve got property managers for these homes for additional liability protection from creditors and large insurance policies covering everything except Acts of God and floods. Note to any real estate investor: flood maps are easily accessible, and no policy I’ve ever seen written includes floods de facto. Interestingly, due to the huge increase in housing prices over the last several years, I sold one of my rentals, seller-financed, with a balloon for about $100,000 coming due next year—which should pay off a good chunk of the first two. Last, these are in areas where the housing market is fairly liquid, and I don’t think I’d have trouble selling if I had to for less than what I owe on them.
The commercial real estate has two good tenants on long-term leases. Just between us, I’m actually cash-flow negative on that property by about $3,000 per month so that I can pay it off more quickly (it’s a 10-year note). While not the perfect situation, the property increased in value after I bought, renovated, and placed tenants into it. This would allow me to take a 20% loss in the value of the property if I were forced to sell and still make a small profit. Also, one of the businesses in the property is partially mine! What I make from that business is nearly what I pay extra on the note, so that makes the net practically a wash with the benefit of enjoying the rapidly rising equity on a building in a prime location in a growing city. The note is at 6%, due to the steady salary I enjoy, as noted above, and the fact that I “occupy” the building. FYI, lenders love it when the borrower occupies a profitable business in the building for which they’re borrowing.
OK, let's talk about the car. Yes, it’s a loan on a new car. However, it’s for my wife, and she drove a beater (ironically, my old car) for a year with only a few gripes. She’s a wonderful woman, and I’d rather sell one of the rental houses than ask her to drive that beater again. Also, the loan is at 0.9% for five years, so it’s mathematically cheaper to borrow that money and invest it into literally anything else than it would be to pay cash for that car. Last, we got a big tax write-off for it because that’s the car she used to manage our properties last year as our property manager. After bonus depreciation and the write-off on our taxes, we saved about $10,000 the year we bought it, and we will continue to write off business miles as we use it here and there for a few of the properties. The mileage deduction will be passive (see passive vs. active real estate investing for more), but it will be accruing over time until we dispose of the properties. While it doesn’t pay dividends to my bank account, it does pay dividends to my wife’s happiness.
Regarding the mysterious loan to private equity, our practice got bought out by private equity (no axe to grind here, I promise . . .), and the consolidation process with other practices was anything but smooth. EMRs were consolidated, payroll and benefits were “streamlined,” and revenue was all brought in-house to be centrally administered. During the heady days of low rates, the PE group bought us and the other practices with variable-rate debt (dumb). The mergers and acquisitions MBAs told the management MBAs that they could have the whole, multi-state conglomerate bought cheaply but that the second sale had to happen quickly [note: the second sale is the sale by PE to another entity, returning the PE group and other investors’ money with a premium]. The management MBAs, I’m sure equipped with all the hubris of a McKinsey consultant, thought this would be straightforward. I mean, it’s all the same specialty, right?
Anyhow, the debt came due, and the consolidated practices hadn’t been resold, so the debt became the albatross about the PE managers’ necks. They asked the docs to volunteer to “purchase” some of the debt because they had too much to “roll over,” i.e., refinance into new debt. I borrowed $250,000 of that debt at X% interest rate on the basis of my winning personality and lent that same $250,000 to the PE group at around a 2X rate. The risk here is clearly that the PE group folds, and I don’t get back that money plus interest. The hedge, however, is that now I have a debt claim against the practices themselves and their future income streams. Last time I checked, debtors had a superior claim to equity holders in times of liquidation, so I feel confident that I’ll at least get my money back plus some interest. In the meantime, I can write off the interest rate I pay for the borrowed money on my taxes as well, so the X% interest rate I pay is really X% minus my marginal tax rate. Simple, right?
More information here:
How the IRS Treats You as a Real Estate Investor
What Haven’t I Said?
Here’s what I’ve left out that might make some of you feel better.
- My income is around $400,000, and my wife works part-time. Worst comes to worst, my income can pay every dollar of everything I owe until they’re eventually all paid off. My wife might make me sleep outside, but the nights are mild where I live.
- I have multiple sources of income: primary job, dividends from other investments, my second job in my own business, the rents from the properties, etc. Even if I get hit by a bus and can’t work, my disability policy would cover about 80% of what I owe month to month, and my life insurance policy is double what I owe.
- My wife can go back to full-time as a moderately high earner; again, it wouldn't be ideal, but, “Hey that beautiful car, sweetheart!”
- Our tax-protected retirement accounts are worth over a million bucks right now, even if I had to go completely nuclear and declare bankruptcy.
- I could pick up part-time work, worth about $3,000 per weekend. It would be miserable to work literally every day, but if residency is doable, then so too would that.
In sum, the estimable risks are worth the even more estimable rewards: early FI, protection against lower physician incomes, satisfaction from providing value, and enjoyment from playing “the game.” While it’s certainly not for everyone, I’m not using callable or variable-rate debt, and the numbers work out. If this all goes the way I think it will, I’ll write a follow-up so that I can field questions relating to the processes and pitfalls. If it doesn’t work out, I’ll pull a Rikki Racela and start doing surveys in between my weekend shifts.
Do you use leverage to your advantage? Why or why not? How much debt would make you feel uncomfortable?