In recent years, using high leverage loans up to 85% loan-to-value ratio (LTV) to finance real estate investment has become increasingly popular. This strategy allows investors to buy properties with less cash out of pocket. However, high leverage also means higher risks. In this article, we will analyze the pros and cons of 85% LTV investment property financing, and provide key considerations for investors who want to utilize this strategy.
The Pros of 85% LTV Investment Property Financing
The biggest advantage of 85% LTV financing is that it allows investors to buy more properties with less cash. For example, with 20% down payment, you can buy 5 properties valued at $100,000 each. But with only 15% down, you can buy over 6 properties at the same price point. This increased buying power enables investors to build portfolio faster.
Another benefit is the ability to maximize leverage. Real estate investment typically offers leverage options up to 80% LTV. Going to 85% allows investors to squeeze out maximum financing and optimize return on equity. This strategy is especially useful when property values are rising, as investors can realize gains on the bank’s money rather than their own capital.
Moreover, with only 15% down, investors’ cash is freed up to pursue other opportunities or used as buffer for unexpected costs and vacancies. The remaining equity can work harder compared to tying up 20-25% on each deal.
The Cons of 85% LTV Investment Property Financing
The biggest risk with 85% LTV financing is exposure to market corrections. If property value drops more than 15%, investors will be underwater and face foreclosure risks. This is especially dangerous for overheated markets nearing the top of cycle.
Relatedly, there is little room for error with such thin equity cushion. Unexpected repairs, prolonged vacancies, or rising interest rates can quickly erase thin gains and turn projects negative. Without enough equity buffer, investors may be forced to bring additional cash to keep afloat.
Another downside is reduced options for refinancing and cash-out. Most lenders require at least 20% equity to refinance. With only 15% down, early refinancing is off the table. There is also less equity available for cash-out refinancing to capitalize on property appreciation.
Key Considerations for Utilizing 85% LTV Strategy
For investors who want to utilize 85% LTV financing, some key considerations include:
– Make sure you have a sizable cash reserve (15-20% of portfolio value) for unexpected costs and vacancies. Don’t over-leverage all reserves into down payments.
– Be conservative with valuations, vacancy projections and cost estimates. Leave adequate room for error with thin equity.
– Choose markets with strong fundamentals and growth potential. Avoid speculative plays and untested markets.
– Structure loans with fixed low rates and longer terms to manage interest rate risks.
– Underwrite deals to minimum 1.25 debt coverage ratio (DCR) so there is cushion for declines in NOI.
– Hold properties that achieve 20% equity for at least 12 months before selling to allow for refinancing. Manage sequence of purchases and sales.
85% LTV financing allows investors to maximize leverage and accelerate portfolio growth. But the strategy also amplifies risks and limits options if things go south. Careful underwriting, ample reserves and a sound exit strategy are key to effectively utilizing high leverage investment property financing.