Debt: The Double-Edged Sword

How leverage can accelerate your success—or destroy your portfolio. A balanced perspective.

Debt is the most powerful tool in real estate investing. It's also the most dangerous.

The real estate education industry loves to celebrate leverage. They show you spreadsheets proving how a 20% down payment can generate 30% returns on equity. They tell stories of building empires with other people's money. What they don't talk about enough is how leverage amplifies losses just as efficiently as it amplifies gains.

What Leverage Really Means

When you use debt to buy real estate, you're making two bets. First, you're betting the property will generate enough income to service the debt and ideally produce additional cash flow. Second, you're betting that the property value will either appreciate or at minimum stay stable enough to preserve your equity.

If both bets work out, leverage is wonderful. You control an asset worth several times your cash investment, and you keep all the appreciation while only investing a fraction of the purchase price. This is how wealth is built in real estate.

But if either bet fails, leverage becomes a liability. If income drops below what's needed to service debt, you're paying out of pocket to maintain the asset. If values decline, your equity can evaporate—or go negative. Suddenly you're trapped: you can't sell without bringing cash to closing, and you can't hold without bleeding money each month.

The Conservative Approach

Here's my framework for using debt responsibly. It's not exciting, but it keeps you solvent.

Rule 1: Debt service coverage ratio of 1.25 minimum. This means the property's net operating income should be at least 125% of the annual debt service. If you're borrowing $200,000 at 6% for thirty years, your annual payment is roughly $14,400. Your property needs to generate at least $18,000 in NOI to meet this standard.

Rule 2: Maintain liquidity reserves. I keep six months of debt service in cash reserves for every property I own. This is not the same as a general emergency fund—these are property-specific reserves.

Rule 3: Conservative loan-to-value ratios. I target 70–75% LTV on purchases when possible. Yes, this means larger down payments. It also means I have equity cushion from day one.

Rule 4: Stress test every debt assumption. What if interest rates rise and you need to refinance at higher rates? What if rental demand softens? Run the numbers with pessimistic assumptions.

When Leverage Makes Sense

I'm not anti-debt. Used correctly, leverage is how you scale. But "used correctly" has specific criteria.

Leverage makes sense when you're buying cash-flowing properties in markets you understand, with conservative underwriting and adequate reserves. It makes sense when you have multiple properties so that one problem property doesn't threaten your entire portfolio.

Leverage is dangerous when you're speculating on appreciation, when you're stretching to qualify for the loan, when you're counting on everything going right, or when you're using debt to buy in markets you don't know.

The 2008 Lesson

The financial crisis taught a generation of investors a hard lesson about leverage. Properties that were moderately leveraged survived. Properties that were highly leveraged destroyed their owners, even if they were decent assets. The difference was the margin of safety.

I know investors who owned solid rental properties in good markets—properties that would be worth twice as much today—but lost them in 2009 because they were leveraged at 90% and couldn't weather eighteen months of distress. The properties didn't fail. The capital structure failed.

Use debt. It's one of the primary advantages of real estate as an asset class. But use it with respect for what it is: a tool that amplifies outcomes. If your deal works without leverage, leverage makes it better. If your deal doesn't work without leverage, leverage makes it worse.

Never use debt to make a bad deal look acceptable. Only use debt to make a good deal more efficient.