Thread by @TihoBrkan

1/ A thread on leverage.

Using financing to your advantage can be a double-edged sword when it comes to investing in any asset class. However, some asset classes aren't designed for leverage (crypto, commodities, etc) and some are (property, forex, etc).

2/ There are many ways to think about leverage. I'm not here to convince you you should or shouldn't use it — however, I do want to share a story my mentor (who owned over 150 million of property) once told me in Sydney, Australia a long time ago.

3/ He taught me to think in many different ways when analyzing investments, and when it comes to leverage he always said to think about it from the lenders' perspective. In most cases lenders are banks.

Imagine a start-up idea that needs financing? If you walk through the...

4/ ...banks doors and ask for a loan, what will happen? They will laugh at you. No track record of income or profits = no chance of a loan 99.9% of the time.

What about private equity? Lending was slightly easier, but still hard, before the GFC of 2008 but today it is almost...

5/ ...impossible to get a corporate loan unless you are very big business. And if you are, as most private equity guys tell me, gearing of 30% is about as lucky as you will ever get (varies for everyone).

What about public equity? Imagine the bank is Wells Fargo. You walk...

6/ ...through the door and say you love how well run Wells Fargo is, how solid their balance sheet is and so on, and so forth and you tell the bank you want to borrow money from them to buy their own stock?

They will laugh at you. Not a single bank will lend you money...

7/ ...over the long term to buy public equities — not including short term margin loans used by brokerage accounts.

This is because banks know that money would be dead money. People would lose it so recklessly in the stock market due to very high volatility and price swings.

8/ Now, as a final idea, you walk through the banks door one last time and tell them you want to buy a cash flowing real estate down the road?

They will say how much do you want? Thank you and sign here.

9/ Quite a simplified story to understand how banks view risk. If it is good for them and their trillions of dollars they all lend out for residential, commercial and industrial real estate around the world — it is also good for me.

After all, banks aren't trying to lose money.

10/ Understand that there are thousands of risk managers underwriting RE loans on a daily basis, analyzing all kinds of information & data.

They are looking at all kinds of risks, plus follow regulations (depending on government rules) can be loose or tight lending standards.

11/ And with all of this in mind, banks clearly know why they are comfortable lending up to or over 80% LTV for residential single-family homes where people have a consistent income.

Or up to 60% or more for commercial properties with long term contractual agreements where...

12/ ...tenants will be locked in for 10 or 15 years and produce a positive cash flow.

Or shorter duration 2-3 year 65% LTV for project financing for a developer who has proven consistency and a track record in previous projects.

These loans aren't perfect, but they make sense.

13/ Unlike the real estate side, lending to businesses can make sense, but with very tight risk parameters and very low gearing levels.

As I said at the start, some assets are much better suited to handle leverage & banks understand that (since it's their capital on the line).

14/ Advantage of real estate is its ability to carry a much larger debt load relative to other asset classes, thus amplifying returns beyond what any other asset can produce as a CAGR.

Please understand this doesn't mean that every single real estate deal should be levered! 😂