Chris Clothier is one of the most successful investors in the industry. As co-owner of Memphis Invest, Chris and his family manage millions of dollars worth of rental real estate for clients around the world. Read his new article!

1. “Smart real estate investors
are learning to use leverage
wisely and efficiently to put
more money in their pockets.”
Continued on pg. 58
R
eal estate investors are being bombarded with
advice today from every direction and it is
sometimes hard to find two pieces of advice that
are the same. There are so many options and so
many opportunities that becoming confused is
a common feeling among investors. Well get ready, because
here comes one more piece of advice that may run contrary
to what many are advising investors to do today. I happen to
have learned my lesson when it comes to leverage and I have a
special place for it in my portfolio. Smart real estate investors
are learning to use leverage wisely and efficiently to put more
money in their pockets.
SURPRISING INVESTORS WITH SOUND ADVICE
In the 4th Quarter of 2012, I made a presentation to a group
of investors in Northern California and I surprised many in
the room when I made a statement that I did not believe you
should buy real
estate and leverage
it for cash flow.
Given that I am
a partner in two
companies that
specialize in help-
ing investors find
properties that pro-
vide a positive cash
flow after lever-
age, this statement
caught much of the
audience by surprise. But I followed that sentence with a bit of
a clarification. I told the group that there are many ways inves-
tors can be fooled or even fool themselves today into thinking
that they are making a positive cash flow on their property. I
told the group that often, the biggest mistakes investors make,
is sacrificing long-term stability for short-term gains.
THE BANK WINS EVERY TIME
When I purchased my first home, I was given one option by
the three different finance companies I visited… a 30-year
Surprising Investors
With Sound Advice
on Leverage
by Chris Clothier, co-owner
of MemphisInvest.com
mortgage. The 30-year mortgage has become the staple of
real estate investing and even Warren Buffet’s recent statement
about the 30-year mortgage shook the real estate world.
What many people fail to recall about Warren Buffet’s as-
sessment of investing in real estate is that he used the phrase
“…if he could…” which, is very different than stating “this is
what I am doing.” This is worthy of an article all by itself as
different
inves-
tors and
investment
companies
have taken
his short
interview
and turned
into the
greatest
marketing
piece they have ever had. His five minute interview has been
used thousands of times already to convince investors that
they need to mortgage to the hilt all because Warren Buffet
mentioned it in his interview. But they all forget two impor-
tant points.
1. He is one of the wealthiest men on the earth and can af-
ford as much leverage as he is comfortable taking on.
2. He never says that he is buying single-family homes.
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3. He actually lists reasons not to. Now,
the mortgage is not one of his reasons,
but why would it be? Like I said...he
is one of the wealthiest men on earth!
The point is that a 30-year mortgage
has become standard and not only
standard for what companies want to
show, it has become standard for what
investors want to see.
How Do Investment Compa-
nies Show their Numbers?
Many companies, who provide invest-
ment opportunities, including mine, will
show a mortgage projection based on
the 30-year mortgage. Why? Because it
is what the average, every day investor
wants to see. It is how we have been
programed. A simple search of the
Internet will return article after article
extolling the benefits on using a 30-year
mortgage, especially for the positive ef-
fects it has on an investors’ cash flow.
When I first started investing, I was
coached to use the 30-year mortgage
as a tool to boost my monthly income
while allowing a renter to pay down my
note. When I first started, I loved the
idea of using a 30-year mortgage and
putting 20% or less down as a GREAT
tool to boost my cash flow. And it did.
It made my cash flow go up and I had a
certain level of comfort with that. The
problem is, unless you have significant
reserves in place, heavy leverage can
come back to bite you on investment
properties.
Another major point that I missed
when I first started investing and has
been taught to me over the years from
some investors much smarter than me,
was that for the first 25 years of my
ownership of that property, I would
be paying more in inter-
est payments than I was
earning in cash flow. In
the first 15 years it would be
substantially more!
Own Property Out-
right And Reap The
Rewards
I am a big proponent of
owning real estate out-
right. I have used leverage
sparingly over the last four
years and only as a tool to
acquire properties and not
as a tool to own properties.
I have put every property
that I have used leverage
to purchase on a quick
pay off schedule.
Many homeowners and
real estate investors will
tell you that there is a simple
strategy that makes a 30-year
mortgage a good investment. You
simply place a 30-year mortgage
on an investment property and pay it
off like it is a 15-year mortgage. I am
neither for nor against this strategy, I
just do not use it myself for the reasons
I will expand on below. I know as I write
this that there will be some readers who
will comment that yes, this is the precise
strategy that they use and that they
calculate each month exactly how much
money to pay to reduce the principle
each month. They feel that they get a
lower rate since a 15-year mortgage can
cost as much as .25 to a .50 point more.
To those readers that follow this
strategy and actually follow through on
this strategy, I will say that I believe you
are in the minority and congratulations!
It takes
tremendous
self-discipline
to be able to
make that strategy
work and I have
met many investors
who claim this will
be their strategy only to
find that they like bragging
about higher cash flow more than
they like bragging about owning
the property. The discipline it takes to
carry out this strategy is often missing
from many investors.
Put Your Self In Position
To Own Your Property
Outright
As I stated earlier, the better strategy
and the one that I am seeing more
investors come around to is using
leverage to purchase properties, but
not necessarily carrying that lever-
age for long periods of time. In
fact, many investors are choosing
to structure deals so that they are
paying off the properties as soon
as possible. Investors taking this
route are usually financially secure
and are not necessarily real estate
investors. Often times, they recog-
nize the need to diversify into real
estate, but are often passive investors
looking for the security and consistent
return that real estate can give them.
They see real estate as a secure invest-
ment and rental properties as a product
that will have continued demand in the
“...I am seeing more investors
come around to using leverage
to purchase properties and cash
to hold them long-term.”
Continued on pg. 60
Surprising Investors with Sound Advice..., pg. 20
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4. Surprising Investors with Sound Advice..., pg. 58
foreseeable future. I have a good friend here in Tennessee who
is a very successful executive and he has recently made moves
to acquire property as he seeks to diversify. When he and I had
lunch, he explained his very reasoning and his absolute distaste
for taking on credit risks and leverage. This is a common
theme among more and more affluent investors looking to di-
versify. They are using several different strategies to purchase
the properties.
1. They are purchasing properties for cash and holding for a
consistent rate of return recognizing that they can place mini-
mal financing against the property in the future to assist with
leveraging a larger portfolio.
2. They are purchasing property using a 15-year mortgage.
They then take the cash flow each month and use it to reduce
the principle. In some cases, this can reduce the term of the
loan to less than eight years.
3. They are structuring the term of the loan to
match the monthly note to the rental amount
received.
4. They are purchasing using a mixed bag of
options including cash purchases, refinancing
existing properties at low leverage, bundling a
portfolio to acquire leverage for new properties.
Regardless of the scenario that investors are
following, they are using leverage to increase
their purchasing ability and using the cash flow
produced from each investment property to
reduce the principle. The idea behind affluent
investors purchasing plans are to own the assets
outright in the shortest amount of time. This
enables them to keep as much of the return on
the investment as possible.
The Single Biggest Expense
In A Leveraged Property
They recognize that there is only one fixed expense that the
investor can be in direct control of and that is interest. Man-
agement, taxes and insurance are all fixed costs, which the
investor has little to no control over. Vacancy is a variable cost
that even with the most prudent management is going to affect
an investor at some point and there is nothing an investor can
do to prevent. Routine maintenance and major replacement
costs are also variable costs that, while an investor can prepare
for and take steps to reduce, there is still little an investor can
do to limit and nothing an investor can do to eliminate these
costs. That leaves interest costs as the only major expense that
an investor has control over as it relates to earnings potential
on a property.
Many investors that I am talking to today are choosing to
do everything possible to reduce the over-all costs of interest
including choosing higher interest rates to secure shorter terms
and buying cash flow properties not for the cash flow, but to
purchase more properties faster. I want to make sure every-
one caught that last sentence. While in San Francisco, this
was a big point I was trying to get across to the audience and
based on their reaction, it made sense to them.
How I Buy Properties
As an investor, I believe in buying properties that make
sense based on what I have experienced as an investor. I
have bought junk properties. I have bought “cheap” proper-
ties. I have bought properties and done the minimal amount
of work to get them “rent ready.” I have bought properties
with creative financing such as ARM mortgages and even
bought a couple with interest-only loans. Every one of those
strategies was aimed at producing Higher Monthly Cash
Flow. And every one of those strategies almost sunk me
completely as an investor.
Today, I buy properties where the fundamental econom-
ics make sense. I told the crowd in San Francisco that when
buying properties that produce a monthly positive cash flow,
they should consider using that money to reduce principle.
I cautioned them that if they were attracted to real estate
and cash flow because they needed to pay bills, then, in my
opinion, they really needed to be positive they were getting
sound financial planning before buying. I told them that in
my opinion, real estate purchased for buy and hold is a great
way to build and maintain long-term wealth, but a lousy way
to earn short-term money. I told them that real estate has
the greatest pay-off when you own it outright and that as an
investor, getting to that point should be your highest priority.
Using leverage to build your long-term portfolio is a great
tactic. Using leverage to build your short-term monthly cash
flow is not.
Am I off my rocker? Am I spot on? Let me know what
you think…
Chris D. Clothier is a Partner at MemphisInvest.com and
Premier Property Management Group. He can be reached at:
chris@memphisinvest.com or 901-751-7191.
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