II- Credit Leverage
Starvenus Holdings has made a strategic choice to not capitalize on the leverage of credit. All Starvenus Holdings properties are 100% funded through the sale of equity, (RealTokens). No credit is issued which means that 100% of the property is purchased with investors’ funds. There are several reasons for this strategic choice :
1.Some people, for personal, religious or economic reasons, do not wish to depend on credit. In case of a financial crisis, as it was the case in 2008, real estate assets cannot be seized in case of difficulty in repaying the loan.
2.What happens if the property is not rented for several months?
If Starvenus Holdings had chosen to take a loan out for the property, instead of fully funding it with equity sales, a loan payment would need to be added to the recurring expenses of a house. In the event a property has vacancies resulting in less rental income than projected, a property will experience a shortfall of cash flow. However, the loan payment and the recurring normal property expenses continue and must be paid. After a few months, the company’s cash flow will not be able to cover its expenses.
It will have 3 choices:
Sell the property
Current investors will have to contribute additional funds to make up the shortfall.
New investors could be added to provide additional funds, but this will result in diluting the share of the previous investors.
For these main reasons, Starvenus Holdings wants the option of the utilization of credit leverage to be an individual Tokenholder’s choice
To do so, Starvenus Holdings has developed a new module: The RMM powered by AAVE. All the technical aspects will be discussed in this article. To summarize, this module allows you to create your own credit leverage by collateralizing your RealToken in order to borrow. Since this is an individual choice, the risk of liquidation only occurs by the user who chooses to activate this feature
And this is not a feature that is unilaterally occuring for all Token Holders on the same property. RMM allows for some token holders to choose to collateralize their RealTokens while allowing others to not.
For example, with 1389 Bird Ave, Birmingham, MI 48009:
You choose to deposit 200 of your Bird Ave RealTokens with a value of $10,058 (200 * $50.29 Token Price) with an expected RONA of 7.51%. At a 60% Loan To Value (LTV) rate*, you could borrow up to $6,034.8 (60% * $10,058).
*Loan To Value (LTV) rate is calculated by dividing the amount borrowed by the investment and/or appraised value of the property, expressed as a percentage. The higher this ratio, the more debt you have and the more you increase your liquidation risk.
However, in order to avoid the risk of liquidation, you decide to keep a safety margin, and instead only borrow $5,000 (LTV 49.7% i.e. $5,000$ / $10,058) at an interest rate of 4%* .
*The calculation of the interest rate is explained in the technical article
You decide that with your new borrowed funds of $5,000, you are going to buy additional RealTokens and deposit them as collateral. By borrowing again, this time you choose to borrow 50% of your last deposit and receive another $2,500 ($5,000 * 50%). Your current LTV is 49.8% (($5,000 + $2,500) / ($10,058 + $5,000)), You decide to make a loop.
With initial capital deposited totalling $10,058 and thanks to your collateral leverage, your return of 7.51% has increased to 10.78% ((Total income of $1,459.42 – Interest expenses of $375) / $10,058 of initial investment).
The financial profitability of the transaction has increased by 3.27% (10.78% – 7.51%).
If you want to optimize the leverage of the invested capital you have 3 ways to do this:
1. Increase the RONA
2. Reduce the cost of debt, i.e. the interest rate
3. Increase the debt if the RONA is higher than the interest rate
A – Increase the RONA
To increase the RONA, you can either increase income or decrease costs. Today, inflation in the US is close to 7% and Starvenus Holdings has indicated that in the next 18 months, rent is expected to increase significantly on some properties.
On the other hand, through RealT’s strategy of concentrating properties in a particular city, such as Detroit, Starvenus Holdings is beginning to realize economies of scale. These economies allow it to lower the cost of managing the properties. One can see the first effects on this optimization by reviewing 2 properties in RealT’s offerings – Cadieux Street or Greenfield Street.
For example, with regards to the rental income, if we make the assumption that Starvenus Holdings is able to secure rental increases of 5.2%, then the annual gross rent increases from $96,000 initially to $100,992. The net rent increases to $71,088.
The expected RONA for Bird has now increased from 7.51% to 8% ($71,088 / $880,075, the total investment).