Real Estate Investing Basics

Pick the Better Investment: Which Door Did you Choose??

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Last week I gave two scenario’s. Your task was to decide which is the better investment for you.  The first scenario allows you the investor, to pay cash for a property that needs $10,000 in rehabs.  With the best estimate, this would be a $75,000 flip property.  That same property can be purchased on financing terms for $50,000 and held as a rental which produces $950 in gross rent each month after those same repairs.

There was an excellent spirited debate in the comments section and I thank each of you for your insights and contributions. While reviewing the comments, I noticed many of you were leaning towards purchasing the property with seller financing terms in place.  There were also some great arguments for paying cash for the same property. The good news is, there is a time and place for BOTH doors of opportunity. Let’s take a look at the variables of both:

Door #1 The Cash Option:  Per some of the feedback, if your goal is to flip the property, then you absolutely must pay cash for the property. Being fully capitalized in a $75,000 property for $46,000 is a much better option than financing $50,000, and then coming out of pocket $10,000 in rehab. By trying to flip a zero down financed property you are going to give away $14,000 of profit for the benefit of “zero down” financing.

Here is an additional scenario to consider from Door #1 that could work as well. What if you buy, fix and flip the original property in our example, then use the net profit ($29,000) to purchase a second property.  You could buy and hold the second property for additional passive income or fix and flip the second property for a lump sum of cash that you could then use to do yet another deal.  The choice could be yours.

Door #2 The Financing Option:  This was our most popular option, but again it has to be used correctly. Financing a fix and flip for the additional premium is not worth it.  However, if you are looking to build up assets using other people’s money and hold the asset for an extended period of time, it is to your advantage to use the “free” financing. It is important to note though that it will take over 14 years to reduce the principle balance to $36,000 so you have to remember you are going to be paying for many years for that financing premium.

Here’s another option: What if you take advantage of the financing for 7 years and then decide you want to flip the property for $85,000. You would still owe over $45,500 on the principle balance and be into the property the additional $10,000. You would make a net profit of $30,500 which is $1,500 more than you would have made 7 years earlier if you flipped the property right away, is that a better deal? That is barely the goldmine we hoped for. Conversely, what if the property could sell for $120,000 in 7 years?  After all, we clued you into the a growing economy and next generation population. Your net profit of $74,500 is more than double what you would have earned flipping it right away. That is a GREAT deal!

These two posts have been particularly fun!  I’ve enjoyed getting to know some of you and interacting with everyone!  There are so many variables we could still explore within this fictitious transaction, but these are very real variables you face every day as an investor.  Make sure you are considering every variable available when making an investment. Knowing your exit strategy will help you decide which door is better for you and your investments!

    steven rabago
    Replied over 8 years ago
    Using seller financing is a great option. As suggested in the comments borrowing from a self directed 401k is a good alternative as well. I often suggest Friend and Family Loans as well.
    Sean Kelly
    Replied over 8 years ago
    I would choose door door number two. The cash flow alone would be worth it. If, however, property values increase you still have the option of selling and taking your profits on a capital gain basis. You could also 1033 exchange and defer taxes altogether.