BRRRR with All Cash or Financing?

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BRRRR with All Cash or Financing?

Leo Kotschenreuther
Rental Property Investor · Mountain View, CA · Member since 2017 · 34 posts · 24 votes

Dear BP-community,

I just finished David Greene's book "Long-Distance Real Estate Investing: How to Buy, Rehab, and Manage Out-of-State Rental Properties". Before I had read the book, I was convinced that I wouldn't be able to do an out of state rehab considering my lack of experience with rehabs and it being out of state. My view on that has changed quite a bit now that I have read the book and I want to start doing the BRRRR strategy.

Right now I have about 15k in cash available for real estate investments. From what I have been reading on the forums, I could probably get a loan of another 45k to buy and rehab a property in the next months.

On the other hand I also own a rental property in Texas. It cashflows but not great, it's only 5% cash on cash return. I'm thinking about selling that property in about a year and to use every dollar I have available to reduce the mortgage until then. If that goes smoothly I could have 40k in cash available once the property is sold in a year (some equity from the property and some additional savings over a year).

If you were in my position, would you rather wait until you have enough cash available to buy and rehab a property without any financing or would you find financing and start now?

What are the advantages of all cash purchases? Lower closing costs, no interest payments until the property is refinanced and the potential to negotiate a lower purchase price of the property?

Thanks for your input!

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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
8y

First, you have to understand the difference between cost and expense as it applies to a rental.  There are a number of ways to explain this, but in this case, the best way to look at it is this way:

Cost:  What you pay out of pocket (cash).  An example would be the down payment (or if you paid all cash).

Expense: What your tenant pays from the rent. An example would be property taxes (even though you pay them, it comes out of the rent), insurance, and the big one...the mortgage payment. This it the one way too many REI misunderstand and as a result include the interest on the mortgage when they are discussing the "cost " of the property.

As long as the property is positive cash flow, this is true.  When you are negative cash flow, that negative number becomes a cost.

As far as paying down your mortgage,...why?  That's your money, you're only helping your tenant do their one and only job (pay off the mortgage), and that cash you're putting in has the same value in your equity as it would have in your hands.  The difference is while it is in the property, it is dead.  In your hands, it is alive...and can grow.

Cash is not a noun, it's a verb.  When it becomes a noun, you lose.

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  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y

    First, you have to understand the difference between cost and expense as it applies to a rental.  There are a number of ways to explain this, but in this case, the best way to look at it is this way:

    Cost:  What you pay out of pocket (cash).  An example would be the down payment (or if you paid all cash).

    Expense: What your tenant pays from the rent. An example would be property taxes (even though you pay them, it comes out of the rent), insurance, and the big one...the mortgage payment. This it the one way too many REI misunderstand and as a result include the interest on the mortgage when they are discussing the "cost " of the property.

    As long as the property is positive cash flow, this is true.  When you are negative cash flow, that negative number becomes a cost.

    As far as paying down your mortgage,...why?  That's your money, you're only helping your tenant do their one and only job (pay off the mortgage), and that cash you're putting in has the same value in your equity as it would have in your hands.  The difference is while it is in the property, it is dead.  In your hands, it is alive...and can grow.

    Cash is not a noun, it's a verb.  When it becomes a noun, you lose.

    10Reply
  • Andrew SyriosPro Member
    Moderator
    Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
    8y

    I would finance from square one, but it all depends on how aggressive/conservative of an approach you want to take. And that all boils down to what your goals are. So I think that's the question you need to ask yourself.

    Podcast Guest on Show #121
    1Reply
  • Leo Kotschenreuther
    OP
    Rental Property Investor · Mountain View, CA · Member since 2017 · 34 posts · 24 votes
    8y

    @Joe Villeneuve Thanks for reminding me of that. A cash flow positive property is actually a really great thing, even if it's not that much. This is how I learn to pay less for the next property.

    For paying down the mortgage, sure it would lock up the money in the property. I would be saving interest but considering my interest rate being at 4.25% it's not that much

    @Andrew Syrios I would love to hear more about why different people prefer financing or all cash purchases. What are the reasons you prefer financing? Just to be clear, even if I buy all cash I still want to pull out all my money when I refinance after a few months or a year.

    1Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y
    Originally posted by @Leo Kotschenreuther:

    @Joe Villeneuve Thanks for reminding me of that. A cash flow positive property is actually a really great thing, even if it's not that much. This is how I learn to pay less for the next property.

    ...but you are not saving interest...at least not for you.  You're not the one paying it.  It also comes off the  back end of the mortgage...which you never get to to actually receive it.

    Go look at an amortization schedule for the next 5 years before you add to the principle, and after, to see how much less interest is charged over that time period.  This is a compound interest formula...not a simple interest formula.

    0Reply
  • Leo Kotschenreuther
    OP
    Rental Property Investor · Mountain View, CA · Member since 2017 · 34 posts · 24 votes
    8y

    @Joe Villeneuve For every dollar of the mortgage I pay off in addition to the monthly payment, the portion of the payment that goes toward the principal gets a little bigger and the portion that goes towards interest gets a little smaller. Not a great return on investment though considering the low interest rate on the mortgage.

    Let's leave the mortgage aside for now. Would you rather wait a year and buy deals all cash or start now and use hard money or private lenders?

    2Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y
    Originally posted by @Leo Kotschenreuther:

    @Joe Villeneuve For every dollar of the mortgage I pay off in addition to the monthly payment, the portion of the payment that goes toward the principal gets a little bigger and the portion that goes towards interest gets a little smaller. Not a great return on investment though considering the low interest rate on the mortgage.

    Let's leave the mortgage aside for now. Would you rather wait a year and buy deals all cash or start now and use hard money or private lenders?

     You are telling me about theory.  I'm talking about actual numbers.  You are talking about "%", and I'm talking about "$".  In both cases, they are NOT the same thing.

    Don't talk about "theory or %", talk about "Actual numbers with $", and you'll see what I'm talking about.

    0Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y
    Originally posted by @Leo Kotschenreuther:

    @Joe Villeneuve For every dollar of the mortgage I pay off in addition to the monthly payment, the portion of the payment that goes toward the principal gets a little bigger and the portion that goes towards interest gets a little smaller. Not a great return on investment though considering the low interest rate on the mortgage.

    Let's leave the mortgage aside for now. Would you rather wait a year and buy deals all cash or start now and use hard money or private lenders?

     I just calculated the interest savings you would have over the course of 1 year if you had an $80k mortgage at 4.25% over 30 years, and made $1000 extra payments, and $3200/month extra payments.

    $1000/month extra payments = $236.  That means it cost you $1200 to make (save) $236

    $3200/month extra payments = $757.  That means it cost you $38,400 to make (save) $757

    In both cases, you are actually losing money doing this.

    The money you are adding each month has the same face value if you:

    1 - convert it to equity (extra payments),

    2 - Keep it in the bank,

    3 - Invest it in something else over that year.

    0Reply
  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    8y

    @Joe Villeneuve, what the poster is saying does make sense. The relatively small amount of money he would put towards a mortgage over a year's time would not likely be able to put into another productive use over that time. So, paying down the mortgage and saving some interest is superior to keeping it in an interest free checking account.

    Also, that aspect is secondary to the poster's main question.

    @Leo Kotschenreuther, I do BRRRR but locally not remotely. I buy and rehab in cash and one advantage is that by doing that I can immediately refinance when I am done with my rehab. If you buy with a loan, then I believe lenders will want you to own the property a year before refinancing it.

    Also, if you take a loan up front for purchase and rehab costs, the loan is based on an appraisal where the appraiser "imagines" the work you will do and forms an opinion of value. Since he is imagining the work to be done that will be less reliable than a refi after work is complete. So, if the work is done in cash and then you refi, you are more certain of the value and you can make sure you refi as much equity as you reasonably should from it (not too much, not too little).

    0Reply
  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    8y

    @Leo Kotschenreuther, one additional advantage to working with cash from the get-go is that if you buy and rehab with a loan and then refi afterwards, then you are doing 2 loans each time. There are costs to close a loan (appraisals, title insurance, etc). So, there is a cost savings to be had by working with cash as well.

    0Reply
  • Jaron WallingPro Member
    Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
    8y

    Also, to add to @Kevin Sobilo comment, you won't be able to make strong offers as quickly as other investors. By strong offers I mean cash offers because everyone here knows a cash offer wins 99% of the time. 

    1Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y
    Originally posted by @Kevin Sobilo:

    @Joe Villeneuve, what the poster is saying does make sense. The relatively small amount of money he would put towards a mortgage over a year's time would not likely be able to put into another productive use over that time. So, paying down the mortgage and saving some interest is superior to keeping it in an interest free checking account.

    Also, that aspect is secondary to the poster's main question.

    @Leo Kotschenreuther

    @Leo Kotschenreuther, I do BRRRR but locally not remotely. I buy and rehab in cash and one advantage is that by doing that I can imnt for purchase and rehab costs, the loan is based on an appraisal where the appraiser "imagines" the work you will do and forms an opinion of value. Since he is imagining the work to be done that will be less reliable than a refi after work is complete. So, if the work is done in cash and then you refi, you are more certain of the value and you can make sure you refi as much equity as you reasonably should from it (not too much, not too little).

    0Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y

    @Kevin Sobilo  Did you look at the actual numbers?  You can't look at the theory only.

    This is the basis for one of the options for his "original question".

    0Reply
  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    8y

    @Joe Villeneuve, yes I did and the return was pretty good in your numbers. To get ANY return over a short period is better than no return.

    Since his scenario is to refinance after 1 year, any return is better than the likely alternative of 0% return from an interest free checking account for that short period.

    0Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y
    Originally posted by @Kevin Sobilo:

    @Joe Villeneuve, yes I did and the return was pretty good in your numbers. To get ANY return over a short period is better than no return.

    Since his scenario is to refinance after 1 year, any return is better than the likely alternative of 0% return from an interest free checking account for that short period.

     The return (savings on interest over the first year) was a whopping $757, spending $40k.  How is that a better return than using that $40k in a different investment...such as a 20% DP on another property worth $200k (twice the value in my example).  He'd probably be getting $700k/month instead of $757 TOTAL.

    Why would anyone buy $757 for $40k?

    0Reply
  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    8y

    @Joe Villeneuve, perhaps you misread the post. The $40k was a combination of equity and additional money paid on the mortgage.

    So, the reasonable assumption is that the amount paid on the mortgage is much smaller than $40k, and so that putting it to another short term productive use would likely not be possible.

    Also keep in mind that even in your scenario the entire $40k is not available for a full year. So, assuming a steady savings rate, it is equivalent to only $20k for a full year, which is a 3.875% rate of return, again much better than a 0% savings account that is the likely alternative.

    0Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y

    @Kevin Sobilo  I read it.  $40k is the sum of built up equity from the early payments (interest savings) and money contributed.  In order to arrive at that total, you would need to contribute $3200 extra per month towards the principle.  That means over $38k of that $40k is the extra cash out of pocket contributed over the course of a year to save a total of $757.

    0Reply
  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    8y

    @Joe Villeneuve, I don't see that what you are saying is in the post. Maybe I'm just missing it.

    What is see in the post is:

    "If that goes smoothly I could have 40k in cash available once the property is sold in a year (some equity from the property and some additional savings over a year)."

    So, I don't see where you get anything to assume this is all or even mostly from additional savings over 1 year. The likely scenario seems to be much less and since it is available on a stream basis through a year difficult to deploy into a liquid investment with a guaranteed short term rate of return over ~4%.

    0Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y

    I think we are both making assumptions because the poster left out the actual numbers.  Maybe we could address this more accurately if we had the actual numbers broken down to work with.

    0Reply
  • Leo Kotschenreuther
    OP
    Rental Property Investor · Mountain View, CA · Member since 2017 · 34 posts · 24 votes
    8y

    @Joe Villeneuve @Kevin Sobilo Let me share the actual numbers with you.
    I currently have about 16k equity in the property I mentioned. My estimate was that I would lose 6k of that equity when I sell it due to closing costs. I also currently have 15k in a money market savings account that is earning 1.8% interest per year. If I were to put the 15k into the mortgage now, an extra 52.52 would go towards the principal every month. Over the course of a year, that would sum up to 630.24 and compared to the 15k that is about 4.2% (the interest rate of the loan is 4.25% so this number checks out). In addition to that, I could probably also contribute another 1250 every month and get the "saved interest return" as well. This brings me to the mentioned 40k.

    Long story short, making additional payments into the mortgage saves interest and the ROI is better than in a savings account. On the other hand the money will be locked up and I would have to sell the property in order to access the money. Considering the risk of the property loosing value until I sell it (maybe the market drops), this is probably not a great return and the savings account might be the better choice. Since I'm having a job that pays well, I could also save up about 2k every month and would get to 40k of savings (within 12.5 months) even without selling the property.

    1Reply
  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    8y

    @Leo Kotschenreuther, you lose when selling the property if the market goes down whether you pay more on the loan or not. Unless you think there is a risk you will go upside down or the market will change in a way that you will not sell your property in a year, then what you were thinking makes sense to me.

    0Reply
  • Leo Kotschenreuther
    OP
    Rental Property Investor · Mountain View, CA · Member since 2017 · 34 posts · 24 votes
    8y

    @Kevin Sobilo @Jaron Walling Thanks for sharing why you prefer all cash, that was in fact my intended question.

    Good point Kevin, I lose no matter what the market does when I sell the property. So the risk is that I could lose more if the market goes down.

    0Reply
  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    8y

    @Leo Kotschenreuther, your loss is the same either way if the market goes down. The risk I see is if the market goes down enough that you decide not to sell. In that case the money you put into the loan is locked into it.

    If you are in a stable market, that risk is low. If you aren't then that is a consideration.

    0Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y

    "I also currently have 15k in a money market savings account that is earning 1.8% interest per year. If I were to put the 15k into the mortgage now, an extra 52.52 would go towards the principal every month. Over the course of a year, that would sum up to 630.24 and compared to the 15k that is about 4.2% (the interest rate of the loan is 4.25% so this number checks out). In addition to that, I could probably also contribute another 1250 every month and get the "saved interest return" as well. This brings me to the mentioned 40k".

    You are looking at this from a % point of view.  From a dollar and "sense" point of view, you can throw a dart blindfolded at an investment and make over 4% return in a year.

    Pay an extra 1250/month and you're saving a total of 336 more.  That's a grand total of 936.

    What you are doing is paying $15,000 for $936. If you put that $15k into another property, as a 20% DP, and rented it out, you should be able to get at least $400/month in PCF...that's $4800 over that same year...that's over 4.5 times the $936 you're trying to get your way.

    On a cash flow basis, you're losing money because you are now into a big negative cash flow situation.

    0Reply
  • Andrew SyriosPro Member
    Moderator
    Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
    8y
    Originally posted by @Leo Kotschenreuther:

    @Joe Villeneuve Thanks for reminding me of that. A cash flow positive property is actually a really great thing, even if it's not that much. This is how I learn to pay less for the next property.

    For paying down the mortgage, sure it would lock up the money in the property. I would be saving interest but considering my interest rate being at 4.25% it's not that much

    @Andrew Syrios I would love to hear more about why different people prefer financing or all cash purchases. What are the reasons you prefer financing? Just to be clear, even if I buy all cash I still want to pull out all my money when I refinance after a few months or a year.

     Financing allows you to buy more faster. But of course, it's also more risky. We believe that level of risk is acceptable, but others don't (or perhaps, they don't have anyone lined up to finance the upfront costs, or at least not at terms that make sense).

    Podcast Guest on Show #121
    0Reply
  • Vaughn Smith
    Property Manager · NJ · Member since 2017 · 786 posts · 396 votes
    8y

    @Leo Kotschenreuther one of the best perks of REI is that you can use long term leverage to build wealth. I don't think there is any benefit that outweighs that fact. Can purchases are faster, and you don't have to pay interest or a mortgage but think about where you are in your journey, and what the opportunity cost is before purchasing a property using all cash financing

    1Reply
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