Buy using leverage, or save-up, buy in cash and then refi?

Question

Here’s the short question: Should we buy 1-2 rental properties next year using a 25% down payment, or save/wait 24-36 months and begin a cycle of buy in cash and getting delayed financing.

Here’s the context: My wife and I own 4 rentals and will purchase another 7-8 in the next 5 years. Long-term, we hope to get to 40 doors and $10k/month income in 17 years.

We have very good credit, good/secure W2 jobs, and good non-real estate finances. We also have an adequate cash reserve to cover ourselves and other rentals though this cash reserve is off-limits for any purchase or planned rehab. Our real estate capital fund is currently depleted due to a recent purchase.

We do not use partnerships, hard money lenders, seller financing, Sub-2, turnkey companies, or LLCs. We are sticks in the mud who buy through a realtor and use 30-year traditional financing. Ultimately, we need to leverage these houses to let us continue to grow and retire on-time.

We plan to target SFR with a total cost of around $75K, though we would consider anything from $50K to $100K. We are out of state investors who will buy in Charlotte for a while, and will move to another market (Atlanta?) in a few years.

We have historically used financing at the time of purchase, but we are wondering if that’s the best route to go. And for the next 24 months, I think we have two options:

Option 1 – Buy using traditional financing. This route is what we have done: Once our capital fund is where it needs to be, we find a house, put 25% down using traditional financing, pay for repairs in cash. Then save up again until the capital fund is large enough to do it again.

This approach lets us be nimble, and lets us directly control things like leverage and financing. This also ensures that our money is always working. The down side is that we cannot work with wholesalers or buy pursue cash-only purchases.

Option 2 – Save up until we have enough in our real estate capital fund to buy a house and do any repairs in cash. Once the house is purchased and rehabbed, do a delayed financing (or a refi) to get out most of the capital and put it back in the capital fund.

This approach would certainly save us money – though I have no clue how much. If we were cash buyers, we could buy through wholesalers and probably get a better deal than on the MLS, and even if we buy through the MLS using cash, we would have stronger offers to present. The downside is that we could not buy anything for the next 2-3 years, and we would always be at-risk for having our money locked-up in a property. I’m also not a fan of so much capital ‘sitting around’ between purchases.

I know that the answer to questions like this is 'it depends' but I'm interested in your thoughts.

Mark McKibben · Answer

I am using a HELOC on my main home so I can pay all cash for my rentals then I do a cash out refi on the investment property to pay the home equity off. Then I repeat the process over and over. I have 5 rentals 4 are free and clear. They cash flow $3,100/per month so its like a snowball effect.

John Chapman · Answer

Jeremiah, yes, I suppose that "delayed financing" is a better term than "refinancing" when you buy with cash and then pull money back out after the fact. My experience and understanding is you that you will have an incredibly difficult (if not impossible) time if you buy a property with cash and then try to get your cash back out using conventional, Fannie Mae financing. You are better off purchasing with the financing in place. (Again, my information may be a little dated, but this was the case when I was still doing conventional financing a couple of years ago.)

For example, when I was still using Fannie Mae Financing, I would buy a property using hard money, which would also cover most of the repairs, fix the place up, get a tenant in place and then immediately refi the note into conventional financing. Fannie Mae would only let me refi an existing purchase money note, not pull cash out of the property.

In terms of being able to buy houses for cash, my experience is that this is more important for distressed homes needing significant repairs, that is, homes that wouldn't qualify for conventional financing. From your initial post, I didn't think you were buying distressed homes, particularly because I would imagine it would be difficult to rehab from afar. If the homes you are buying aren't distressed, then you are probably paying retail or slightly below. (Nothing wrong with that if it fits your model.)

I think you may be under a slight misconception about cash offers. I don't think, as a general matter, you'll be able to use cash offers on houses with little to no work and get a significant discount. You'll be competing against retail buyers and other investors.

As for access to wholesalers, I don't say this to bash wholesalers because I know there are good ones out there, but I wouldn't hold my breath or base an investing decision on my ability to get access to their "deals." The good wholesalers that I know have told me that, "They need another buyer like they need a hole in the head."

Duncan Taylor · Answer

Jeremiah,

With four properties currently mortgaged, you are going to have both of these options taken away from you as you currently know them in the very near future.

You are going to be forced into commercial financing. When that happens, find a lawyer and a CPA familiar with that world and let them help you navigate the waters.

As a strategy, high leverage can be a good thing when you are starting out, but once you reach critical mass, it becomes an albatross around your neck.

If your planning shows you need the income from 40 sfh rentals to support you through retirement you want those paid for as soon as possible after purchase.

With each paid for house you do two things, you improve your financial strength going into any future deal and you reduce the real risk you face when things don't go as planned.

A couple of years ago, we had the start of a major real estate correction. I say the start because it was prevented from fully correcting. The correction will complete, I think it will do it within the next 5 or so years and I have put my money where my mouth is by selling out all interest in real estate investments in the US. The only real estate I currently own are our houses, all 100% paid, and the building in Seattle where the offices of the software company I run is located, again 100% paid for.

Given what I firmly believe is coming, those using leverage need to be keenly aware of its risks and the warning signs indicating the need to reduce that leverage. Timing the market at the micro level is a crap shoot at best.

Now, having said all that, if you are going to continue to buy in this market to hold long term, then for the next couple of years at most, I would buy with 25% down. Then start piling up cash. Once the real correction happens, you can join the real investors like me who will snatch up deals that are considered unimaginable today.

Donald Trump is an arrogant, self aggrandizing, jerk. But, you should definitely follow his lead on this and others like him... PILE UP CASH IN INFLATION PROTECTED EASILY LIQUIDATED ASSETS if you want to have the time of your life as an investor in a few years.

David Krulac · Answer

@Jeremiah B.

Short answer:

1. Finance as much as possible for as long as possible, making sure that the property is positive cash flow and that you don't over extend yourself. Only borrow what you can handle.

2. Save your cash, you will need some for your rentals, to buy more rentals, and meet expenses. Being cash poor is not a good strategy

Marco Santarelli · Answer

@Jeremiah B. : I was referring to a purchase money loan that you get when you first close on the property. There would be no other loan or refi. Just one loan right from the beginning -- no delay.

Duncan Taylor · Answer

Depending on how you title these properties and how strong your income is individually and your wife's income is individually you may not get past 10.

The good news is once you get into the commercial financing world things get much easier really fast. But, that is a discussion for another time.

Bill Gulley · Answer

Someone may have mentioned this, yes I'm skimming again.

Get with your bank, drop 30 or 40% down get purchase money and construction advances with a future advance note, when it's done roll it over to an 80% end loan. This way you only have one initial closing and a refi at reduced costs instead of a purchase transaction, then another full refi. :)

Jeremiah B. · Answer

All - thanks for the great feedback so far! You all win a gold star in my book!

To clarify, my question is really about how to buy it; not how to hold it. Using either option, I would plan to leverage the property as much as I can, as soon as I can. To that point, I completely agree with the comments made above the about the value of leveraging and considering the risk of leveraging/more liquid assets in an overall portfolio.

The points about getting 40 mortgages is well made, but I don't want to get off-topic on that. Suffice to say we have several years until we bump up into our limits (currently 10 for me, 10 for the wife), and I fully expect for the lending to look very different at that time.

John, Joe and Marco - it sounds like you're talking about delayed financing rather than refinancing. How do the terms of a delayed financing deal differ than the terms of a pre financed deal? I had assumed that they were identical, but I may be wrong. And I understand that traditional refinancing is basically no longer an option.

Also, I'm a little surprised no one has mentioned the benefits of paying in cash. I've never bought in cash and it's possible I have some miss-conceptions about the benefits of doing so.

Michael Heisterkamp · Answer

Upon reading some of the replies more closely it seems like some people have misunderstood the OP. The OP is asking which is more beneficial, to use leverage before the purchase or after the purchase. The OP plans on using leverage regardless of the situation.

Scott C. · Answer

I vote for using leverage. As long as the analysis was done correctly and you get a property that provides positive cash flow.

We are currently financing our third property. Our first two deals were cash deals but we felt that by financing the third deal we would be able to keep some cash reserves.

Scott

Buy using leverage, or save-up, buy in cash and then refi?

Buy using leverage, or save-up, buy in cash and then refi?

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