Buying with cash versus financing. What are pros and cons of each?

Question

I'm 18 and I'm looking to buy my first rental property in the next two years! I'm debating whether or not I should buy my first property with cash or finance it.

If I buy it with cash, it will take me 3 more years to save up for it. And if I'm going to finance it, then I'll be getting less cash flow from the property, which might delay my goal of achieving financial freedom. I have almost $30k saved up now and I'm looking to buy a rental property (single family or multi family) for under $150,000.

Which option do you think I should choose? What are the pros and cons of buying with cash and financing?

Thank you!!

Dan H. · Answer

I had a recent post on virtually the same subject that I heavily borrowed from for this reply.   Note the numbers.   Recognize 1% monthly rent ratios are not easy to find and most 1% rent ratios will higher than 50% costs for sustained expenses and vacancy.   In other words, my cash flow estimate s likely higher than you will be achieving,

Vtxax and S&P have recently provided better returns than unleveraged RE. I do not invest in RE unless my projected return is far greater than vtxax or S&P.   This would be rare on unleveraged RE.  It is very rare to get 25%+/year return on  RE.

Let’s say you have a 1% monthly rent ratio and a 50% sustained vacancy and expense ratio.  Your return from cash flow is 6%.

The return produced from tax savings varies significantly by situation, I view the use of accelerated depreciation in the first year as a reducer on the down. For example if I can purchase at $500k with $100k, but achieve $25k 1st year accelerated depreciation savings, I choose to treat it as if I used $75k down and purchased at 85% LTV. Standard depreciation typically is fairly small impact on the return of an unleveraged asset. For example even on a condo where structure is 90% of purchase price, the tax benefit on standard depreciation is less than 3.3%.

Average appreciation per FRED is 3.8% for this century.  With no leverage, there is no leverage multiplier.  https://fred.stlouisfed.org/series/ASPUS

6% from cash flow + 3.3% + 3.8 is 13.1% which is less than recent history of the S&P and less than half what I expect from RE investing.

RE is a lot of work.   If I can get a similar or better return via something passive like S&P, why would I invest in RE.

Different people have different goals but the numbers do not advocate for unleveraged RE investing.

Good luck

David Cherkowsky · Answer

If you were to buy with financing now, what is preventing you from paying down the loan over the next three years, while also benefiting from the cash flow, principal paydown, and appreciation in the mean time?

Most people in real estate finance their purchases. Leverage lets you put less money down upfront and amplifies your returns on appreciation, though you're trading away some cash flow to do so.

Nicholas Mann · Answer

Analyze deals and buy something with 20-30% down that makes you a decent return on investment (cashflow). Waiting for more money, just to buy with cash will delay you truly learning from the experience of owning/managing and growing as an investor/business owner. I sat on these forums for years before I purchased something and once I got into it I said the same thing as everyone else "wish I started sooner"

Lindsay Davis · Answer

@Daria Shipitsyna,

First off, it’s awesome that you have $30,000 saved up at 18. You’re well ahead of the curve!

To answer your question, the reason why most investors finance their purchases is because debt has the potential to dramatically magnify your returns when things go right. The idea is that you can acquire a property using a bit of your money and some of your lender’s money, and then you can use the rental income to pay your lender back.

In fact, financing (or leverage) is arguably one of the biggest advantages of investing in real estate. You can often borrow $4 for every $1 you put down (if you shoot for 20% down), or even more if you opt for something like an FHA loan. This allows you to control much larger assets with a relatively small amount of your own money.

The big con, of course, is the risk of default. If you’re unable to pay your lender in time (and most will demand rigid monthly payments), your lender could foreclose on your property, which means you’d be forced to sell it—usually at an inopportune time.

If you buy a property in cash, then you won’t face this risk at all—plus, every dollar of rental income is yours to keep. Of course, the big downside of buying a property in cash is that you’re putting in far more of your own money to buy a property that generates the same amount of potential rent. This could make it more difficult for you to get started and lower returns over the long haul.

I hope this helps. Let me know if you have any more questions!

Buying with cash versus financing. What are pros and cons of each?

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