what is more profitable, all cash or cash out refi?

10 Replies

the math suggests to me that leverage makes you more profitable using cash out refi method where you buy all in at 75% arv then cash out in 6 mo.  That versus buying all cash. 

Myself and a friend have been debating it for weeks. He believes using no leverage makes you most profitable.   I keep rrunning the math and its just not making sense. 

We both start 60k cash.  Buy 60k house arv 80. He flows 8400 a year,  i flow 5500 with debt.  Cash out 6 months later,  get second one,  now i flow 11000 a year.  The end. He never catches up if we both stop here.  What am i missing?   Say it takes him just 2 years to save 60k. By then id have 4 going on 5 houses all flowing 5500x4=22000, versus 11000 all cash. And used the same 60k 4 times with it right back in my hands. 

All things equal. I don't get what I'm not seeing that he is.  Maybe he considers all the interest as less profit taking. 

You're right and you're friend is wrong.

Christopher B., Contractor

You are correct. Leverage can increase your cash on cash return. 

However there are other factors. The loan payments can make a positive cash flow property turn negative. You must be aware of all the hidden expenses in rentals. It is easy to think you have positive cash flow until you have vacancies, repairs, turnover costs, capital expenses etc. 

Also leverage increases your risk. Leveraging to the max is fairly risky.

Yeah not trying to bring up all the variables, just keep it simple.  These are projections.  Both situations have expenses and variables.  but on a projection basis, and leverage working FOR you and not against you (market collapse), by definition leverage wins and is more profitable even though there's a cost for the leverage.  the cost is covered by the customer, i.e. the tenant. 

So in theory it costs me zero to obtain 2 houses with 2 cash out refis. 

he's more profitable when you look at the money in his hand! He pays cash and you leverage he will get more cash back every month you will because he has no debt service!

That is where it ends.

While you received less cash, because you have debt to repay. You have more cash to reinvest in other deals so you could potentially match your cash.

Easy numbers to illustrate point

House cost - 100k produces -$ 200 or $1000 and 20k down 

So your friends put 100k down he makes more than you $200 versus $1000

On the other hand you only put 20k down, you have the same 100k you buy 5 houses 

So now you have

5 houses $500k value 100k down 1k cash "plus" you have principle paid down ! 

So who wins?

He's not more profitable if you look at the money in his hand, even with 1 house each.  He starts behind 100k.  I start behind 20k if I buy the same house with 20% down.  If nobody does anything more then eventually he overtakes me, like 10 years down the road.  On a net worth basis 1 house per, 1 mortgaged 1 not, asset value the same, then yes he has a higher net worth.  It only makes sense to leverage if one is going to re-invest it.

In Michigan the 20% down versus all cash isn't as drastic as 1000 to 200 cash flow.  It's more like 700 vs 500.

But anyway, check this out:

All cash scenario:

Buy 1 house 50k, all cash, cash flow 700/month, 8400 a year. 

6 month cash out refi

Buy 1 house 50k all cash, cash flow 500/month, 6000 a year.  Cash out at 6 months, buy house 2, 50k all cash, cash out refi, 500/month cash flow 6000 a year. 

8400 < 12,000, same time frame, using leverage with 2 mortgages, same money.  And he never catches up, ever.  Gets further behind every year for 30 years and then gets even further behind by 400 more a month every month from 30 years to death.

Assume ARV = 80k on these houses:

Scenario 1: 80k asset + 8400/year = 88,400 net worth

Scenario 2:

20k asset +  6000/year = 86,000

20k asset + 6,000/year + 60k in the bank = 26,000

Net worth = 112,000

It only gets worse for the all cash buyer to keep leveraging the same investment money over and over and over.  The same 50k can grow instant equity over and over and over. 

It's basically the same situation to start off with 2 20% down mortgages at the same time but gets even worse for the all cash buyer.  A little bit more profit but the 20% is trapped in the house  unless both get refinanced to get the 20% back out in 6 months.  Just more closing costs.

Either way, leverage wins.  By definition leverage should win, all things considered equal.

And I don't know why people seem to forget about compound interest.  10 houses today is going to compound much faster for you than 5 today and 1 every 6 months for 2.5 years, all things equal.

The market is hot for rentals here, and it won't be that way forever.  Gotta take advantage now.

But the key word is PROFIT.

From scenario one, all things considered, he is more profitable because if the asset is the same value then he earns 8400, his net worth is higher.  The problem is that the net worth is fictional, unusable, and subject to substantial market risk.  I dunno, but it's an interesting conversation to have.  I enjoy it.

@David Roberts  

@Joe Villeneuve  

I greatly respect the both of you and you always post great info.

I am going to have my wife read this a few times.  I have tried to tell her how us having 2 paid for properties is our gateway to grow.

My future plans are to take 70% from my Roseville property (42k) and use that to buy 2 more properties.

When and if we move to Farmington Hills and rent out Lincoln Park property for 6 months and pull 70% out of that one again that should be about 40k and buy 2 more properties.  So I want to leverage these 2 properties to get 4 more properties.

If I use that 85k to pay cash for 4 fixer uppers and bring the value up and have rents of at least 750 a month each.

So that would be 3k plus 850 plus 795=$4645

I would use my cash for the rehabs and just get them rent ready with fresh paint and flooring.

so go into debt to be able to collect 4600 a month for only a debt of 80k.

Am I thinking this out right.  I am good at having a good vision of how the house will look after I am done.  But I have trouble looking at the numbers sometimes. 

So, put a 2-300/month loan on 2 properties (say 4-600 a month in P/I) paid by the tenant to acquire another 4600 per month?  Sounds like a pretty good strategy to me.  

Compound interest.  The earlier you do that the better. 

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

Lock We hate spam just as much as you

Join the Largest Real Estate Investing Community

Basic membership is free, forever.