All cash or financing?!?
Lockport, NY · Member since 2015 · 41 posts · 8 votes
Hello, I am a new member to BP and currently saving up to invest in real estate with my cousin as a partner (also currently working on getting my real estate license). We decided on renting out small multi-families to start and working our way up to getting apartment buildings with the occasional fix and flip. We plan on financing our properties with mortgages and finding a local portfolio lender.
My question is this - once we are in a position to do so, should we switch to purchasing our properties with all cash, or is financing a better way to go? I understand there are leverage benefits to financing but I would like more feedback on which is the better way to go.
Thanks for any and all replies!!
All my rentals are free and clear now, this is what calculates to net worth. I'm not in the business of continuing to acquire every rental available, we are extremely picky about what we purchase and why. Net worth is all that matters, that's a result of equity through appreciation, sweat equity, smart purchasing, pay down of debt. Cash flow helps through pay down of dept or purchase of more properties. Leverage means nothing if you're not creating equity and net worth, leverage that only creates more dept is meaningless. Again, show me anybody who believes too much in leverage and I'll show you twenty more who went BK in the last recession and as those lessens are forgotten show me those who again believe too much in leverage and we will see them and and more BK'd in the recession that will eventually come. Keep in mind in the next recession all that equity we have I'm talking about can be tapped and 'leveraged' by buying all those really leveraged investors properties at a big discount, just like was done in 2009-2011. This is a long game not a short one. If the cyclical nature of real estate isn't in your game plan you're not realistic in how this works and have way to short of an investment window. Which is why so many went belly up in the last recession, those were all the people who think this is a sprint to leverage yourself as fast as possible into as many properties as you can chasing cash flow and 'control' of properties, cash flow can be a very precarious thing in a down turn, like trying to cup mist in your hands.
Continuing to utilize financing will allow you to grow your business at a more rapid pace. The cash that you could use to purchase a property out-right, could potentially be applied as a down payment on several properties.
Also, adding financing to your rental analysis forces you to buy better deals. When you buy with cash, you don't need the property to carry your debt service. This could lead you to "settle" for worse performing deals. If you can get your deals to cashflow with debt service, they will be that much better once your loans are paid off.
As you're relatively young, its okay to utilize leverage. As you get older, you will pay off these loans and become more liquid.
Let me know if you would like to discuss further...I'm local to Rochester!
Great response. I've been studying up a lot on this topic and trying to get our strategy down for acquiring property. Definitely don't want to go into investing blindly so I appreciate any and all advice.
I can see the clear benefits of financing new property as opposed to paying in cash but how will I know if I'm over-leveraging?
If you can eventually buy with cash why wouldn't you? If you're in the position to put down large amounts of cash that means you have it, so unless you're keeping it under the mattress you'll need to do something with it, either invest it in the things you're most interested in - real estate or diversify it into something else - stocks... etc...
Cash is king for a reason, when we use cash we get deals that we would miss, cash give you power over your competitors in a competitive market or a very desirable property, it allows you to often get better prices (lower) on properties because sellers look at you as being guaranteed to close versus those with financing contingencies.
For everybody who talks about leveraging, there were 20 who went bankrupt in the last recession who were leveraged and believed everything would just continue to go up. Nobody got a property paid with cash foreclosed on.
Those are also good points from the other side of the fence. I know I'm just a new investor but it seems to me that leveraging is the way to go AS LONG AS you don't put yourself in a position of going "under water" and over leveraging yourself. Having exit strategies should put yourself in a position of knowing when to finance and when to pay cash.
There are benefits and down sides to both and there's no reason to not do both if you can figure them into your strategies.
Cash is king for a reason, when we use cash we get deals that we would miss, cash give you power over your competitors in a competitive market or a very desirable property, it allows you to often get better prices (lower) on properties because sellers look at you as being guaranteed to close versus those with financing contingencies.
You are confusing CASH with financing contingencies. I can get the same deal/price/interest and STILL use the power of leverage. Paying cash just TRAPS your money in an illiquid asset.
I agree with all points above but have yet to actually win a "great deal" just because I was paying cash. I've won two bidding wars with traditional financing even. I decide on the price I should pay for a deal to make it work, regardless of whether it's cash or financing. How you pay shouldn't affect what you pay. At this point, we buy houses all cash and then refi them, hoping to actually get more out of it afterwards. That's the smartest way IMO and something I wish I had learned earlier on.
As @Nick Baldo said, financing allows you to obtain more properties. I don't know how much cash you have but let's say you have enough to buy one property or even two. Then what do you do on the next? You don't have the cash to buy, maybe now you don't even have the 20-25% for your down payment. Now you have to use a HML to buy the whole thing, which just costs you even more, and then refinance. This means you have to find REALLY good deals to make all of these costs work and not spend any money out of pocket-- and it's doable. Many people run their businesses this way but it is certainly harder. If you had saved your cash for up front costs and then refinanced, you can just rinse and repeat over and over.
Cash is king for a reason, when we use cash we get deals that we would miss, cash give you power over your competitors in a competitive market or a very desirable property, it allows you to often get better prices (lower) on properties because sellers look at you as being guaranteed to close versus those with financing contingencies.
You are confusing CASH with financing contingencies. I can get the same deal/price/interest and STILL use the power of leverage. Paying cash just TRAPS your money in an illiquid asset.
Not sure I am confusing CASH with financing contingencies, as that was exactly what I was referring to.
Not sure how your cash is trapped, equity can always be tapped.
I agree with all points above but have yet to actually win a "great deal" just because I was paying cash.
Just depends on the market and the property. In Denver most of 2015 cash was everywhere. When I cashed out of a property in the beginning of 2015 we had offers, 3 or them cash at over asking, the ones that weren't cash weren't even looked at. The market is cooling some, but cash is still always king. We are looking at a VERY hot commercial property with no supply and the fact we are cash with no loan contingencies, no appraisals, no inspections will play a factor in our offer over others. No doubt if there is lots of supply cash isn't as important, flip that around to a sellers market or a very desirable property and it's certainly a factor.
Cash is king for a reason, when we use cash we get deals that we would miss, cash give you power over your competitors in a competitive market or a very desirable property, it allows you to often get better prices (lower) on properties because sellers look at you as being guaranteed to close versus those with financing contingencies.
You are confusing CASH with financing contingencies. I can get the same deal/price/interest and STILL use the power of leverage. Paying cash just TRAPS your money in an illiquid asset.
Not sure I am confusing CASH with financing contingencies, as that was exactly what I was referring to.
Not sure how your cash is trapped, equity can always be tapped.
You compared using CASH versus having a financing contingency. I have bought properties without financing contingencies but still financed and took advantage of leverage. I accomplished all the things you did by paying CASH only without paying CASH.
True, generally, BUT NOT ALWAYS equity can be tapped but AT A COST.
@Daniel Lehman With the current market, we've found that cash offers abound these days, and to compete with those, we had to offer cash as well. You can refinance your cash out after the purchase.
@Shannon Sadik @Account Closed Said it perfectly.
I believe the question isn't whether you should buy the rental with cash but should you hold the rental in cash. I can't find a reason to ever hold a house in cash. For one, your return on investment will be much lower if you are holding it in cash rather than securing a loan (assuming the rates aren't incredibly high). You can run the math and see for yourself, all cash will always mean a lower ROI. Two, you won't be able to grow as quickly if you didn't use financing to purchase your deals. Of course, its always better to buy with cash and refinance after if the property is high in competition.
@Mike F. I don't agree
For everybody who talks about leveraging, there were 20 who went bankrupt in the last recession who were leveraged and believed everything would just continue to go up. Nobody got a property paid with cash foreclosed on....... If you are investing in rental property you should be primarily focused on cashflow and also should be planning on holding the property for a long period of time. If your rental did depreciate in value then you would still be getting the monthly cashflow and your mortgage payment would also remain the same so where is the risk of going into default? It would seem that if you had all of your cash tied up in the rental property then you would actually be worse off.
Not sure how your cash is trapped, equity can always be tapped..... This seems too risky considering you wouldn't be able to tap the equity in the property after its value has decreased. Of course no one plans on the value decreasing but I would rather take that risk with the banks money and diversify mine amongst several properties while earning a higher ROI.
Then again, I invest in an area that has a very stable rental rate. In Rochester, NY even if the housing market suffered the rental rate wouldn't change drastically enough to not earn a profit. Does the rental rate fluctuate drastically in Colorado, Hawaii, other markets?
All my rentals are free and clear now, this is what calculates to net worth. I'm not in the business of continuing to acquire every rental available, we are extremely picky about what we purchase and why. Net worth is all that matters, that's a result of equity through appreciation, sweat equity, smart purchasing, pay down of debt. Cash flow helps through pay down of dept or purchase of more properties. Leverage means nothing if you're not creating equity and net worth, leverage that only creates more dept is meaningless. Again, show me anybody who believes too much in leverage and I'll show you twenty more who went BK in the last recession and as those lessens are forgotten show me those who again believe too much in leverage and we will see them and and more BK'd in the recession that will eventually come. Keep in mind in the next recession all that equity we have I'm talking about can be tapped and 'leveraged' by buying all those really leveraged investors properties at a big discount, just like was done in 2009-2011. This is a long game not a short one. If the cyclical nature of real estate isn't in your game plan you're not realistic in how this works and have way to short of an investment window. Which is why so many went belly up in the last recession, those were all the people who think this is a sprint to leverage yourself as fast as possible into as many properties as you can chasing cash flow and 'control' of properties, cash flow can be a very precarious thing in a down turn, like trying to cup mist in your hands.
I like to purchase the properties for cash and then do a delayed financing to pull all my money out. With delayed financing, you can pull out 75% of the appraised value up to 100% of the purchase price plus closing costs.
I just bought a property for $151k cash and am in the middle of a delayed financing to pull all my money out and purchase another one.
Another good thing about cash is you dont have to worry about the bank. Because I had cash, I was able to purchase my property which had septic issues. A bank would most likely never lend on a property that needed a septic system replaced.
So I bought it cash, fixed up the septic system and then refinanced it with delayed financing. You can do delayed financing up to 6 months after the time of purchase.
My personal advice for what it's worth is to start reigning in debt now. Watch very carefully the signs the next 6 months. We've got good signs - 5% unemployment (tempered by the real unemployment rate is over 7%, tempered with the largest non-participating unemployed in history), we've got good signs 2.5% economic growth (tempered by that historically we should be closer to 4%), we've got good signs the Fed raised rates (tempered by they said they would raise 4 more times in 2016, watch and see if they do or they have to pull that back which is what everyone is predicting), we've got sub $2.00 gallon gas with consumers having $700 or more income to spend (tempered with a mild localized banking meltdown- Dallas Fed has suspended mark-to-market, JP Morgan for the first time since the recession (22 quarters) has had to increase it's loan loss reserve. Things could get really ugly very quickly with $20-$25 dollar oil. Need I mention China or the stock market...
Not saying the sky is falling but I'd start looking at things very differently right now until we get signs that things are getting worse or going to get better, this is a very pivotal time and mid 2016 might not end up where we are hoping and high levels of exposure through leverage is not going to be where I would want to be.
@Mike F., you said: "All my rentals are free and clear now".
What wasted potential!
All my rentals are free and clear now, this is what calculates to net worth. I'm not in the business of continuing to acquire every rental available, we are extremely picky about what we purchase and why. Net worth is all that matters, that's a result of equity through appreciation, sweat equity, smart purchasing, pay down of debt. Cash flow helps through pay down of dept or purchase of more properties. Leverage means nothing if you're not creating equity and net worth, leverage that only creates more dept is meaningless. Again, show me anybody who believes too much in leverage and I'll show you twenty more who went BK in the last recession and as those lessens are forgotten show me those who again believe too much in leverage and we will see them and and more BK'd in the recession that will eventually come. Keep in mind in the next recession all that equity we have I'm talking about can be tapped and 'leveraged' by buying all those really leveraged investors properties at a big discount, just like was done in 2009-2011. This is a long game not a short one. If the cyclical nature of real estate isn't in your game plan you're not realistic in how this works and have way to short of an investment window. Which is why so many went belly up in the last recession, those were all the people who think this is a sprint to leverage yourself as fast as possible into as many properties as you can chasing cash flow and 'control' of properties, cash flow can be a very precarious thing in a down turn, like trying to cup mist in your hands.
These are WISE words. I think I will cut and paste your post, frame it and put it on my desk.
Mike, do you use equity line of credit on your current homes to purchase other rentals?
Jason D - the first thing I did was right about your age and was pay off my personal home. My 1st move was from an apartment to a home owner was to an affordable house that needed a lot of work, I improved the cosmetic issues but also added value to the home (finished the basement, added a bedroom and a basement) so right off the bat I increased the value of the home and that built instant equity (kind of like a fix and flip, except I didn't flip it instantly I lived in it) Next was to pay off the mortgage, every penny went into the mortgage, you make sacrifices in your life style but at 25 like yourself that wasn't a problem. Take a look at Dave Ramsey, read The Millionaire Next Door.
First rental was purchased tapping home equity line of credit. Paying cash gave me 'leverage' with sellers over others.
Purchased a number of rentals nothing in war zones, everything in excellent neighborhoods that would appreciate. All properties like the first, ability to put sweat equity into and rehab and improve to create further equity. Once I had a number purchased I then stopped or slowed down and concentrated on paying off the mortgages one by one, the first one takes the longest then it's like a snowball gaining momentum down hill. As you get rid of a mortgage payment that money can be added to pay off the next one, so on and so on. Again every penny from personal income and rentals was applied to mortgages to get out of debt. Sold a couple along the way to get rid of some properties that were not ideal for my rental goals which is very low time management of tenants while self managing all the properties, no property managers, that eats into money you can use to pay down the debt. The properties appreciated greatly during this slow time also so networth was continually improving.
Eventually you get to a point you have no debt, tons of equity and rental income stream, this could be off of 1 rental or 20 rentals or anything in between it just depends on your plans, but that is how you build net worth which is the only thing that matters. All cashflow goes to paying off the debt to own free and clear.
When the recession hit others were stuck, couldn't or wouldn't buy when the world was coming to an end and bargains were everywhere. I bought lots of stocks at the bottom and started buying properties again, didn't take long 3-4 years to pay off everything again from the momentum I already had and the proceeds from all those excellent companies who stock prices were beaten down that all came back. (Example buying Ford at $1.90 a share selling at $16.00, buying United Airlines at $6.00 selling at $50.00) Think "cyclicals" they rise and fall with the economy, economy goes down they go down the economy goes back up they go back up, remember this in the next recession that's not rocket science that's common sense.
My path is not the fast track, but I never believed I would get rich quick in real estate I always planned on real estate being a get rich slowly venture over time. The way I do things Momentum replaces Leverage. The longer you're doing this the more momentum carries you instead of leverage and you're safe the entire journey. Buy slowly, buy excellent properties that will appreciate, self-manage, put excellent tenants in your properties (no section 8), pay off debt, ride the economy over the long term.
I love your strategy Mike F.
Sound strategy. So if someone were to take that approach and lets say, finance 10 properties and then buckle down on paying off those properties before buying another property, what's their next step? After those properties are fully paid off do you then refi/heloc some of those properties to put towards your next 10 properties, or do you leave them alone and just use money from your cash flow as deposits or even to fully pay off your next 10?
If you refi or heloc some of the first 10 to use for your next 10 then isn't that kind of going against 'staying out of debt'? I would think you would want those first 10 properties to stay free and clear while you get your next 10. And eventually you'll have 20 or 30 fully paid off properties that you can use cash flow to continue buying rental properties all cash.
I know I'm a newbie investor but am I making sense? lol
Mike, from what you're saying, you did finance your first rental. You may have used your personal residence as collateral but you took out a loan with the sole purpose of buying a rental property. You say they're free and clear now but then mention how after you purchased a number you'd buckle down and pay off the mortgages.
To me, when someone talks about the philosophy of paying cash to purchase properties, they don't mean taking $$ off of an existing property to buy a new property but rather using funds made from your main source of income to purchase homes cash. I get you're able to take the financing contingency off the offer and are "paying cash" for the purposes of your new purchase but you're really financing behind the scenes.
You have no mortgages now but it sounds like financing properties was key to get you to where you are today. I would also ask what the interest was on an owner occupied loan when you paid it off? I agree a nest egg is essential to prevent a personal "financial collapse" but when you have a 3.5% interest owner occupied loans over the last year or two, after tax deductible interest is really like 2.5%, I can't see any sense in paying that thing off quickly.
I do agree with the nest egg philosophy though, don't finance to the hilt and hope things don't drop out. I think if you could comfortably put down 20-30% on a non-owner occupied property, while still maintaining a nest egg of a few thousand per property to cover CapEx, then I think that would be a safe financial move.
I think leveraging does improve your cash on cash returns but one thing that nobody speaks about is TIME. If you had $100k and had the choice between buying a single property and making 8% cap rate($8k/yr on your $100k) or buying (5) $100k properties at 80% financing and making 15% cash on cash return($15k/yr on your $100k + equity) do not forget that you're managing 5 tenants versus 1. It will make you more money but take much more time. But again this goes back to your rental property goals.
@Mike F., you said: "All my rentals are free and clear now".
What wasted potential!
Wasted potential? You people are weird.
it's a pros or cons,
all cash would be more attractive to seller, cause it's a more guarantee to get their home sold, then you might be able to do a cash out refinance later.
@Mike F., you said: "All my rentals are free and clear now".
What wasted potential!
Wasted potential? You people are weird.
It goes back to your goals when purchasing rental properties. If you're looking for something to replace your 401k or another investment vehicle to give you more passive returns over the long haul so you can comfortably retire, that's different than the person looking to quit their job and dedicate their full time to acquiring and managing properties.
@Mike F., you said: "All my rentals are free and clear now".
What wasted potential!
Wasted potential? You people are weird.
You mean: if you had ONE million dollars of equity free and clear, you would not consider borrowing against say half of it, to conservatively be able to DOUBLE your equity within short order? All because it would be: weird to borrow wisely? Weird to have TWO million dollars of equity if you owe $500k? OK; I'm weird...