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.
Dan,
Welcome to the forum, I am another local Rochester investor. As others have said I believe it depends on the market, I have not seen cash offers in Rochester have the same impact as other parts of the country I have invested in.
I believe that @Chuck VanDyne and @Shannon Sadik are correct, especially for someone who is young.
There is value to owning the properties free and clear at some point, just not sure which point that is.
Your decision is similar to another one you will face at some point, at what point do you stop focusing on acquiring properties and focus on paying them off?
There are valid points on both sides and like a lot of things leverage is a powerful double edged sword. The bottom line is that you need to be able to sleep at night and only you can ultimately decide how much risk you are comfortable with.
Russ
@Account Closed
I appreciate your reply. I agree with you in that it really depends on the market and that I think it comes down to the individual investor's strategies and goals. I can see the pros and cons of both sides and I don't think it needs to come down to only one or the other.
I see no reason why you cant finance some properties and pay all cash for others. Definitely at first I'll be financing and using leverage to expand my portfolio at a much faster rate than if I tried to pay all cash but at some point I'm sure I'll be asking myself when I need to slow down and get some properties paid off.
I think that when I get older and want to slow down immensely maybe to the point of completely retiring and sitting pretty on my investments that I'll be more concerned with having properties paid off - but then again, by the time I get to that age, properties will probably be close to paying themselves off anyways.
For people who love investing I wonder if they never get to that point and are always looking to acquire.
I worked for a guy in his mid 30s who had started a tech company in high school, he sold it to ebay for a very large sum of money. Instead of sitting on a beach enjoying a drink he started another company. Guessing there are some real estate investors who are the same way, they dont have a number and they will never stop acquiring.
Best of luck in the new venture, happy hunting.
Russ
To those who question that I'm against financing, I didn't mean to give that impression. My 1st property I was saving for since I was 16 years old with my first job, I had a healthy down payment on my 1st house because I had saved for it forever. But I did financed it. But I also paid it off. I then borrowed against my equity (loan my self the money) for down payments on rentals.
This was in reference to the original point in reply to leveraging everything. Everything has it's place but net worth is measured in equity not cash flow. To control a property that will never appreciate that takes a lot of time to manage the tenants because its a C or D property and you've got C & D tenants, to do all of that for a $125.00 a month cash flow and preach now all you need to do is do that 100 times and your RICH!!!!! No thanks. Sooner or later you need to actually own something instead of the bank owning it or you've got nothing.
Again - read The Millionaire Next Door. It has nothing to do with getting rich quick.
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?
The answer could be Yes, Maybe, Sure....
The real beauty of it really is though that you have options isn't it.
At this point we are now looking to move away from residential and get into the holy grail of commercial real estate. Options, lots of options when you actually pay things off and have net worth.
Those were my heros growing up, I didn't care for the flashy guy who sold the flash and cash. I admired that old bastard down the street who you eventually found out owned 6 gas stations, a small warehouse and got started sucking sewers with his small honey wagon business and invested the profits. Those are The Millionaires Next Door.
Those old bastards had all the money when they got older, Mr Flash and Cash was working some other scam still and still driving around a junker and couldn't rub two pennies together. While Mr Honey Wagon was taking his entire extended family on a cruise.
To those who question that I'm against financing, I didn't mean to give that impression. My 1st property I was saving for since I was 16 years old with my first job, I had a healthy down payment on my 1st house because I had saved for it forever. But I did financed it. But I also paid it off. I then borrowed against my equity (loan my self the money) for down payments on rentals.
This was in reference to the original point in reply to leveraging everything. Everything has it's place but net worth is measured in equity not cash flow. To control a property that will never appreciate that takes a lot of time to manage the tenants because its a C or D property and you've got C & D tenants, to do all of that for a $125.00 a month cash flow and preach now all you need to do is do that 100 times and your RICH!!!!! No thanks. Sooner or later you need to actually own something instead of the bank owning it or you've got nothing.
Again - read The Millionaire Next Door. It has nothing to do with getting rich quick.
I would argue the opposite of that, though. When you have financed/leveraged a property using your cash, you're building both cash flow(net worth if you save it), equity through paydown(net worth), and appreciation(net worth). By paying all cash for your properties you're limited to only the cash flow and appreciation, and do not gain that pay down of equity that comes with the financing.
In the case of the $125/mo cash flow, there's likely another $100/mo in equity being gained by debt paydown, as well as appreciation occurring. I think they just aren't talked about quite as much because cash flow is what puts food on the table.
Just running a quick example through my spreadsheet:
$100k purchase, $1100/mo rent, $2400/taxes, $600/yr insurance, $1500/yr maintenance, paid in cash yields 7.64% return on your cash or $7,644/yr of cash flow. Add to that 4% appreciation each year and your first year yields you $11,644 of net worth gain.
Using the same $100k you could purchase 5 of these deals:
$100k purchase price, $20k down, 5%/30yr amort, same numbers as above. This gives you a cash flow of $2,491 per property. You gain that same $4k of appreciation, now at $6,491. Add in the $1,180 of debt paydown(1st year), you're at $7,671 net gain on this one house and you'd have the ability to buy 5 of them, or make $38,355 off of your $100k, when counting all 3 avenues(cash flow, appreciation, debt paydown).
Even if the expenses change, rent changes, the net worth growth will still be significantly higher with the leveraged scenario. I don't really see it as any more risky, either, with 20% down on each property. It just takes more time to manage.
Great discussion! I am in the middle I guess. Leveraged but paying things off. Most all of us needed to leverage in the beginning. I have grown comfortable just having what I have paid off. No more hussling for that new property. Can you imagine?
I always thought I would be max-leveraged and looking to grow perpetually. I like where @Mike F. is. I congratulate @Daniel Lehman for having as much capital as they do together. Be careful with partnerships, Dan. Put everything in writing and prepare for the Ds! Are you forming an LLC or buying as TIC?
Don't be surprised to look up one day and be comfortable with a lot of equity. Not be hungry for every deal in sight. Maybe be in a position to just engineer a transaction for someone else because it doesn't fit your specific asset type in your specific target market. Happy investing!
Tbh I haven't discussed that with my cousin (partner investor) yet. Not sure what a better route is to go as far as LLC, TIC and JTs are concerned.
@Mike F., you said: "All my rentals are free and clear now".
What wasted potential!
This is something that I do not get. For years I have heard you must always be growing your business.
If you have sustained income and it can keep up with or surpass inflation, why must you have more?
It is important to pay attention to your own risk tolerance and cash flow needs.
@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...
The market where you are doubling your money is largely gone now. We all did double our money, and if you did it correctly should have been up at 3-4x. Doubling your money was easy, didn't take Einstein to buy a discounted house, and buying a house that is worth half it's real value, let alone 25%, is hardly the action of a investment god either. It's just simple numbers and following through.
Right now we're looking down the barrel of a recession, and people on BP are touting leveraging. Property has long since recovered it's losses.
So why exactly would I leverage large amounts of equity when we are possibly looking at a downturn? Even my dog learns from mistakes; it all seems a bit 2006 round here.
I would argue the opposite of that, though. When you have financed/leveraged a property using your cash, you're building both cash flow(net worth if you save it), equity through paydown(net worth), and appreciation(net worth). By paying all cash for your properties you're limited to only the cash flow and appreciation, and do not gain that pay down of equity that comes with the financing.
In the case of the $125/mo cash flow, there's likely another $100/mo in equity being gained by debt paydown, as well as appreciation occurring. I think they just aren't talked about quite as much because cash flow is what puts food on the table.
Just running a quick example through my spreadsheet:
$100k purchase, $1100/mo rent, $2400/taxes, $600/yr insurance, $1500/yr maintenance, paid in cash yields 7.64% return on your cash or $7,644/yr of cash flow. Add to that 4% appreciation each year and your first year yields you $11,644 of net worth gain.
Using the same $100k you could purchase 5 of these deals:
$100k purchase price, $20k down, 5%/30yr amort, same numbers as above. This gives you a cash flow of $2,491 per property. You gain that same $4k of appreciation, now at $6,491. Add in the $1,180 of debt paydown(1st year), you're at $7,671 net gain on this one house and you'd have the ability to buy 5 of them, or make $38,355 off of your $100k, when counting all 3 avenues(cash flow, appreciation, debt paydown).
Even if the expenses change, rent changes, the net worth growth will still be significantly higher with the leveraged scenario. I don't really see it as any more risky, either, with 20% down on each property. It just takes more time to manage.
Wow, 2008-2010 was so much fun.
Look hey, I love your new found love of leveraging, and all I can do is encourage people like you, to keep doing what you're doing. I think you're great. Don't let anyone tell you that you're being foolish. Or the risks. Risks pisks...who cares. Leveraging is great. Repeat after me "WE LOVE LEVERAGING".
People like you did wonders for my net worth. I wish you all the best, and just remember, when it all goes horribly wrong again, I'll be here, cheering you on through the foreclosure and short sales process and buying your assets at massive discounts. With cash.
I would argue the opposite of that, though. When you have financed/leveraged a property using your cash, you're building both cash flow(net worth if you save it), equity through paydown(net worth), and appreciation(net worth). By paying all cash for your properties you're limited to only the cash flow and appreciation, and do not gain that pay down of equity that comes with the financing.
In the case of the $125/mo cash flow, there's likely another $100/mo in equity being gained by debt paydown, as well as appreciation occurring. I think they just aren't talked about quite as much because cash flow is what puts food on the table.
Just running a quick example through my spreadsheet:
$100k purchase, $1100/mo rent, $2400/taxes, $600/yr insurance, $1500/yr maintenance, paid in cash yields 7.64% return on your cash or $7,644/yr of cash flow. Add to that 4% appreciation each year and your first year yields you $11,644 of net worth gain.
Using the same $100k you could purchase 5 of these deals:
$100k purchase price, $20k down, 5%/30yr amort, same numbers as above. This gives you a cash flow of $2,491 per property. You gain that same $4k of appreciation, now at $6,491. Add in the $1,180 of debt paydown(1st year), you're at $7,671 net gain on this one house and you'd have the ability to buy 5 of them, or make $38,355 off of your $100k, when counting all 3 avenues(cash flow, appreciation, debt paydown).
Even if the expenses change, rent changes, the net worth growth will still be significantly higher with the leveraged scenario. I don't really see it as any more risky, either, with 20% down on each property. It just takes more time to manage.
Wow, 2008-2010 was so much fun.
Look hey, I love your new found love of leveraging, and all I can do is encourage people like you, to keep doing what you're doing. I think you're great. Don't let anyone tell you that you're being foolish. Or the risks. Risks pisks...who cares. Leveraging is great. Repeat after me "WE LOVE LEVERAGING".
People like you did wonders for my net worth. I wish you all the best, and just remember, when it all goes horribly wrong again, I'll be here, cheering you on through the foreclosure and short sales process and buying your assets at massive discounts. With cash.
Let's be clear. I own ten investment properties with no liens at the moment as I don't have the time to manage fifty properties. But why don't we forego the personal attacks and instead explain why my numbers are wrong?
Where are you getting your 100s of thousands of dollars to buy properties cash if you are not leveraging anything? Even if you started off with $1mil at a 8% cap rate, $80k/yr is not going to give you much to reinvest.
Don't get all precious, it's not a personal attack.
Your numbers are correct, but in the real world, real world things happen. Like tenants stop paying. And the chance of multiple tenants who stop paying in a recession is very high. Sure there are landlords who weathered the storm, but many didn't.
The problem is that during a recession there is a substantial increase in risk, which no one ever takes into account.
Very quickly, one tenant stops paying, becomes two tenants, becomes three. Then you have a property that's trashed and needs a couple of a grand to sort out. The quality of potential tenants is low, you dash for the cash and accept a tenant who you wouldn't dream of touching normally, you get two months of rent, a trashed property, and it's out for three months+, not to mention another couple of grand for repairs.
This period of bad occupancy requires you to dig deep into your pocket. But when you're making $100per month per door, it all goes south horribly quickly. Which is exactly what happened.
We picked up a number of properties from an investor who had done exactly the above. The banks had had to write off something like $500k of debt on what we picked up. I almost felt sorry for the banks. Almost. I know that his end amount was in the region of $800k. I know another investor who runs a local investment group - his losses were in the region of $3m. This stuff did happen.
Wow, 2008-2010 was so much fun.
Look hey, I love your new found love of leveraging, and all I can do is encourage people like you, to keep doing what you're doing. I think you're great. Don't let anyone tell you that you're being foolish. Or the risks. Risks pisks...who cares. Leveraging is great. Repeat after me "WE LOVE LEVERAGING".
People like you did wonders for my net worth. I wish you all the best, and just remember, when it all goes horribly wrong again, I'll be here, cheering you on through the foreclosure and short sales process and buying your assets at massive discounts. With cash.
It was not the overleveraged people that helped you but the downturn in the market. Also seems if you were illiquid by having ALL your cash trapped in your properties then it would be hard for you to take advantage of the lower prices. Also, just because you bought something for less than a previous sale DOES NOT mean you got a "deal". The market is what the market is at any point in time.
What about the person that has their money all in equity? Real estate rich, cash poor. If they had a sudden need for liquidity they would also need to "sell low" to get them out of their predicament.
Don't get all precious, it's not a personal attack.
Your numbers are correct, but in the real world, real world things happen. Like tenants stop paying. And the chance of multiple tenants who stop paying in a recession is very high. Sure there are landlords who weathered the storm, but many didn't.
The problem is that during a recession there is a substantial increase in risk, which no one ever takes into account.
Very quickly, one tenant stops paying, becomes two tenants, becomes three. Then you have a property that's trashed and needs a couple of a grand to sort out. The quality of potential tenants is low, you dash for the cash and accept a tenant who you wouldn't dream of touching normally, you get two months of rent, a trashed property, and it's out for three months+, not to mention another couple of grand for repairs.
This period of bad occupancy requires you to dig deep into your pocket. But when you're making $100per month per door, it all goes south horribly quickly. Which is exactly what happened.
We picked up a number of properties from an investor who had done exactly the above. The banks had had to write off something like $500k of debt on what we picked up. I almost felt sorry for the banks. Almost. I know that his end amount was in the region of $800k. I know another investor who runs a local investment group - his losses were in the region of $3m. This stuff did happen.
So how do you purchase properties without leveraging existing ones?
To me the issue was less the investors legitimately putting 20% down but the people that "fudged" the down payments. Marked up the $100k house to $120k and the seller would write a check at closing for $20k. This was almost common practice and got to the point it wasn't even frowned upon. Or people that would refinance at 90-100% of appraised value(I believe there were programs to even go over 100%), and appraised values had gotten very loose and they were really upside down on properties. Those are the ones that were left holding the bag, not the ones that legitimately put $20k down on a house selling for $100k.
I simply cannot understand how anyone could have all their cash trapped in a free and clear property, this simply is not possible. In addition even if this was a possibility I think you're missing the point two other ways. 1) You have a tremendous cashflow when you have no debt, which means you probably have a good cash reserve. 2) You don't have to tap 10 homes equity to purchase 2 more in cash, there is nothing stopping someone with 250K in equity in a house to tap the equity for just $25K and put that down on another house and get a mortgage on it. Equity equals more freedom not less.
I simply cannot understand how anyone could have all their cash trapped in a free and clear property, this simply is not possible.
if you are earning an income and paying taxes on that money and then giving that money to a mortgage company so that you do not have to make a payment in January of 2046 but IF something happens TODAY such as a major illness or accident and you can no longer work then even if you have another paid off property you may have a heck of a time getting that cash out or if you can get the cash out it may come at a greater expense than if you'd just kept some of your cash as well, cash.
Yeah, sorry, not following you, like I said - . 1) You have a tremendous cashflow when you have no debt, which means you probably have a good cash reserve.
When you have rental properties you are working right? You own a business in the business of rental properties, as long as you have an income in your business and are filing a tax return with income whether you are actively out spending 10 hours a day painting your properties or sitting on a beach in Hawaii, the banks don't care, they are looking at your income.
I guess to make it simpler, if I have 4 million dollars in equity I think I can use a little tiny bit of it if I wanted to buy another property. If I have $2000.00 in equity, probably not. So somewhere in that large expanse between that 2K in equity and 4 million in equity there is probably a place where things are pretty simple.
There are no simple answers. All answers are function of your investor and life cycle. However, there are some basics:
If there is too much cash in one place that's not moving - it is exposed...
High IRR is impossible with all cash...
LTV on asset value is not at all the same thing as LTV on purchase price...
Finally - you must be able to exit! Period!
Good luck :)
That tremendous cash flow is mostly your OWN money being handed back to you in low monthly installments. Why would you pay your own AFTER TAX money into a property? It won't increase your profitability. The bank won't give you a discount. You won't have a second asset capable of earning money. It just does not make financial sense.
So how do you purchase properties without leveraging existing ones?
Earn money outside real estate. You do reach a point after a few properties that they are generating that extra cash you need but it still helps to have that outside income. The property game is an expensive game to play.
That tremendous cash flow is mostly your OWN money being handed back to you in low monthly installments. Why would you pay your own AFTER TAX money into a property? It won't increase your profitability. The bank won't give you a discount. You won't have a second asset capable of earning money. It just does not make financial sense.
Yeah, sorry Bob, we must be speaking two different languages. I could swear my tenants are paying me out of their income and my tax returns for my rentals show a profit.
Maybe post some spread sheets or something to explain yourself. I'm just interested in net worth buddy not debt, sorry this doesn't compute. I'm fine with different strokes for different folks and how you can get to your goals, but can't really follow your logic on net worth being a bad thing. At this point I wish you best of luck in your adventures.
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.
So by "every penny" you don't mean of your wage income but ONLY the tenants. See where you said one thing but meant another?