Cash vs. Loan
Arlington, TX · Member since 2016 · 57 posts · 21 votes
Cash vs. Loan
Most Popular Reply
Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
10yThere's nothing wrong with starting all cash. That's how I started. Leverage is where your growth is going to come from, however, unless you're young enough that you can wait the 20-30 years to expand naturally. The key to that is not to be over-leveraged. Personally, I like the 50% threshold, in that half of my properties would be noted and half free, or that all properties would be noted no greater than 50% (the former is better IMO). This provides for growth potential and still leaves a boatload of equity out there for riding out the difficult times.
I use the same 50% mark as a threshold for profitability, i.e. more than 50% of my units would have to be vacant at once before I would be dipping out of my own money (outside of the business) to cover expenses.
Skyline Properties
27 Replies
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes10y
There's nothing wrong with starting all cash. That's how I started. Leverage is where your growth is going to come from, however, unless you're young enough that you can wait the 20-30 years to expand naturally. The key to that is not to be over-leveraged. Personally, I like the 50% threshold, in that half of my properties would be noted and half free, or that all properties would be noted no greater than 50% (the former is better IMO). This provides for growth potential and still leaves a boatload of equity out there for riding out the difficult times.
I use the same 50% mark as a threshold for profitability, i.e. more than 50% of my units would have to be vacant at once before I would be dipping out of my own money (outside of the business) to cover expenses.
Skyline Properties - Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes10y
Leverage through financing is one of the advantages of real estate. Instead of doing several all cash, you could do four times as many financed. On the flip side, all cash gives you better negotiating power, because you can close quickly. Without financing you will have great cash flow day one.
There is no right or wrong answer, but you will find strong opinions leaning towards financing.
- Rental Property Investor · Dallas, TX · Member since 2012 · 502 posts · 263 votes10y
What is your ultimate goal? Are you looking for cash flow to quit your day job? Accumulate properties for retirement? Just looking to earn better than 1% on your cash sitting in the bank?
For me, while I have a good W-2 income, and interest rates are insanely low, I want to accumulate as much debt as I can. Obviously I don't want to get in a negative cash flow situation, but if the numbers work, I want to take on as many loans as I can.
- Investor · Princeton, TX · Member since 2014 · 1k+ posts · 1k+ votes10y
@Jesse Chunn It will probably make it is easier to get financing once you get some rental history.
- Arlington, TX · Member since 2016 · 57 posts · 21 votes10y
@Account Closed Thanks for the reply. I don't really have a problem with getting financing. Like I said, I have good credit and income. The question is more around the pros and cons of cash vs leverage. But you do bring up a good follow up question. If I were to quit my day job, do lenders look at a rental that basically "pays for itself", or do they require other income, as if the property doesn't generate cash flow? Or does rental history (experience) make a big difference, as you suggest?
- Investor · Princeton, TX · Member since 2014 · 1k+ posts · 1k+ votes10y
@Jesse Chunn Some banks require a two year rental history on EACH property before they count the rent as income for the ratios they use to qualify you. Others require the owner have a history as a landlord.
It is a relatively good time to get a mortgage because of low interest rates.
- Investor · LaGrange GA · Member since 2014 · 121 posts · 55 votes10y
Another option to consider would be applying your cash to a larger multi-family deal. Since you have the funds available, you could leverage them to purchase a multi-family with 20-25% (depending on lender requirements) down. I would expect some economies of scale from a multi-family, and therefore a potentially higher cash on cash return. Another thing to consider with cash properties is that your COC return decreases substantially due to the significantly higher (5x if comparing 20% down to 100% all cash deal). With a lower COC return, you're making less money for how much 'skin' you have in. Although leverage isn't free, it allows you to invest in more expensive, potentially better investments.
I am with @Andrew Herrig and would take a loan if that's a possibility.
If you were looking at 3 80K properties in cash (240K), and are making $500/door cash flow, you're making $1500/mo in cash flow.
Take the same 240K, use it as your 20% down payment, you now have 1.2M available to buy. Look on loopnet.com to get an idea of what kind of returns you could get with a leveraged 1.2M property to compare the results... my bet is that you'll make FAR more than the $1500 with a large multi-family using leverage than you will with 3 all cash deals.
- 10yColleen F.Pro MemberInvestor · Narragansett, RI · Member since 2013 · 8k+ posts · 4k+ votes
It is easier to get loans when you have a job vs just the rental property income. Another factor is low interest rates now make loans attractive now vs later. While your approach is fine loans leave you more cash on hand to expand when/if you decide to quit your day job. They also give a bigger cushion in the bank to lean on when you have capital expenses or have a killer deal come up that needs ready cash. I guess I would consider do you have to use cash for a particular house and go from their. Its harder to finance equity later in my experience as well.
- Arlington, TX · Member since 2016 · 57 posts · 21 votes10y
Originally posted by @Matt Vogt:
Another option to consider would be applying your cash to a larger multi-family deal. Since you have the funds available, you could leverage them to purchase a multi-family with 20-25% (depending on lender requirements) down. I would expect some economies of scale from a multi-family, and therefore a potentially higher cash on cash return. Another thing to consider with cash properties is that your COC return decreases substantially due to the significantly higher (5x if comparing 20% down to 100% all cash deal). With a lower COC return, you're making less money for how much 'skin' you have in. Although leverage isn't free, it allows you to invest in more expensive, potentially better investments.
I am with @Andrew Herrig and would take a loan if that's a possibility.
If you were looking at 3 80K properties in cash (240K), and are making $500/door cash flow, you're making $1500/mo in cash flow.
Take the same 240K, use it as your 20% down payment, you now have 1.2M available to buy. Look on loopnet.com to get an idea of what kind of returns you could get with a leveraged 1.2M property to compare the results... my bet is that you'll make FAR more than the $1500 with a large multi-family using leverage than you will with 3 all cash deals.
Matt,
I totally agree with you on that, however, I am scared stiff to jump into a big multi-unit because I simply don't know what I don't know. I have zero experience. I have not bought a single property (other than a few primary residences) and it seems like it would be a good idea to have at least a couple of deals under my belt before getting into something like that. Would you (or anyone) disagree and suggest that I just go for it?
- 10yGino BarbaroPro MemberRental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes
Hi Jesse
Buying SFH for investments is different than buying a personal home. You don't have to jump into a big multi, but you should consider this niche. You don't have to do as many deals, economies of scale are better and per unit const tends to be cheaper than SFH
Food for thought?
Good Luck
Gino
- Investor · LaGrange GA · Member since 2014 · 121 posts · 55 votes10y
Jesse,
I understand your concerns and am not in your shoes. You've worked hard and saved a lot, and want to protect your investment. We take risks in hopes of returns, but we also mitigate risks as best as possible. If you're more comfortable dipping your toes in and easing into rentals, then (1) single family house might be a better way to go about it until you're more comfortable. Being green in any new venture is going to have it's learning pains, and it's good to be honest with yourself upfront (which you seem to be). Know your strengths and weaknesses, then get help with your weaknesses. If you're confident in your analysis, then have several other people look at it and provide feedback. Do this again and again without buying property, just learn the numbers.
I am fairly young and can handle a lot of risk... I don't have a tremendous amount to lose, and I can rebound in a few years. Two years ago I was looking at buying my first personal property, the thought of having that amount of debt made me sick and I missed out on a few deals because of it. In reality, I wasn't ready. Now I have two properties and am anxiously awaiting and planning for my next deal. I eased into it, and it helped me be comfortable with something new with relative risk. Looking back, I wish I would have been a little more committed.
Perhaps a good solution would be buying a SFR with leverage, keeping as much available for funds as possible. Manage the 1st SFR for a bit until you're comfortable.... Very low risk if well researched etc. Once you're comfortable, re-evaluate your situation, experience, and tolerance for this type of risk. When you re-evaluate, once again look into the pro's and con's of either a SFR or Multi-family, and cash vs leverage.
You can always pay off your mortgage early too... rates are low, and I would take advantage before we see rate increases and inflation increase.
- Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes10y
Buy 'em all cash.
Should you ever need access to additional capital, once you've quit your day job, well documented rental income counts as qualifying income for lenders with IQs greater than a gerbil.
Here's how you test that theory before you quit your day job should that be on your "to do" list:
- Own a bunch of properties in the clear for two tax years with two clean/honest sets of Schedule E on your two sets of tax returns.
- Go apply for a mortgage at 75% LTV on the most expensive property.
- Refuse to provide your paystubs when requested, tell your lender that she or he only gets to use rental income to qualify you.
- First lender that can do it is your go to gal/guy from then on out. Might take you a few tries.
- Boom, you're in the clear. Go put in two weeks notice.
- Take your wad of cash and go put it to work on your time and your schedule - now that you don't have a day job you should have time to find (or make) some killer opportunities. Or.... pay it back and know for certain that you can access your equity should you need to.
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes10y
Originally posted by @Jesse Chunn:
Originally posted by @Matt Vogt:
Another option to consider would be applying your cash to a larger multi-family deal. Since you have the funds available, you could leverage them to purchase a multi-family with 20-25% (depending on lender requirements) down. I would expect some economies of scale from a multi-family, and therefore a potentially higher cash on cash return. Another thing to consider with cash properties is that your COC return decreases substantially due to the significantly higher (5x if comparing 20% down to 100% all cash deal). With a lower COC return, you're making less money for how much 'skin' you have in. Although leverage isn't free, it allows you to invest in more expensive, potentially better investments.
I am with @Andrew Herrig and would take a loan if that's a possibility.
If you were looking at 3 80K properties in cash (240K), and are making $500/door cash flow, you're making $1500/mo in cash flow.
Take the same 240K, use it as your 20% down payment, you now have 1.2M available to buy. Look on loopnet.com to get an idea of what kind of returns you could get with a leveraged 1.2M property to compare the results... my bet is that you'll make FAR more than the $1500 with a large multi-family using leverage than you will with 3 all cash deals.
Matt,
I totally agree with you on that, however, I am scared stiff to jump into a big multi-unit because I simply don't know what I don't know. I have zero experience. I have not bought a single property (other than a few primary residences) and it seems like it would be a good idea to have at least a couple of deals under my belt before getting into something like that. Would you (or anyone) disagree and suggest that I just go for it?
Jesse, I think that's a totally reasonable philosophy. Both types of housing have advantages and disadvantages. The advantages have already been listed for MFH, but how about the disadvantages?
- A smaller market of potential buyers should you want to sell
- A market of only investors, usually looking for a deal, should you want to sell
- Competition with corporate MFH owners
- Apples to apples, generally lower quality tenants in apartments than houses
- Higher opening costs to get "in the game"
I think SFH is a good way to get your beak wet. Some investors move on to MFH, and do very well. Others stay with SFH, and yet others decide that real estate isn't for them. If you end up in that boat, there will be a bigger market for selling your investment.
Skyline Properties - Business Manager · Annandale, VA · Member since 2012 · 23 posts · 7 votes10y
I would start with cash and then move quickly into borrowing.
The reason I would start with cash is because based on your post, you're limiting factor isn't going to be capital starting out, it's going to be building a team that can renovate, manage, rent, find deals, etc. However, once you have line of sight to having those things in place and can start to build your business I would quickly look for financing. Don't underestimate the time and potential hurdles you could face getting financing. The opportunity cost of waiting is too large! Borrow sooner, rather than later.
Please take your personal preference into consideration. Mathematically it's almost always better to borrow if you can invest at a higher rate than you borrow at. So if you can borrow at 5% but get 10% returns, the more you can borrow at 5% the higher your ROE is and the more money you make. Think about it, that's how banks make money! However, you're not a bank or a corporation so if you are uncomfortable handling and managing debt take that into consideration.
- Arlington, TX · Member since 2016 · 57 posts · 21 votes10y
Thank all of you so much for the input. Even more helpful than I expected.
From the advice I have gotten here, there are a few gems in my opinion. Thanks again to the respective contributors, and keep 'em coming:
- Financing / leverage allows for faster growth.
- Financing allows for a much larger portfolio (for a given amount of cash), with lower positive cash flow per property but more positive cash flow overall.
- Having some percentage (say 50%) of properties free and clear (100% equity) can act as a backstop to protect against downturns and other bad situations.
- Rates are low right now so now is a good time to borrow as much as possible.
- Starting with cash and then quickly moving to borrowing can reduce the complexities when first starting out and building a team.
- Using financing leaves more cash on hand to deal with unexpected expenses.
- A large multi-unit benefits from economies of scale, which supports the argument to leverage existing cash to finance larger cash flow (ROI) as a percentage.
- One "con" for large multi-units is that the market for multi unit properties should I need to sell is tougher because of limited buyers.
- Gaining two or more years of proven rental revenue will be considered as good as employment income by smart lenders.
- Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes10y
@Jesse Chunn, in many (most?) cases, people with cash to burn - burn most of it!
You asked whether you should just "go for it", but the fact that you ARE asking, means you have a good chance of turning your cash into MORE cash.
(Especially, if you're mainly using other people's money as well)!
Lots of good responses already.
My advice is: even if you want to pay all cash for a deal, make sure that it would STILL be a cash-flowing and/or under-market-value "deal" if you were to leverage it highly instead.
ie. Make sure each deal is: a smokin' deal! Cheers...
- Arlington, TX · Member since 2016 · 57 posts · 21 votes10y
Very good point. I have not been doing that. I will from now on, especially since I have always assumed that there is a good chance that even if I pay cash I might get an equity loan later to fund more deals. I never want to be in a situation where a property is not easily paying for itself (and then some).
- 10yIan WalshBusiness MemberLender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
Having cash in this business when first starting can be a double edged sword. It is never a bad thing to have cash, but you need to think as if you don't have any. I would protect your cash until you learn exactly what it is you want and how to get it in investing. It is very easy for new investors that have some money to come in with cash and blow it or use it incorrectly. Think boot strapped even though you are not.
- Arlington, TX · Member since 2016 · 57 posts · 21 votes10y
I appreciate that insight. That seems to be a running theme, along the same lines as assuming you will be paying for property management even if you really intend to manage the property yourself. Plan for the most-encumbered scenario and if it works in that "conservative" scenario then you have the best likelihood of good cash flow and cushion in case of problems.
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes10y
Originally posted by @Brent Coombs:
@Jesse Chunn, in many (most?) cases, people with cash to burn - burn most of it!
You asked whether you should just "go for it", but the fact that you ARE asking, means you have a good chance of turning your cash into MORE cash.
(Especially, if you're mainly using other people's money as well)!
Lots of good responses already.
My advice is: even if you want to pay all cash for a deal, make sure that it would STILL be a cash-flowing and/or under-market-value "deal" if you were to leverage it highly instead.
ie. Make sure each deal is: a smokin' deal! Cheers...
This is a good point that should be restated, because there could always come the day that you might *have* to leverage it in a serious situation, and you don't want to own properties that are unprofitable once they are leveraged if at all avoidable. This becomes less important when you have a wealth of free & clear properties to choose from should the opportunity/situation arise, wherein you can ignore the smaller cash return properties and leverage the more profitable properties so that they remain profitable, but when you are first starting out you don't want to have to dip into your own pocket if something goes wrong because the property won't cash-flow when leveraged.
Skyline Properties - Property Manager · Pittsburgh, PA · Member since 2012 · 267 posts · 136 votes10y
I would prefer to not have ALL my cash tied up in properties. Sometime it is strategic because all cash offers can get you better deals which are beneficial when you cash out. Be very careful if you buy all cash and want to refi to get the cash back out. Appraisals can be hit or miss and you may not get the equity out you were expecting.
If you have a lot of cash I would leverage it to buy an apartment building. Economies of scale are in your favor. I like single family homes but if you have a couple hundred thousand you could leverage a nice complex. Just my opinion.
Leverage is one of the great things about real estate. You can spend 20k to own a 100k asset.
- Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes10y
If you are going to buy cash, you should be looking at houses that can only be purchased all cash to take full advantage, eliminate retail competition, and get the biggest discounts. These include:
- Distressed sellers that need to close fast, like pre-forclusures
- Auction homes.
- Off market deals found by driving for dollars, networking, mailing campaigns, etc.
- Buying through a wholeseller.
- Foreclosures that can't get a certificate of occupancy for one reason or another, and there are some pretty dumb/minor reasons as well as major ones.
The caveats to the list above are that you will need to do more of your own due dilligence to ensure the deal is a good one ... this includes:
- Doing your own comparative market analysis to make sure the price is a good deal, since there will not likely be an appraisal done in escrow.
- Have a title company do a preliminary title search before making an offer to spot any liens or title issues ahead of time, since title insurance may not be obtained in escrow.
- Have a general contractor walk the property with you (if possible) to validate scope and cost of repair work, since an inspection may not be done in escrow.
Then, once you purchase, rehab, and rent the place, you can cash out refinance to pull money to put into your next deal if you like (called the BRRRR strategy around these parts) ... x10 of these for you, and x10 for your spouse = up to 20, 30 year fixed mortgages through fannie/freddie ... then you can go to local banks to get portfolio loans for more if you like ... or not and stay free and clear and the houses should print cash flow for you like little ATM machines ...
- Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes10y
- I like how I did bullet points and then after that suddenly bullet points were the cool thing for this thread. :P
- Arlington, TX · Member since 2016 · 57 posts · 21 votes10y
Brilliant. I hadn't thought of that, but it makes total sense. Use cash where cash creates the biggest advantage. Simply brilliant.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes10y
I have an ongoing internal debate on the amount of leverage to keep. In the end, leverage wins out. Real estate is too much work to only earn the cap rate and not taking advantage of leverage removes real estates' primary advantage over other asset classes.
Your long term expectations for inflation could influence your decision as well...paying low rate debt 5-10+ years from now is attractive to me.
Middle of the road leverage is not a bad place to be either.
Join the conversationCreate a free account to reply, vote on answers and follow this thread.