Use Leverage or Stick with Cash?

Buying & Selling Real Estate
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Use Leverage or Stick with Cash?

Ericka G.
Investor · Atlanta, GA · Member since 2015 · 366 posts · 283 votes

If you have cash, should you use it or is it better to use leverage if you can?  So far, I've almost exclusively used cash to build our small portfolio.  My goal for the year was to fully replace my current after tax income with an equal amount of income (after expenses) from our properties.  

Based on my calculations, I'm one deal away from reaching that goal, but I'm at a crossroads trying to decide which path to pursue next and would appreciate input...

Option A: Use leverage and  ~$70k as downpayment/closing costs to buy a multi-family four-plex for $225k, gross income: $2,750/mos, net income: $1,375/mos.  

OR

Option B: Use cash and buy a 3/1 SFR for ~$50k, gross income: $1,440/mos, net income: $1,000/mos - this has been the model we've used to build our portfolio thus far and we have a proven niche approach for this scenario

My husband is advocating that we diversify and buy a MF and also use leverage while I can since I have a very solid "9 to 5" right now and struggled to get financing when I was freetired and focused on growing the portfolio. I see his point but am hesitant to take on debt if I don't have too since the cashflow really isn't a whole lot more on the MF.

Any thoughts?

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James Wise
Real Estate Broker · Cleveland Dayton Cincinnati Toledo Columbus & Akron, OH · Member since 2013 · 30k+ posts · 20k+ votes
9y

The best part about real estate investing is the ability to leverage other people's money.

You buy a house with someone else's money (the bank) and then you pay off the loan with someone else's money (the tenant) Best business plan in the world!

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  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    9y
    Originally posted by @Ericka G.:

    Alan Grobmeier LOL. I literally had just made up my mind to take the MF/leverage plunge and then I saw your post. Can you share why you feel SF are better than MF from your experience? You raise a good point since we self-manage and both work full time.

    You have to customize based on your market, wherever that may be, and the value in your market. That said, it is difficult (not impossible) to scale on SFHs. In my market, I love SFH, but depending on the size empire you want to build, MFH may be your only/best option.

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  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    9y
    Originally posted by @Thomas S.:

    The reality is that there are in fact many proven models.

    The model you chose to follow should be determined by three primary factors.

    1) how conservative of a investor you are. (all cash ...extremely conservative, always fear the worse case scenario. Wealth growth very slow)

    2) how much wealth you wish to accumulate. (the greater the wealth the greater the risk you must be prepared to take based on #3)

    3) in what given time period. (time is not infinite)

     Excellent post. Especially #3, which most people who are totally opposed to leverage seem to miss - hey, I'm talking to you too, Dave Ramsey! Unless you've figured out immortality, you've got a very limited window to build and enjoy this wealth. Let's say 40 years, tops, if you work from when you turn 20 and quit hustling at 60. 40 years is a grain of sand, and for most people it's not going to be anywhere near 40 years because they didn't even begin to understand money until they hit middle age and started realizing "holy crap, I'm going to be working until I'm dead". 

    If time is not on your side - and it's not, Mick Jagger - then you need to figure out how to make multipliers of yourself. Leverage is that multiplier. You get out your transmogrifier (thanks Calvin) and make as many duplicates of yourself as you can reasonably control and will achieve your goals in the quickest time possible in the least amount of risk and effort relative to the reward. Does this mean you hock everything you own to 100% tomorrow? No, and it's unlikely anyway, but does it also mean you pay for every single thing you own, cash, and just sit around saving up ala Dave Ramsey until you have a bucket of money? That's an equally risky proposition. The answer is in between. 

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  • Michael Lee
    Investor · Coppell, TX · Member since 2008 · 2k+ posts · 646 votes
    9y

    If  you noticed, I made two communications on this newsletter and did not realize until last night and I realized that they show me the latest post and I responded to that one. I meant to write that Responce to some else.  I apologize  for making that mistake and just realized there might more than 1 page and I am shown the latest letter by someone.  My letter was not written to you.

    Sorry,

    Michael Lee

    3Reply
  • Ericka G.
    OP
    Investor · Atlanta, GA · Member since 2015 · 366 posts · 283 votes
    9y
    Michael Lee ah ok, no worries. Thank you for clarifying - it is tricky with so many posts. If you press the "@" button on your keyboard and type the first letter of the name of the person you're replying to, you should get a drop down list of names so that you can tag your reply to a specific post/person.
    0Reply
  • Brian Garrett
    Real Estate Investor · Palm Beach County, FL · Member since 2017 · 3k+ posts · 2k+ votes
    9y

    This was a very informative post. Learned a lot of different perspectives and pros and cons of both sides. I've been going through this debate in my head since I have saved up a pretty decent amount of cash from previous business endeavors and I'm just now beginning REI. Now it's starting to sound like the only time buying cash makes any real sense at least for me personally is for flips since it's a quick turnaround on my money but anything that I'm buying for cash flow purposes should be financed since I can spread the money among multiple properties that way I'm ultimately generating a higher ROI and making the banks money "free" to me and I'm still making profit on that money as well through both the cash flows and properties appreciation. Then once the properties appreciate a certain amount I can cash out refi on them and pull the "free to me" money out of them to roll over into new properties. Does this make sense? If so then wouldn't I only have to put up my own cash once and I could just keep leveraging it over and over again for my cash flow buy and hold deals by just following that same strategy while I'm also getting to keep my cash for more flip deals?

    1Reply
  • Account Closed
    Manassas, VA · Member since 2016 · 6 posts · 3 votes
    9y

    @Ericka G. It appears that many of the people posting in this thread have been discussing the merits of using leverage vs using all cash, but I don't think it has to be so black and white. I think a very good solution for you could be to use a moderate amount of leverage so that you can purchase more SFR's that you are experienced in and comfortable with.

    If you leveraged the SFR at 50% LTV then you would have a monthly debt service of around $190. This brings your monthly cash flow down to $467 and allows you to do the same exact deal again since you only financed half of the first project with your own cash.

    That means that you can use the same ~$50k and generate $934 per month instead of $657 using a conservative amount of leverage.

    3Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    @Brent Coombs

    For myself, I reckon it's totally OK that once you decide you own ENOUGH properties for your future RETIREMENT income needs, to let your tenants pay them off for you COMPLETELY,

    That plan is still not generating enough "safe" return in my opinion. I presently hold several 100K in mutual funds that have consistently generated a average 9% return over the past 10 years. Rather than have cash sit in a property at retirement you would still be farther ahead to keep your properties leveraged and invest the cash elsewhere.

    Money left in a property generates a very low return (applicable mortgage rates) compared to most moderately conservative investments.  

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  • David Tiemann
    Investor · Hereford, TX · Member since 2016 · 53 posts · 42 votes
    9y

    For a long time I was a cash investor.  Kinda followed the Dave Ramsey approach of 'no debt'.  I have since changed my view and started using leverage to build my portfolio.  Using leverage I have been able to double my number of units and get into small multi families, where the overall return on my investment is better.  I am cautious about using leverage.  I have a blend of 'paid for' properties and some that are mortgaged.  Overall the debt to equity ratio is 40/60, and I am comfortable with that.

    1Reply
  • Account Closed
    Manassas, VA · Member since 2016 · 6 posts · 3 votes
    9y

    @David Tiemann, How much do you leverage your properties now? And what returns have you seen as compared to when you used all cash?

    0Reply
  • Ericka G.
    OP
    Investor · Atlanta, GA · Member since 2015 · 366 posts · 283 votes
    9y

    One thing I'll add to the discussion is that with small deals like many of the ones that I do, we're looking at loans of less than $50k...I don't think banks lend less than $50k?  How have folks used leverage on smaller deals?

    Also, someone raised a really good question earlier that still hasn't been addressed by all of the leverage advocates on here.  Can those who were heavily leverage through the last downturn speak to how the downturn impacted them, if at all?

    1Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    It didn't impact me at all. I held all my investments, income remained consistent and vacancies were no different. Interest rates, as we all know, have dropped and remained low increasing my profits considerably. Leverage has been a plus in a downturn due to lower rates. 

    Money has been tighter but downturns are a opportunity to buy not sell. 

    1Reply
  • Ericka G.
    OP
    Investor · Atlanta, GA · Member since 2015 · 366 posts · 283 votes
    9y

    @Thomas S.  Good to know - glad that you weren't negatively impacted by the last recession.  This feels messed up to say, but I'm kind of looking forward to the next downturn, now that I have a bit of knowledge and capital...will start using leverage carefully in the meantime.

    0Reply
  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    9y
    Originally posted by @Ericka G.:

    One thing I'll add to the discussion is that with small deals like many of the ones that I do, we're looking at loans of less than $50k...I don't think banks lend less than $50k?  How have folks used leverage on smaller deals?

    Also, someone raised a really good question earlier that still hasn't been addressed by all of the leverage advocates on here.  Can those who were heavily leverage through the last downturn speak to how the downturn impacted them, if at all?

     We have done cash-out refi's. Hasn't been a problem for us yet, but we rehab the properties and force appreciation - ie if we buy at $50k by the time we're done with a rehab we are appraising at 100. 

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  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    9y
    Originally posted by @Thomas S.:

    @Brent Coombs

    For myself, I reckon it's totally OK that once you decide you own ENOUGH properties for your future RETIREMENT income needs, to let your tenants pay them off for you COMPLETELY,

    That plan is still not generating enough "safe" return in my opinion. I presently hold several 100K in mutual funds that have consistently generated a average 9% return over the past 10 years. Rather than have cash sit in a property at retirement you would still be farther ahead to keep your properties leveraged and invest the cash elsewhere.

    Money left in a property generates a very low return (applicable mortgage rates) compared to most moderately conservative investments.  

     Just to stir the pot a bit on this discussion ... to what end Greg? If you already have all the retirement income you need (with margin) from free and clear properties, then why seek out more from other higher returning investments (like mutual funds)? I don't argue that on average they may generate a 9% return over long periods of time, which is higher than the "return" of the mortgage interest rate that equity gets, but you are taking on more risk to get that return where as the savings of mortgage interest while it is low it is also guaranteed. Taking on that extra risk may make sense if you need to grow your portfolio, no argument there, but if you already have your income needs met with a lower risk vehicle, then seeking out more than that is just adding risk for not much if any marginal benefit IMO. Returns must be risk adjusted and put into the context of the investors personal needs and goals, which I think is what was missing from the argument. Or perhaps I'm missing something in what you are trying to say?

    3Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    9y
    Originally posted by @Brent Coombs:

     Not true.  My answers here are based on specific questions/comments "here".  As far as "never paying off completely" is concerned, it isn't a straight "yes or no"...more like a "when and who".

    I don't pay off any mortgages...my tenants do...sometimes more than once.

    2Reply
  • Michael Evans
    Real Estate Consultant · Lancaster, CA · Member since 2014 · 423 posts · 223 votes
    9y

    It's based on your risk tolerance and how you manage and shift risk.  I use leverage all the time.  Here's an example:

    You can buy a house for $100,000 and it returns $10,000 per year (10% CAP rate) cash on cash. If you use leverage and put in $10,00 cash to buy that $100,000 house, it may cost you $5,000 per year in finance costs. So your returns are reduced from $10,000 to $5,000. But what would you rather do? Make $10,000 on $100,000 (10% ROI) or make $5,000 on $10,000 (50% ROI). By using leverage, you can take your $100,000 in cash and buy 10 $100,000 properties at $10,000 each, with each one returning $5,000, for a total return of $50,000. So now your $100,000 is returning $50,000!

    Plus, you have significantly managed your risk.  Instead of putting all of your $100,000 into a single property, you spread your risk among 10 different properties.  Now you can better manage your risk by investing in 10 different markets. This is a basic principle of Money Management (don't put more than 5% of your Total Investment into a single investment position).

    Now here is the downside of leverage.  When using leverage for buy and hold real estate investments, you run the risk of your vacancy rate increasing to the point where your monthly income can't satisfy your monthly financing costs.  You run the risk of becoming upside down on your cash flow and not having the cash to pay your debt.  This happened to a Japanese billionaire I know in the late 1980's.  He owned a lot of commercial properties in West Los Angeles using leverage (100:1) and became very rich very fast.  But when the recession hit in 1989, his commercial tenants went out of business, his vacancy rate increased, his monthly rental income decreased and he couldn't generate the cash to pay his debt financing.  He went bankrupt and lost all of his commercial buildings.  He was over levered and didn't setup up his business entities correctly.

    I suggest using leverage for flips.  When using leverage for buy and holds, you have to find a way to manage the vacancy rate risk (we've developed a system that solves this risk).  We've developed a system where we use 10% leverage on flips (10:1) and 15% leverage on buy and holds (6.67:1) in order to generate 50% and 10% annual returns respectively.

    Stay Blessed!

    5Reply
  • Brian Garrett
    Real Estate Investor · Palm Beach County, FL · Member since 2017 · 3k+ posts · 2k+ votes
    9y

    @Michael Evans Interesting points and valid ones at that. There are very clear advantages to leveraging that's for sure. For me personally, with my limited knowledge since I'm still new to REI, it seems to make more sense to use cash for flips since it's a quicker turnaround on my money and I don't incur the extra holding costs associated with a loan. The buy and hold cash flow generating deals are the ones I thought leverage would make the most sense for. You seem to feel the exact opposite. Am I overlooking something or not considering something?

    0Reply
  • David Tiemann
    Investor · Hereford, TX · Member since 2016 · 53 posts · 42 votes
    9y

    @Account Closed In the last 18 months I bought one house at auction and rehabbed it, all with cash.  That deal is returning 11.6% cash on cash. 

    I also bought a house and rehabbed it using some of my money and a small mortgage.  58%loan/42%cash.  That deal is returning 11.4% cash on cash.

    I also bought 4 triplexes and leveraged them.  85%loan/15%cash.  Before any improvements that deal returned 42% cash on cash.  We have since replaced windows, rehabbed a couple of units, and made some other improvements, along with raising rents.  Now that deal is returning 49% cash on cash.

    Even with the bigger returns I am cautious about how I use leverage.  I didn't notice much of an effect from the last down turn.  Our economy in this area is agriculture based, so the volatile real estate market swings really don't happen here.  Agriculture has been pretty stable based on the fact that everyone has to eat.     

    0Reply
  • Ericka G.
    OP
    Investor · Atlanta, GA · Member since 2015 · 366 posts · 283 votes
    9y
    Michael Evans "You can buy a house for $100,000 and it returns $10,000 per year (10% CAP rate) cash on cash. If you use leverage and put in $10,00 cash to buy that $100,000 house, it may cost you $5,000 per year in finance costs. So your returns are reduced from $10,000 to $5,000. But what would you rather do? Make $10,000 on $100,000 (10% ROI) or make $5,000 on $10,000 (50% ROI)." That is a great case for leverage and makes a lot of sense. I also like that you have a leverage/risk formula that you stick to...
    0Reply
  • Michael Evans
    Real Estate Consultant · Lancaster, CA · Member since 2014 · 423 posts · 223 votes
    9y

    My business partner and I have spent the last two years developing this investment system. We have also developed other leverage investment systems outside of real estate (such as options and judgement liens).

    Stay Blessed!

    0Reply
  • Brian Garrett
    Real Estate Investor · Palm Beach County, FL · Member since 2017 · 3k+ posts · 2k+ votes
    9y

    @Michael Evans Just in case you overlooked my response to you before I'm tagging you again in hopes of you addressing my question. Thank you!

    0Reply
  • Remus Phillips
    Investor · Bowie, MD · Member since 2017 · 47 posts · 8 votes
    9y

    @Ericka G. "I'm genuinely trying to understand how others use it to close 100 deals when I can barely get a bank to loan me money for 2 or 3, hence why we've used leverage for 3 deals and cash for 4 deals thus far"---you better preach!  I'm in the same situation!

    0Reply
  • Marcus Johnson
    Investor · Saint Paul, MN · Member since 2015 · 663 posts · 512 votes
    9y
    Ralph R. You had mentioned in your post to compare Dave Ramsey and Robert Kiyosaki's net worth. I did so and Dave Ramsey's net worth is 55 million and kiyosaki's net worth is around 80 million. Dave Ramsey is only 56 and he went bankrupt in his late 20s whereas kiyosaki is 69 and you would think that he would be far more wealthy for using leverage than someone who just uses cash and has no debt. Dave Ramsey accumulated his wealth and far less time.
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  • Ralph R.
    Investor · Bethel, AK · Member since 2013 · 1k+ posts · 852 votes
    9y

    @Marcus Johnson

    You might want to read more  on Kiyosaki.  He started off living in his car.  Im not wanting to get into a shoving contest about whos right or wrong but heres a link to a BP Blog that talks about Cash flow  and it speaks a little about leverage. 

    https://www.biggerpockets.com/renewsblog/2016/07/0...

    RR

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  • Ralph R.
    Investor · Bethel, AK · Member since 2013 · 1k+ posts · 852 votes
    9y

    @Marcus Johnson

    Marcus I don't want to get into a debate on Leverage or cash flow.  Everybody needs to make his own decision.  there is a BP blog posted by David Greene called:

    The secret the rich understand about building wealth (and no its not about cash flow.) 

    Im not sharp enough to get the link to post here and work so you will need to look it up on BP.  It addresses cash flow and speaks some about Leverage.

    I don't know if you have read rich dad poor dad or his follow up book the money quadrent  but Kiyosaki  and his wife started out living in his car.  Bankruptcy allows you to keep some things, and rearrange debt in a manner that you can handle it.  Its possible to have a bankruptcy and still be on your feet.  It does destroy credit thereby preventing you from getting loans for a while.  much like one poster already noted, Ramsey "touched a hot stove" and now he's afraid to go in the kitchen. You may also note that many of the heavy hitters on this site have posts in this thread indicating the same thing I stated.  I just went into a little deeper explanation for new comers that are trying to establish a financial strategy.  to each his own.    

    Cheers

    RR

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