Was wondering everyones thoughts on Paying Cash for SF rental Homes. I bought my 2 Sf Rentals Cash and have really enjoyed it. It has made it stress free not worrying about monthly payments. This way between tenants or durng rehab your not stressing a payment. I realize some people wont agree with missing out on deductions and leverage. I know i could purchase some more property if i did cash out refis but hate to take on the debt. Maybe this is a mistake I realize rates are awesome but not having that debt over my head is a good feeling. And not having those mortgages really puts me in a great cash flow spot to save alot of money. Please let me know your thoughts.
Not only are interest rates great, but the real estate market capitulated recently resulting in very favorable acquisition pricing right now. Those two factors together make this an excellent environment to accumulate property. There is a strong thesis that asset values will increase over time, and those that take full advantage of this confluence of fundamentals are poised to become very wealthy (or wealthier). Utilizing the inexpensive leverage currently available allows maximum asset accumulation.
All that said, the choice to invest levered or un-levered is a personal choice that is dependent on individual goals and risk tolerance. Perhaps you will miss out on levered wealth accumulation, but you will sleep well at night. Kudos to you for at least being in the game.
Not only are interest rates great, but the real estate market capitulated recently resulting in very favorable acquisition pricing right now. Those two factors together make this an excellent environment to accumulate property. There is a strong thesis that asset values will increase over time, and those that take full advantage of this confluence of fundamentals are poised to become very wealthy (or wealthier). Utilizing the inexpensive leverage currently available allows maximum asset accumulation.
All that said, the choice to invest levered or un-levered is a personal choice that is dependent on individual goals and risk tolerance. Perhaps you will miss out on levered wealth accumulation, but you will sleep well at night. Kudos to you for at least being in the game.
I fully agree with Brian Burke. Like any investment you need to look at your risk tolerance. If an investment causes you to loose sleep at nights it probably is more risky than you are comfortable with. An all cash investment can be a great investment as well and may still meet all of your long term goals.
You want to remember that you still need adequate cash reserves though. The unexpected still can happen even if a property is fully paid for.
I have said this on a few other posts, but cash flow always beats out perceived tax savings. And nothing can beat peace of mind. You generate more wealth by having a paid off mortgage than the tax savings you get from a mortgage interest deduction.
John Briggs there is more to the story though. I agree with all you said, but the flip side is that your wealth will grow much more slowly.
The decision to use leverage or not is not just a tax consideration. The OP has expressed a low risk tolerance and so in his situation it probably would be better to use all cash. Personally I use leverage not for the tax advantages but for the opportunity it gives me to increase cash flow and build wealth faster. The tax savings is just gravy I enjoy before going to sleep at night.
Charles Perkins, it's semantics. We are saying the same thing. Ron expressed how he likes not having the debt over his head. I was simpling communicating that there is nothing wrong with his philosophy. Just as there is nothing wrong with your philosophy. As for the tax savings, I was pointing out that when only looking at a mortgage interest deduction, you build wealth faster by not paying someone else the interest even if you are stuck with a higher tax liability.
I agree that through leverage and the velocity of money, you can build wealth faster than if you pay for the entire property in cash. But i also know many horror stories of "investors" who did not do it the right way and over leveraged themselves and lost everything, including their primary residence. Of course, they didn't have such a wonder group like BiggerPockets. Alas!, we don't know what we don't know. :)
Amen. Leverage can be both good and bad. An investor needs to understand there investments, insuring that future capital expenditures are covered, future vacancies are covered and that Murphy is kept a bay.
@ John Briggs I fully agree and understand what your saying. When I started investing in rentals myself i never wanted to put myself in a situation where i feel over leveraged or stressed. Alot of people in the last 10 years got in way over their heads loaning more money than they should have been! And it caused alot of heartache and stress for alot of homeowners and landlords.
Your strategy is safe especially if you are also taking care of the reserves.
@Charles Perkins Thanks for the replys! Call me old school but I do like to play it safe! Also having my properties paid for has given me the ability to save by having a nice cash flow from the houses versus a small net profit if they were leveraged.
Like any investment you must know your risk tolerance. Sounds like you know exactly what your comfort level is and your investments are doing well. Sounds like a success story to me. Keep on making it happen.
Most investors don't have much of a choice. It's leverage or not buying, because they don't have enough cash. If you do have the cash, you have the option.
It's also often a question of age. Younger investors haven't had the decades needed to build a substantial nest egg. Older investors have and become naturally more defensive as they approach retirement.
As has been said, leverage is a personal decision. It can be a highly effective tool. In William Nickerson's classic book, the first sentence is; "the road to real estate riches is paved with borrowed money."
On the other hand, many have been crushed by over leveraging. Not so much in the early part of the up cycle (like now), but when real estate investing is hot and the crowd has jumped on the bus.
all you gotta do is take your cash flow & divide by what you put down. my parents bought a condo in 2004. they've had 2 renters in 6 years but their return on investment is like 2%.
if you bought recently, I'm sure you're getting a good ROI. Plus any equity purchase as I'm sure you bought a distressed property. Would need to know how much your initial rehab was. I've seen properties picked up for $20k but needed $60k in rehab.
My two homes I bought for cash were $35K for purchases and closing costs. I spent $15K in repairs/rehab for an all-in $50K. Rented for a combined $1550 per month.
I am not super risk averse but I have no ability to get leverage. I am super happy to stay out of debt and I should be able to buy a 3rd house in a couple months. There are several ways to do this and neither is wrong. Charles Perkins I appreciate your opinions and understanding that not all will go one single path.
Absolutely Will Browm. There are many paths that lead to success and we all define what that success is. Don't let someone else define your success.
It helps though to have your eyes wide open to all the possibilities and make decisions based on knowledge that you have learned and the knowledge you have of your unique circumstances.
There is absolutely, positively nothing wrong with paying all cash and not leveraging. I don't want anything I say in the post to communicate that leverage is necessary, optimal or even "better" than all cash. They are both valid strategies depending on your goals and risk tolerance.
That said, from a *purely* financial perspective, leverage (when done right) will provide more cash flow, more net profit and higher ROI than all-cash purchases will. Yes, each property will throw off less cash, but you'll have more properties, and the net income from the combined properties should be higher than from the few paid-off properties (again, when done right).
But, that's just from a purely financial perspective. We all know that investing is about more than just financial decisions. It's about attempting to remove stress, sleeping well at night and being comfortable with your decisions and positions.
Originally posted by J Scott
I know what you're getting at, but don't care for the phrasing.
If you emphasize the will then it will provide more cash flow, more net profit, and higher ROI than all cash purposes. However then you qualify your statement with "when done right" it really detracts from the bold certainty of the will.
In fact leverage can indeed do good things, but always raises risk. Leverage narrows your ability to react during a crisis. It can force you into sub optimal long term decisions to meet the payment schedule. It adds expenses that are demanded by the lender (lower deductible insurance, for example).
Lots of investors over the last few decades here in Florida found that leverage was a great thing when home prices were increasing 12% per year, but found it pretty terrible when suddenly prices dropped by 60%. The corpses of leveraged transactions can still be seen in houses that are unoccupied or even unfinished for several years.
And actually I don't think we're that far apart, and I may be unfairly grousing at semantics. I've borrowed in the past to buy real estate -- and may in the future -- but am currently totally unleveraged. It was just I was struck by the bolded certainty of the good things leverage can do with the "when done right" added at the end. That smacks of what statisticians call 'survivors bias'. If we define those making money with leverage as doing it right and those bankrupted as not doing it right then the additional risk associated with leverage isn't acknowledged. But it's always there.
We can argue about this until until we're blue in the face. When I was in my 20's, I was more of a risk taker. I would buy any house and finance it. I had a car payment too.
Now that I'm in my 30's and have kids, I'm less of a risk taker. I don't like debt. I prefer to pay cash for houses because I have more money now and don't like to pay interest.
When you start in this business, you will need to borrow money unless you're already wealthy somehow. I would recommend for anyone who finances, make sure you have a fixed rate and no balloon. It's amazing how fast time goes by and you don't want to be stuck with a negative cash flow. The end result should always be to have your debt paid off. I can't tell you how many retired people I know who still have a mortgage on their primary residence. I think they're crazy. If I'm 60 years old and have debt, I will declare myself a loser.
The bottom line is that if you sleep better with no debt, that is the right choice for you. If you properly manage debt and have decent interest rates, it's ok with an appreciating (hopefully) asset like real estate.
If you emphasize the will then it will, provide more cash flow, more net profit, and higher ROI than all cash purposes. However then you qualify your statement with "when done right" it really detracts from the bold certainty of the will.
....
And actually I don't think we're that far apart, and I may be unfairly grousing at semantics.
That's fair...when it comes to investing, semantics can often be the difference between truth and fiction...
To be more specific:
From a *purely* financial perspective, leveraging at a cost of capital below your all-cash ROI will provide more cash flow, more net profit and higher ROI than all-cash purchases will.
I like the benefits of both cash purchases and financing. Either way you go, you still have fixed financial obligations to tend to because there will always be taxes and insurance to pay for. My primary residence has a mortgage payment of 260/month. Taxes and insurance are relatively significant at about 185/month.
My opinion is that the more stable and higher end the neighborhood, property and tenant pool, the more acceptable it is to have leverage. The cheaper properties in more sketchy areas are better paid cash.
Yes, a beat-to-death topic with no right answer. Are there any new things to think about beyond quoting financial formulas (favoring leverage, of course), and talking about "sleeping better an night" (favoring cash buying, of course). I’ll throw some thoughts down, apologize if it’s all obvious.
Leverage increases the financial risk of any investment, which can potentially prove to be your undoing in a couple of ways.
First, if market values fall relatively rapidly AND you have to refinance the debt (because you have a balloon note, for example), then you can be in trouble if you multiply this issue across many properties. Most seem to agree that we’re buying at or near some sort of “bottoming” of prices, as things certainly *seem* cheap in comparison to the 2004-2006 period. Heck, Warren Buffett thinks so, who are we to argue.
Second, and probably more importantly then, is that the more potentially volatile the net operating income of the property, meaning higher operating risk, then the more likely that the leverage can create problems for you. It's agreed that lower demographic properties have greater volatility and a much greater chance of having a disappointing (if not outright negative) ROI for longer stretches, due to evictions, turnover, lack of good tenants due to high unemployment, and general social pathologies and bad financial habits among the lower-income tenant group. Lower income workers are the first to be laid off in a bad economy, which is evident when you look at white-collar versus blue-collar unemployment. Also, age of housing stock and level of rehab performed will drive amount and variability of maintenance expense, and thus figure into operating risk.
So, it would seem that you would want to minimize or avoid leverage on the lower end, and use it moderately on the mid to upper end of the rental spectrum. And this works out pretty well with reality, because the cheaper houses are very hard to finance anyway, due to bank not liking small loan sizes, bank red-lining, and bank usage of “# of loans” as a limiting factor in providing credit. For some reason, banks seem to be moving away from using total dollars of loan exposure to adopting this “# of loans” thing, not sure why.
To which you’re saying, “no kidding!” And when using leverage, you definitely want to pay attention to your cash reserves and keep them very healthy.
As far as the type of loan, I have only fixed rate loans and 30yr ARMS with defined life-time caps. I can quantify my payments on these loans under any rate scenario. I don’t like balloons or straight floating rate debt like HELOCs. Banks can and will refuse to renew performing loans if the bank has no appetite for that loan type when your renewal date comes up, or if the bank is under financial stress and is attempting to shore up its capital.
And if you use leverage, I'm an advocate of closely monitoring the debt coverage ratio across your portfolio. DCR = (Expected NOI - capital reserves) / P&I. This should be at least 1.75 and preferably 2.0 for any property, and even higher for properties that are in C areas or C condition. You should also make sure that (Expected NOI – capital reserves) is at least $150/mth positive, and preferably $200. Since bankers think in terms of DCR, that's just another reason to track it and manage it.
Using leverage also means you have many more properties to manage, perhaps 4x as many properties if borrowing at 75%. This may mean that you have to use a PM company and that is also a source of risk, as many are lousy. Even if you self manage, it’s a ton more work. The flip side is that you MAY get some diversification benefits, but don’t kid yourself here. Most investors tend to buy very similar property types in pretty homogenous areas within a city. But it’s definitely true that something very bad can happen in a particular area (big employer closes, criminal elements move in to a nearby apartment complex, whatever), and having properties in multiple areas can mitigate some of this risk.
The point is that these discussions are just philosophical without framing the location/condition of the property (it’s operating risk), framing the type of financing that will be used, and thinking through how to achieve some diversification benefits in your portfolio.
David -
Great post! I agree that this topic is pretty beat to death with the "obvious" arguments on both sides, but this is also one of those topics that won't be obvious to newer investors, so I completely understand why it comes up a lot and why the obvious answers can be good.
That said, your extra commentary really rounds out the discussion. Your post is the type I want to be able to "save" for the next time this discussion comes up.
I for one plan on paying cash as much as I can. I like the idea of inceasing cash flow significantly. It seems that in the case of paying cash, the market can weeble wobble as much as it wants and you are just worried about renter rates. I think a lot of people make the mistake of including their rental income into their family budget rather than tucking it away to get another property.
thanks kyle I like the cash route but now in michigan market is getting tough lower inventory and prices are on the rise. Im looking to get a few more properties with mortgages cant afford cash for these. Just a little concerned that if these markets keep moving up their wont be much monthly cash flow for me to make. Maybe Im over thinking it but the last 6 months people are starting to fight over fix me upper houses you couldnt give away a year ago!!
Hi Ron,
You may want to consider buying cash elsewhere if it really is that bad. All of those people are fighting over short term capital gains. They're buying into hype in that current market, using leverage and selling to the next guy down the line. If your strategy is buy and hold, patience is your friend, and so is depreciation and long term capital gains.
If getting a mortgage for investment properties doesn't leave you with enough it's probably because it won't leave you with enough.
Take a look at your exposure and make sure you won't be kicking the bucket with all of the flippers when your market dives.