pay cash or finance

15 Replies

Considering to purchase property for rental purpose : Is it best to pay cash or to finance?  The Rich Dad series in in favor of using bank financing to purchase a property. I was thinking that instead of paying 5% interest to the bank , it is best to pay cash if possible. The rental income is only 0.65% as compared to the purchase cost even after paying cash. Are most of the BP members paying with cash if they can afford it or do they finance even though they might have cash in the bank earning low interest or minimum % in the stock market. Thanks. 

Raj Parwani    

Welcome to Buy & Hold.  You will maximize your returns if you use financing.  For the rental income you mention, you should not buy that deal.  Rental property can be very profitable, but you need to learn how to buy houses that meet certain criteria.  You generally cannot make much money if you pay full price and rents are not at least 1% of the purchase price.  I highly encourage you to spend some time on BP, listen to the podcasts, etc. so you learn a) how to buy (and often do some rehab) below market value b) how to evaluate local rental markets (for rent/price ratio, Days on Market for rentals, appreciaton trends, etc.) and c) how to use financing effectively (including hard money, private money, delayed financing).

Do you mean the rent/value ratio is 0.65 or that your annual return would only be 0.65%.  If your return would be under 1%, quite clearly you want to find some alternative investment.

With the 50% rule(1/2 of your rent is expenses) and a 0.65 ratio, you would be looking at about a 4% return on all cash.  I would want serious appreciation potential to invest in such a property.  Financing 1/2 of the property(assuming 5%) would cut your return to 3%, but it would double increases based on appreciation.  

Welcome to BP. 

Your rate of return would be a lot higher when using leverage. 

For example, if you buy a property for $100,000 cash and than sell it for $120,000, your cash on cash return would be 20%, however, if you used leverage and put 20% down instead of full amount, your cash on cash return would be 100%. 

There are a lot of other ways to calculate it, I have just mentioned one. You might want to acquire @Brandon Turner 's new book (No Money Down). You will be pleased with it. 

Hope it helps.

James Syed, Real Estate Agent in IL (#471018522)
618-406-9775

I agree with @James Syed in that you get a higher return using a mortgage. But sometimes you can negotiate a much better price if you offer to pay cash and do a quick closing. 

HI Doug, Jesse, and James:

The purchase cost will be $200k and the rent is appr 1400 /month. So the rent/purchase cost ratio will be 0.7% . IF I finance and put 35 % down, I am going to have a negative cash flow of appr 250/month at 5% interest rate and considering vacancy rate of 1 month and other maintenance expenses. It will then take about 2-3 years to start to get positive cash flow. Currently market in the suburbs of Boston does not give a 1-2 % monthly return on rental properties. I did buy one property under market value due to Estate sale and I have been listening to Podcasts on BP

In reference to Leverage, the return on investment will only come at the time of selling the property and no one knows how much the property will appreciate in 5-10 years. In the meantime i am going to have a negative cash flow for 2-3 years. I am going to buy Brandon Turners book on NO Money Down. 

I have bought J Scotts books on rehabbing and  and repair cost estimates. I am also looking into rehabbing properties. But Since I am new at rehabbing , I am searching for properties with minimum rehab work. I am more interested in making real money like 10-20K on rehabbing each property instead of rental income of under $1500/month and taking the headaches of maintenance and nightly calls from tenants. 

Thanks

@Raj Parwani    You can certainly pay cash for it to negotiate the lowest and best price, and usually cash buyers are taken at a lower price because you can settle quicker. However, many investors that do use cash to make the sale go through, would refinance several months later to get a large sum of their initial cash back to use towards another property. 

Like @James Syed  and @Laura Williams   have already said, you will maximize more by leveraging multiple properties, than paying cash for one.

Jon Huber, Real Estate Agent in New Jersey (#NRS0565737)

No offense but if you put 35% down and are still looking at negative cash flow you need to buy a different house.  You will not make money that way.  If you are buying the house hoping it will appreciate then you need to look at it like an investment not a rental.  You can make more money the 7% investing in the stock market without nearly as much work.  Not many real estate investors would accept less than a 10% return on their money.  Don't get me wrong 7% is better then the less than 1% the bank pays, but you can do a lot better.  You could make 12% doing hard money lending, or even more.

hi Laura , Jon and Jerry:

I do plan on taking the money out of my previous rental property and purchase additional properties at a later time as I need it. 

Currently the properties prices are on the rise again and also not many properties on sale in the market.  I am looking for a good deal and looks like I will have to keep searching. As anyone else , I am looking for rental properties with positive cash flow and they are hard to find in the boston suburbs unless the sale is due to distressed  circumstances. 

Thanks for your response 

@Raj Parwani   Welcome to BP.

If you would have negative cash flow while putting 35%, you still would NOT have any decent rate of return on your all cash investment either. 

It seems to be you are banking on appreciation, it's dangerous unless you know absolutely what you are dealing with. If you are shooting for cash flow (buy and hold), it doesn't look like this property would work. 

If you provide all figures, I could give you a more definite answer.

Hope it helps.

James Syed, Real Estate Agent in IL (#471018522)
618-406-9775

If that is a class A/"B+" property it maybe a good start.  There really are two types of appreciation that can help your investment - value appreciation which is speculative and rental appreciation.  Rental appreciation is riskier than cash flow - but is a reasonable assumption if you have a property that is located in a desirable area and has advantages compared to other properties in the same price range.

While the cash flow on this property or a similar one, won't make you rich - I think you have a lower chance of a 100% loss than you would with a 2% 30K fixer-upper in the mid-west.

Even though you are dealing with a high cost area, you still need to push for a discount on the property.  If you can get in at 90% of value, then you have a cushion to exit if you have to sell soon after you purchase. 

Is this a condo?  What are the taxes on the property?  You might want to keep looking if there is a condo fee and/or high taxes - since those expenses are likely to only get worse.

asking price $210k. My max offer 200k

Rent expected $1400. HOA $225 .

Taxes $2226/yr.  Ins 25/month. 15 days vacancy + end of year Maintenace $1500 and monthly 5% repair = $220 per month. 

I am planning to give cash off we of $195k and there is appr $5k in expenses

hi James : please respond soon

Raj

I would walk away and find another property.  

they initially accepted my verbal offer of $195k and then they backed off and they wanted $205k as cash offer. 

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