Best strategies for a cash buyer?

Question

Hello,

New member here, this seems like a great site and I am glad to be part of it!

I am a real estate professional and have a cash buyer interested in purchasing a rental property.  The market here in SE WI where he is looking has a median home value of around 225K and currently has a shortage of inventory. He does not want to use financing to leverage his money.

My question is what are the best investing strategies for a cash buyer in a market with rather low inventory? It seems to me he would be better off fixing and flipping some properties instead of the buy and hold approach for a quicker and bigger ROI without tying up his cash for years. He simply wants a 10% return after expenses, but I would like to do better than that for him.

Thanks,

Shawn

Jordan Finkelman · Answer

Maybe you could try to have him deploy 100k each into 2x 200k investment properties for a total of 400k in assets.  Overall, 50% leverage.  Transaction costs would be higher but you also would have a better shot at higher gross rents.  Just a thought.  I think without leverage, the vacant house idea requires less work than a flip but more than buying a stabilized asset.  It depends what his experience in the business is.

You could explain the benefits to him of having his property pay down it's own debt with the cash flow and eliminating the leverage (possibly using a 15 year loan).  This way, it amortizes twice as fast although probably won't be able to be cash flow positive even with half down.  In other words, he shortens his time "at risk" of having leverage, while at the same time quickly increasing his equity which helps provide an equity cushion.

Jesse T. · Answer

In tight markets the REO discount is often negligible.  A short sale might be a little more promising since unlike an owner occupant, your client can wait.

Your client wants two things that are reasonable separately - a 10% return and to invest without leverage.  However they work against each other - to the point where most markets they will not exist.

Probably the thing to start with is seeing what type of return he needs to get on his money.  If it remains high, then see if he really is comfortable using some leverage.  One option might be to purchase with cash and leverage after a year or so using the property as a rental.  He might only get 6% the first year, but could push it over 10% with 75% financing at 4.5%.

Shawn C. · Answer

Eva, I would like to provide him with some options and let him choose which he would like to pursue. He has some experience as a landlord, but only from renting a past primary residence of his for time, which is now sold. So this would be his first proper investment property. He is definitely looking to me for guidance and will go where I lead him.

Joel, I have transacted with this buyer in the past and he definitely has liquid cash for a purchase. He is also working with me exclusively so no worries there. My main concern is to do the right thing for him and find him a property that will achieve his goals. My issue is that I am not as familiar with the formulas needed to calculate ROI for an all cash purchase rental so I am trying to learn quickly. I have lots of experience in residential sales however so I can certainly identify potential deals with relative ease.

Like you said, it's going to have to be a purchase under market value that he can put some money into and then place tenants. From what I am seeing in the search I set for him, even the REO properties showing up in the MLS are basically very close to what would be retail pricing. I am thinking he's going to be better off focusing his search more on HUD homes or auction properties, rather than homes that are listed. What's going to make it tough as you said is that he does not want to get involved in financing at all. Perhaps I can change his mind about this.

Joel Owens · Answer

Shawn I would reverse this process and find out if that even exists in your market.

I have found over a decade in this business in commercial investments that buyers want all kinds of things. Doesn't mean they exist where they want to buy! lol

They either have to temper expectations sometimes, look in another area, or buy in another asset class.

This buyer is it someone you have transacted with before?? Have you seen their bank account and financial statements showing liquid funds?? Did they choose to work with you exclusively OR are they calling around everyone trying to just uncover the one deal they can't find?? Have they bought investment real estate before??

You need to find your sales to rent ratio for your market.

Let's use the 1,875 number for cash flow a month. Take away 1/2 annual costs and the rent needs to be 3,750 a month on a 225k property which amounts to about a rent ratio in the high 1's. That is going to be really hard to hit in a hot market in a nice area. Are they willing to buy something vacant and put money into it and place tenants?? They might can create value there.

I don't know why in this low interest environment why he would not use any leverage with a loan. You would really need to see his balance sheet to see how he thinks and where he is coming from with his thought process. When someone says to me they want to pay all cash but want a high cap in the double digits with a super quality asset it's just not realistic in the market. Leverage has to be used to get there.

Example one of my clients can buy a strip center at an 8 cap and with 25% down get cash on cash at 15% or better annual return.

If they want to pay all cash now it has to be 15 cap rate to get close to the same result. It's just simply not going to happen. People just parking all cash with no debt are willing to accept less returns because they see no risk to the asset. Buyers are purchasing that stuff for 6 caps etc. I just wouldn't allocate a ton of time to this person if you are looking for a one in a thousand type property for them in your market. You can keep an eye out for the "deal of the century" but do not let it eat up all your time.

Eva Salas · Answer

As you said, your buyer wants a rental. He does not want to use financing to leverage. Hes let you know his strategy for himself in regards to this property. I would let him know there are other approaches but can't see him going from one end of the spectrum, an all cash buy n hold investor to the other, of flipping with hard money. Perhaps he, like many, just wants to chug along with the property as a rental owning it free and clear. Not all are wheeler dealers like we are on BP ;-)

Is he asking you for the "best"strategy? Or do you want to provide him with some options because he's a new RE investor?

Jesse T. · Answer

Usually flipping is a relatively risky strategy, but if inventory is tight it might be a good market for it.

One thing that will probably increase his chances of success will be if he is willing to either use leverage or decrease his expected return.  To get 10% on a 225K property would have to cash flow $1875/month to do that as a rental.

A cash flow of 5% might be more workable.  The tax deferral(depreciation) probably works out to 1% of value per year.  If he expects appreciation of 2 to 3% he is looking at a return of 8 to 9%.

Getting an leveraged 10% will be easier on a flip.  Especially if it can be done in 6 or 7 months, it only takes a 5 or 6% return to net 10% annually.

Hard money lending is probably the simplest way to accomplish 10% returns.  Although the risk is significant.  It means you wouldn't have a direct buyer for properties, but if you have a contractor interested in flipping, you will be able to connect the contractor with a potential hard money lender.