Should I borrow or use own money?

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Should I borrow or use own money?

Lou M.
Danbury, CT · Member since 2012 · 5 posts · 0 votes

I've been told that having too much equity in rental properties is not good. But I have resources that are not working for me. We all know what banks are paying in interest these days. The stock market is too risky. So is it wrong to invest (pay all cash) money in rental properties that can produce a nice return?
Is there a down side that I'm not seeing?

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Brandon TurnerPro Member
Investor · Maui, HI · Member since 2009 · 13k+ posts · 3k+ votes
13y

Lou M. - A lot of investors will tell you the ROI will be much higher when you leverage to the hilt and that the taxes are higher when you don't have that "interest payment" deduction.

Sure this may be true, but to quote Dave Ramsey, "100% of foreclosures last year happened to people with a mortgage." In other words - loans add risk and if you aren't comfortable with that risk - don't take it. a 10% return that's almost risk-free sounds pretty darn good to me. I can't wait for the day when I can pay every loan off and just relax. For me - security is more important than maxing out my ROI.

Good luck Lou and keep us updated!

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  • Justin SilverioPro Member
    Developer · Andover, MA · Member since 2008 · 1k+ posts · 489 votes
    13y

    I'm not a buy and hold guy but some general thoughts.

    The more cash you invest in a property the less you'll have to purchase new investments. If you want to build a rental portfolio, you'll want to conserve the cash. Also, the more you leverage your investments, the greater your ROI.

    I've heard 20-30% equity in a rental is adequate to mitigate the risk of market fluctuations.

    I'm sure I'm missing a lot but wanted to give you my 2 cents.

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  • Lou M.
    OP
    Danbury, CT · Member since 2012 · 5 posts · 0 votes
    13y

    Thanks Justin. My situation is that I have cash parked and not working for me. I used to invest in the stock market, but not anymore. I'm 52 and just looking to produce income from the cash. I've looked at many deals, and when I work in financing, the numbers don't look good. Basically the rent will pay the mortgage and nothing left over. If I use my money I can get 8-10% return, rather than leave it sitting in the bank at .10% I can purchase many properties with the cash and have a nice portfolio, producing a nice income stream.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    I think the "avoid liability by being mortgaged to the hilt" strategy is silly. If you have assets to protect, work with your attorney to come up with an asset protection strategy.

    Leverage usually produces better returns than buying with cash. But work through the math. In this thread, I posted a couple of math examples for rentals:

    http://www.biggerpockets.com/forums/88/topics/78367-2-rule-on-sfr

    Adjust the numbers to properties you might buy and play with cash vs. financied and see which you like better.

    Leverage involves risk. Many people bought with little or nothing down. They were underwater from the start because of the costs of selling. When prices fell, sometimes by 50% or more, they were totally stuck. You won't get nothing down loans today. 25-30% should be what you expect. That gives you some protection. I don't expect prices to fall by 30%, but if you start with 30% down, you only have to see prices fall by 20% to take all your equity after costs.

    OTOH, borrowing costs are at historic lows. I think there's a lot to be said for taking todays current low prices and current low rates and locking in some rentals. If you have cash for the down payments (and, very often, repairs), you're in a good position to buy.

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  • Scott W.
    Real Estate Investor · chicago, IL · Member since 2012 · 1k+ posts · 231 votes
    13y

    for a rental, if you want to buy in cash, you'd better have a lot of $ leftover for the rehab & reserves.

    most people don't have piles & piles of cash so they leverage.

    there's cheap $ out there, low home prices, & lots of renters, so makes this 'high risk' investment less risky.

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  • Andy Chu
    Involved In Real Estate · Las Vegas, NV · Member since 2010 · 341 posts · 86 votes
    13y

    If it is your intention to only own one home or haven't found other investments yet, then I would say its okay to buy in cash now. I would heloc (home equity line of credit) the home out and in case you found a great investment, you could quickly pull the trigger and trade cash flow of rent for immediate cash in hand.

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  • Scott W.
    Real Estate Investor · chicago, IL · Member since 2012 · 1k+ posts · 231 votes
    13y

    couple things about HELOC's: 1. their rates can change 2. they can be called in

    now i'm not saying they're bad - just have to keep in mind the pros & cons.

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  • Ross Schneider
    Fort Worth, TX · Member since 2012 · 72 posts · 29 votes
    13y

    WIth appreciating assets, you want to buy as much as you can so use someone else's money. With assets that depreciate, use your own money. Some say leveraging is bad and some say it is good. Hard money is a good way to help leverage. I have had plenty of investors use HM for rental properties because they were able to buy more of them, at a much lower interest rate than you would pay for using HM to flip a house. It really depends on what you are comfortable with, and how risk averse you are. I wish you the best of luck, Lou!

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  • Brandon TurnerPro Member
    Investor · Maui, HI · Member since 2009 · 13k+ posts · 3k+ votes
    13y

    Lou M. - A lot of investors will tell you the ROI will be much higher when you leverage to the hilt and that the taxes are higher when you don't have that "interest payment" deduction.

    Sure this may be true, but to quote Dave Ramsey, "100% of foreclosures last year happened to people with a mortgage." In other words - loans add risk and if you aren't comfortable with that risk - don't take it. a 10% return that's almost risk-free sounds pretty darn good to me. I can't wait for the day when I can pay every loan off and just relax. For me - security is more important than maxing out my ROI.

    Good luck Lou and keep us updated!

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    13y

    Hi Lou,

    It's really hard to say what you could possibly do without knowing your situation and how much money you are talking about.

    Your situation is not unusual. I work with clients pulling money out of banks and also exiting the stock market to invest in commercial real estate.Many had the money parked while they figured out when the debt service rates and the the real estate market would bottom.

    Your jobs annual income and time to retirement and cash to deploy and how hands on you want to be for your return will determine avenues you could pursue.

    This is really investment planning and you need to do this FIRST before buying stuff and going "oh crap" this isn't going to meet my goals after all.

    You might find commercial properties are better for your goals or it might be that residential properties fit better.

    I personally love leverage right now because debt service is so low.When prices are depressed is when you want to stock up on properties and deals.

    Some people do not like putting on forums what they have of cash to invest.If that's the case you can simply colleague someone and start a conversation that way privately.

    I do recommend you get with someone local or otherwise to further define your plan before you deploy your cash so that you get the maximum results.

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  • Jeff S.
    Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
    13y

    There are wealthy people out there with no debt. Have personally worked with them and they have had more than enough RE to support themselves in a great lifestyle.

    If you have $1,000,000 in cash and only want a $1,000,000 worth of property you may get a bigger return on the 200k invested as a down payment but then how much do you make on the cash you have sitting there? On the other hand you could leverage the million on 5 mil in property and have it lose 20% and your money is gone. Have worked with people that have done that too. In the end the cash guy lived to spend another day, the leveraged guy disappeared.

    Good luck.

    1Reply
  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    13y

    I would venture to say the bad leveraged deals were a function of the market being overheated,not factoring numbers correctly,and overpaying to obtain seller financed deals.

    They bought wrong at the wrong time and paid to much.The leverage wasn't what made the asset lose money or value.

    Leverage used correctly on larger assets using the income approach you will not incur huge losses.

    The keyword is used correctly.I see many deals transact with people with more money than common sense and scratch my head trying to figure out what they were thinking.

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  • Kumar R
    Lombard, IL · Member since 2012 · 12 posts · 2 votes
    13y

    I am in a similar situation. I can use cash to buy couple of rental units or use the cash as down payment to buy an apartment building. However, the loan terms on commercial properties are a bit scary. I got the following from a bank:

    5.00%, fixed, for first three years, adjusting to the Wall Street Journal (WSJ) Prime Rate + 1.00%, every three(3) years, thereafter. Floor rate of 5.00%. WSJ Prime Rate is currently 3.25%.

    This basically becomes an adjustable loan after three years. Plus they want all of your personal assets tied to it.

    I am new to this. But it seems much safer to buy and hold couple of properties cash than to leverage for a commercial property and into trouble if interest rates start to move in a few years.

    But without leverage, it would be difficult to build a good income stream.

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  • Kyle Hipp
    Investor · Appleton, WI · Member since 2012 · 1k+ posts · 464 votes
    13y

    I would ask if you want cash now or later? Do you at 52 need to have your cash providing you income or grow your capital for future growth. I talked with a gentleman recently who is also 52. He wants to retire at 62 so doesn't need cash now, but does want his capital to grow for future cashflow in retirement.

    If you have $100,000 you could buy a rental in cash and produce $800 in cash flow forever or you could purchase 4 $100,000 investment properties with 25% down on 10 year mortgages and in 10 years have. $400,000 worth of paid off rental property giving you $3,200/m in cashflow when you really need it in retirement.

    I recommend you analyse your needs in this manner before making a decision.

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  • Matt Sheridan
    Bondurant, IA · Member since 2012 · 13 posts · 18 votes
    13y

    Lou,
    If you wanted to avoid the hassles of managing properties and are looking to get 8-10% from your money, you could probably find plenty of people here on these boards (me included) that would be happy to pay that interest to you to use your money to help with down payments! The money wouldnt be very liquid though...Think of it as a great CD rate. Just a thought.

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  • Lou M.
    OP
    Danbury, CT · Member since 2012 · 5 posts · 0 votes
    13y

    Thanks you all! Many different outlooks. I currently have good passive income from another business, but may decide to sell to partners. I'm really looking to sort of be semi-retired. Investing the cash in rentals and reaping the benefits now would be nice. I think the property will appreciate and be worth more ten years down the road. I should get immediate benefits in income, depreciation etc. and if I decide to sell the property 10 years down the line I should recoup my principle + any gain. Does that make sense?

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  • Lou M.
    OP
    Danbury, CT · Member since 2012 · 5 posts · 0 votes
    13y

    Hey guys. I ran the numbers a couple of different ways based on your reply. If I borrow money, then yes I can buy more properties. But I will have to pay the lender 4-5%, and the property may only appreciate at 2% per year. Assuming I'm borrowing 70% of the value, I think the interest payments will wipe out any gain in value. So basically at the end of the ten years I own the property outright, but gave the gain to the lender. If I purchase the property all cash, then my money is earning the interest rather than someone else. I pocket the cash flow, the property still appreciates and I get to keep that too. It's a lower ROI, but may be better in my situation. Any thoughts?

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    13y

    Yes Lou except you aren't mentioning how hands on you want to be with your investment.

    I have clients that love apartment buildings for economies of scale and they have to moniter it some.I have others who love triple net with a monthly paycheck from a corporate tenant.(No the rent is late,fix repairs,eviction,pit bulls,etc.)

    The return you get with annual rent bumps is less but you are certainly getting way more than a bank return plus the depreciation.

    Apartments you will get more annual rent bumps for cash flow.

    To Kumar:

    I got the following from a bank:

    5.00%, fixed, for first three years, adjusting to the Wall Street Journal (WSJ) Prime Rate + 1.00%, every three(3) years, thereafter. Floor rate of 5.00%. WSJ Prime Rate is currently 3.25%.

    -----------------

    Was this a local bank?? Many locals banks are giving short term loans like that.

    You would do much better to go specifically with a multifamily lender for commercial.

    10 years fixed rate with a 25 year amort.

    The loan rate is 75 basis points higher than a starting rate that adjust in a few years.I would take the higher rate locked in for 10 years and build the model into my numbers when purchasing.

    I understand your concern about interest rates but if you set up and plan right there is not a problem.

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  • Lou M.
    OP
    Danbury, CT · Member since 2012 · 5 posts · 0 votes
    13y

    Joel:

    I guess I don't know at this point how hands on I will be. I'm hoping to buy properties in a higher income area, therefore the quality of the renter should be better. Hopefully avoiding evictions, damage etc. I will certainly do the minor stuff myself, but plan to hire others to do repairs and such that is beyond my skills.

    I guess I'm looking for income now, rather than down the road. Who knows what life holds for each of us. Might as well as enjoy it while we can.

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  • Scott W.
    Real Estate Investor · chicago, IL · Member since 2012 · 1k+ posts · 231 votes
    13y

    1. if you're paying 4% interest to the bank, it's cash flowing, & it's only appreciating 2% year, you have to 1st figure out how much you're putting down. let's say you put down $50k on a $200k investment. the next year, it goes up 2% to $204k. this is an 8% return on investment on appreciaton alone. you need to add in your principal paydown. let's say it's $2400/year. now, you're at 12.8% increase in net worth. this is assuming the 50% rule works out (not likely on a higher end rental).

    Now, go with the past 90 years of real estatt appreciation of 5% & you're net worth increased by 25% - again, assuming 50% rule works.

    2. if you buy in a higher income area, you "should" have less hassles (I wouldn't guarantee you that though) yet your tenant pool will be smaller (not as many people will rent for $2k+).

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    13y

    Lou,

    It's a process of elimination.

    How much money do you have to invest??

    For triple net you have to have hundreds of thousands of dollars to invest and buy at a minimum.Unless you are comfortable going in and forming a partnership agreement with multiple parties to buy that way.

    If you are not comfortable having partners and do not have enough cash then you take triple net out.

    Now you are left with say apartments versus houses.It comes down to economies of scale with 30 units in one place or ten houses spread all across town.

    Buying houses in nicer areas will limit problems but it will also reduce your cap.If you are fine say with an 8 cap instead of a 10 for a nicer area and less headache then go for that.

    Sometimes people are unrealistic and want the nicest area at a 10 cap when things are trading at 7 to 8.Generally in those areas you get more appreciation on the back end.

    It's all a discovery process for what you will and won't accept and how much money you have to do it with.

    Apartments you can get in great areas 4 to 5% annual rent bumps whereas triple net maybe 1.75% to 3% a year depending on the deal.

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  • Ann Contorno
    Orland Park, IL · Member since 2012 · 26 posts · 8 votes
    13y

    Or, you can make other people do all the bird dogging and rehabbing and just be a private money lender. Loan money out at a 15% interest rate, don't loan anymore than 60% LTV, and take a first mortgage against the property. If they lose their minds and stop paying you, you have a fixed up house that you will take over for 60% of what it's actually worth and do what you want with it. If they pay, you're getting a 15% return and not really doing anything for it.

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  • Rob K.
    Investor · Southeast, MI · Member since 2012 · 2k+ posts · 1k+ votes
    13y
    Originally posted by Lou M.:
    I've been told that having too much equity in rental properties is not good. But I have resources that are not working for me. We all know what banks are paying in interest these days. The stock market is too risky. So is it wrong to invest (pay all cash) money in rental properties that can produce a nice return?
    Is there a down side that I'm not seeing?

    Lou M. I'm of the opinion that you can't have "too much equity". I would much rather have too much than not enough. You will get a million opinions here.

    The only downsides that I see are if you spend all of your cash on real estate and then have none left over for an emergency, or if you spend all of your money and wish to buy more property.

    I started out by taking on lots of debt because I had no other choice. Now, I use the rents coming in to pay cash for more houses. I like the paid for houses a lot better than ther mortgaged houses. Especially when you have a vacancy.

    Everyone's situation is different. If you have $300,000 in the bank and want to purchase $250,000 of real estate and then stop, I would say by all means, pay cash. If you have $200,000 in the bank and would like to own a million dollars worth, then I would suggest getting mortgages at fixed rates and have a goal to get them paid off in a reasonable time.

    Good luck to you. This was a good thread.

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  • David Beard
    Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    13y

    Sounds like you could use immediate cash flow then. It would make sense to purchase quality properties for cash to deploy your cash more rapidly, then if you feel it appropriate to lever up somewhat to enhance returns, you can obtain cash-out refinances as needed, using the additional proceeds to purchase more (or use as downpayments). This would allow you to get your funds to work as quickly as possible, while testing out life as a landlord.

    You also need two years of landlording experience to be able to count any of the rental income for debt-to-income ratio calculations, even though your ratios have to carry the PITI. If you try to buy a bunch of properties quickly with loans, your ratios will get hit hard. This may or may not be an issue for you, depending on where your current ratio is, but something to be aware of, and another reason you may want to start out as a cash buyer.

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  • Rich Weese
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    13y

    You still have investment time ahead of you. Anything you buy with mortgage now should be free and clear before you pass. I personally have landed in the middle. When I started 40 years ago with no $$$ I mortgaged to the hilt AND used commission. As times went on, I paid off some and continued purchasing. Now, I am in the middle. I have F&C properties to generate cash flow and other properties mortgaged to the hilt-in different entities. I also suggestt food storage, cash storage and metals for additional security.
    I think you have a great variety of suggested methods here. You do need to assess your risk tolerance, anticipated continuing income stream/job and if you have a spouse, have her on board... Rich

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    13y

    Nice to see you back on here Rich.

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