Is It Cash Is King or Let the Bank's Money Work For Me?

13 Replies

I have been in real estate for years. I started part-time, more clerical. Later worked the office gig into full-time and then was licensed. & Over the years have worked a salary niche of commercial and retail property management.  & Property management IS mainly what I do.  

I have decided that I will acquire residential properties in the small towns and rural areas around where I live, as I live in a rural area but have easy and quick access to several different places of opportunity.

My original intent was to go cash only.  Though I would be acquiring property at a much slower rate, I saw the huge advantage to not having to factor in a loan payback, thereby freeing up money for repairs, taxes, insurance and hopefully some cash to re-invest and/or pay ourselves. (hubby & I)

Now he sees if differently.  He said "Why not allow the bank's money to work for you-?"

Why not get the best deals on the properties, let the bank initially pay for it and keep the initial seed dollars for the repairs, taxes, insurance, etc.  

?

I do agree buying power would be greater through an institution.  I still wonder, however, if cash in hand is the best way to go to acquire the properties initially, even if it is slow and one property at a time.  ?

Any thoughts.  

& Oh, forgive me. I see folks have written on this subject. So, definitely will go read what they wrote!  :) 

@Mya Austin According to what you posted, your goal has nothing to do with comfort level, but rather the best strategy to stay adequately capitalized and and have the best return on investment.  (Some investors simply have a preference about not carrying debt.)

In this case, you are much better off leveraging because you can earn a much better return on funds invested than the interest you'll be paying for them.

Let's say you want to keep $5K liquid for repairs and  such for each property and that the acquisition cost of each property is $95K.  Let's also say, for simplicity, that each property nets $10K in profit per year.  Finally, let's say you can get a mortgage at 5% with 25% or more down.  Finally, let's say your have $100K cash.

In scenario one, So with $100K cash, you buy one house for $95K, have $5K liquid, and earn $10K.

In scenario two, you buy three properties for a total of $95K x 3  = $285K, with $85K down ($28.33K each, 29.8%).  You keep $15K liquid ($5K for each property).  The interest in year one is $285K x 0.5 = $14.25K.  You earn $30K ($10K each) profit per property before interest.  After interest that is $30K - $14.25K = $15.75K.

So, you are making $5.75K more in scenario two than scenario one, and you still have $5K liquid per property.  The one caveat is that part of your earnings is from principal paydown, so not all the $15.75K is money you see in your pocket--it's in the house.  If $5.75K goes to principal paydown, then you have the same $10K in your pocket as scenario one but your net worth is growing faster.

@Mya Austin

I think @Larry T. has the right advice on this one. You can make the best use of your resources using a bit of the bank's money. 

When you have a strategy misalignment like this, it may be best to take a step back and talk about your goals. The word financial freedom is thrown around a lot. I tend to think that investors who leverage are smart and get moving fast, but I wouldn't describe the life they have chosen as financially free. They work for their lenders, and the properties (and their obligation) have to keep pace with the lenders, the costs, and their lifestyle (assuming they are being paid by the properties).

The Millionaire Real Estate Investor by Gary Keller, Dave Jenks, and Jay Papasan contains a number of great investor profiles at the conclusion of the book. One I just referened was that of David Fairweather, a Maryland based investor with 30 years in the business and 700 units. 

In his bio David is quick to advocate a conservative perspective, by always keeping a ton of reserves. What was most insightful about him is his early forethought into market downturns and times when the opportunities were there, but money is hard to find (think 2009). I think the more you can rely on cash, you will always move slower, but creativity is at your fingertips regardless of the market. 

I would recommend thinking about your goals in a broader sense, and not letting the easy-money argument take you away from a strategy that better defines your lifestyle. At 60 years of age, I imagine myself holding a pile of deeds, not a mountain of new loans. I don't mind financing on the way there, but eventually I want to own a few things.

Ultimate goal & one I was already working on was being "debt-free".

& Have accomplished a lot in a small amount of time.

Gaining properties is, however, a goal. & I am skilled in property management ands am lucky to be paired with someone from maintenance for 30 years. Not a bad combo. & While our experience or skill doesn't cover everything, I think gives is a slight checkmark on the right side for this endeavor.

I still like the idea of debt-free. I also do realize some advantages the other way.  Perhaps a mix-? 

& Wrote it, but do not see it here.  *No, is not a comfort level thing. Strategy. As I see it, I have nothing to lose and, perhaps, much to gain. I could do this and completely fail. 

However, if I never step out----- I would never really know, eh?  :)

I completely get the appeal of being debt free. But keep in mind, when that debt is used to purchase property, you have a corresponding asset to offset the debt. It's not as liquid as cash, obviously, but you can convert the property to cash if you need to.

@Mya Austin

Cash talks when getting the deal! I put an offer in on a REO, potential buy and hold that would have been a good little money maker and could have secured a home equity loan pretty quickly and offered cash but didn't because I figured I would offer a little over list price as incentive. I later learned that another investor offered 10% less cash and got the deal. Funny thing is, he didn't have the cash in the bank either. He just had an agent who would submit an offer without the supposedly required proof of funds. By the time the bank demanded a proof of funds letter he had secured a line of credit and had the funds in his account to show cash liquidity. That property is still producing a 20-30% CAP.

Cash has tremendous value when it can be deployed quickly in situations where you can identify equity and purchase it at a discount.  Sellers will trade equity for peace of mind in distressed situations or other situations where it make sense for them to do so.  

I would favor keeping enough cash or instant credit (think LOC) to be able to purchase your target projects for cash one at a time. You can then refinance them and repeat the process. This gives you the advantage of being able to purchase the equity at a discount and provides leverage for your portfolio for projects you hold long-term.

In general as you age and/or your tolerance for risk goes down you should have lower overall leverage ratios in your portfolio.  Having adequate cash reserves to have staying power during panics in the market cycle is a must.  To me this should be your primary concern if you hold a lot of projects with debt on them.  The secondary concern should be what is outlined above to be able to finance target projects with cash quickly to generate value for sellers.  

It's different for everyone. I started out using the bank and doing some creative financing. Though, I slowly moved into buying for cash. Though it can be much slower to acquire properties, not having a mortgage takes a lot of stress out from the equation. Plus it adds to the overall cash flow. Best of luck with your decision! 

Originally posted by @Mya Austin :

Ultimate goal & one I was already working on was being "debt-free".

As others have said, don't confuse consumer debt with debt on investments.  The former costs you money.  The later makes you money.

If your goal is  a portfolio of properties, you need to preserve cash for purchase & operations.  Buy  with cash for immediate closing and refi later to recoup cash for the next deal.

If you want to maximize cashflow with profits, minimize debt to reap profits.  

Accrued property values are useful only at the end-game exit time.