Owning in Cash (Need Advice)
Investor · New York City, NY · Member since 2017 · 146 posts · 56 votes
I own 4 properties (3 duplexes / 1 fourplex in B grade neighborhoods) in cash. So far I've been relieved to own them in cash because the first 12-16 months I had to fix/replace/upgrade a lot of things that the previous landlord(s) neglected as well as deal with some bad inherited tenants. I likely would have lost money when all was said and done if I also had a mortgage to pay. Things have since settled and the investments are bringing in nice monthly income.
However, I can't help but get the feeling that while I was blessed to have the cash to own that it utterly kills my ability to buy more investments and there's probably a better way to do this than the way I've done it? I also have cash set aside for rehabbing/flipping which is something I intend to do.
I'm really just looking for some advice from people who have been down this road that might be able to share their wisdom.
There is a big difference between playing offense and playing defense. There are a lot of offensive players on bp who will be destroyed in the event on an economic contraction and it will come. Who knows when it will come but I have seen a lot of people pretending that values will only increase and rents will only increase and leveraging according to this assumption. There is a lot to be said for playing defense, especially at these prices. Save your money and play offense when the time is right!
@Account Closed, first I would reflect on what went right and what went wrong with your current properties. For example, could or SHOULD you have known about any of the issues that have come up so far. Did you do all the due diligence you could have before closing on them.
You mention flipping as a future goal. Flipping sounds sexy, but its a job more than it is investing and you don't reap the tax benefits of owning real estate long term doing that. Have you considered BRRRR (Buy Rehab Rent Refinance Repeat). Its a solid proven strategy to get from one rental to many over a shorter time. You also have the advantage of doing all your cap ex (capital expenditures) up front. So you should have less maintenance issues since you just rehabbed these units.
Frankly, I don't think there's anything I could have done better in regards to the pre-purchase process. Most of the Sellers I have come across will deduct a few bucks here and there if the water heater is old or the roof has some years on it, but they were solid deals. The tenant situation I don't think anyone can really know for sure especially since the Sellers tell you how great they all are. Like I said, I've since turned the properties into cash-flowing investments.
In regards to BRRRR I think it is definitely something I'm into if the right property comes my way. In regards to Refinancing - is that something people do immediately after they have rented it out or do they wait a few months, a year, a few years, etc... ? I haven't been on Bigger Pockets in awhile - so I really forgot about the BRRRR method.
The problem with hoarding cash in real estate is that you are losing money every month based on the opportunity value of that cash. If you assume a descent return of 10% on your cash you must deduct $833 for every 100K of equity straight off the top of your rental income every month. Easy to see how hoarding cash will kill the cash flow of almost any property.
To maximise returns you maximise leverage. If you do not wish to invest in additional income properties put your cash in a income/mutual fund. You will still double your return. My choice would be to mortgage and pull out every penny possible or sell and start over if they do not cash flow with full leverage.
@Thomas S. Based on what you're saying I could just refinance the properties as is; maybe I wouldn't pull out every penny, but even if I did I think I'd still probably have a 6.5% return on the four that I own.
What I'm not understanding is how hoarding cash is killing the cash flow. If anything, I'm bringing in greater cash flow by not having a mortgage to pay? Are you suggesting that by owning more properties with leverage (vs owning less with no leverage) that I have greater value because those homes will appreciate over time and I'll pay down the debt over time?
Maybe I don't understand you question but I see no problem not having a mortgage. Like you said, no payment gave you room to breath when you had CapEx.
I'm happy and casually looking for more when I have properties paid for...
@Account Closed I think the main point of it hurting your cash flow is because you aren't using it to buy ANOTHER rental property that could be cashing flowing in addition to the ones you already own. Basically, you are not using your money and leverage to your full potential thus raising your opportunity costs of not acquiring more properties.
2 properties cashing flowing at 250 a month each is better than 1 cash flowing at 300 a month.
@Account Closed I think the main point of it hurting your cash flow is because you aren't using it to buy ANOTHER rental property that could be cashing flowing in addition to the ones you already own. Basically, you are not using your money and leverage to your full potential thus raising your opportunity costs of not acquiring more properties.
2 properties cashing flowing at 250 a month each is better than 1 cash flowing at 300 a month.
This is something that we look at closely as we are in a similar situation to the OP. Right now, ALL of our properties are paid off, 100%. Our two recent acquisitions are paid off as we go through the first steps of BRRR and we are deciding if we are going to keep them paid off or, as is continuously recommended here, refi them to get cash out and move onto the next property.
Let's take one of our new properties as an example.
Purchase price $193,000
ARV $214,000
Rental income $1850 (yeah I know, we didn't hit 1%. This is more of an appreciation buy)
If we did a typical 30 year commercial note at 5.5% APR (how we get financing) we'd have a free cash flow of about $400 per month.
However we won't do a 30 year note. At our age it takes too long to pay it off and we'd be too old. So we'd need to do a 20 year note.
So with 20% down (commercial loan) and 20 years on the note, the cash flow drops to about $216 per month.
If instead I leave the property paid for, the free cash flow is $1279 mo.
With these free cash flows, it would take 5.9 houses with a 20 year note each, to equal the cash flow of one paid for house. That would be 5.9 times the appreciation but 5.9 times the risk and 5.9 times the work.
I know that I could run these numbers with 5% down and a conventional mortgage, but then I'd have to calculate PMI and I'm frankly too lazy at the moment since I'm not going to pay PMI anyway so 20% down is my minimum.
I'm not calculating the appreciation lost on those 5.9 properties we didn't buy, or the opportunity cost of the sunk capital. I'm happy to let someone else do it and I'd love the input. Unfortunately I'm off to go meet a property manager and have run out of time. But at least here is a cash vs. cash comparison.
When a property has dead equity that money is generating a return separate from the property itself. In effect you have tied up your cash to BUY cash flow. The maximum return that cash can generate is equilivant to your prevailing interest rate. If a mortgage rate was at 5% then you, at the very best earn a 5% ROI but usually far less. The deceptive part is the principal portion you are also receiving. Because you have your cash sitting in the property you must earn back all that cash before you can count your cash flow as a positive. Investors with equity choose to only see what they want. They choose to not see the real numbers. As such cash buyers generate the lowest ROI of all possible investment options.
The biggest issue most people face with investing in real estate is understanding the value of their cash and actually doing the math on what income is generated by their cash and what in fact is actual income from their investment property. It is complicated and the primary reason why most do not understand that leverage generates a greater return than cash. Amateur investors trick themselves into believing cash generates a higher return only because they place no actual value on their cash.
Imagine buying a 1M property with all cash and charging 3K per month in rent. Assuming all expenses are 2K per month does that property produce 1K per month in positive cash flow. No the property is generating nothing it is the cash that is generate all the income at a ROI of 1.2%.
There are numerous threads going into the details of how leveraging multiple properties outperform a single property purchased with all cash. The math does not lie it is investors that CHOOSE to not understand the math that is the problem. The funny thing about mom and pop investors is that, although they believe their paid off properties are generating a high return, in reality they are not. The same money in a income fund for 30 years in most cases would do far better without the hassles of actually owning real estate (this excludes areas of above average appreciation). Ignorance is bliss.
I think the question always falls to "How big do you want to be". Obviously if you are fine with the income generated from the houses you own then being paid off is probably the better approach. Some people seem to have a misconception that you have to go full bore or nothing at all.
We all have boundaries on what we want our portfolio to look like. I am personally more in line with Dan Moore in that it's not always about how big you can build your empire. I want to get to a point that I am comfortable with the units I have (i.e. they are the right ones, in the right quantity, and will provide sufficient income when paid off) then work on paying them off.
It sounds as if you are at a gate point in your "path" that you have determined you have a desire to grow bigger. To do that you need capital and so that is either going to be your cash or a lenders cash. Refinancing your properties would be a great option to get that cash if you don't personally have it and benefit from some of the great real estate models.
This being said I would reflect on how big you want this next step to be. You could obviously probably refinance all the properties you mentioned giving you the largest sum of money to reinvest and done right this could probably work out very well. Although if all your looking for is maybe one or two more units the simpler method maybe to just try it on one of your properties so you get a flavor for what it is like before you commit your whole portfolio to being refinanced.
There is a big difference between playing offense and playing defense. There are a lot of offensive players on bp who will be destroyed in the event on an economic contraction and it will come. Who knows when it will come but I have seen a lot of people pretending that values will only increase and rents will only increase and leveraging according to this assumption. There is a lot to be said for playing defense, especially at these prices. Save your money and play offense when the time is right!
Comes down to risk and time. If you know for certain you can invest the cash-out and get a higher return then go for it. For me, I love the idea of having them paid off and have the ultimate holding power. Regardless of what happens to the economy I know, I am good. This doesn't mean that leveraged investors will be hurt. The smart ones who know what they are doing will have the proper reserves set but most do not.
To me, it's more about time. I want to net more per deal and have fewer properties to deal with. I can then focus my energy to make more money so I can buy more properties cash. See how that works. If I am dealing 40 homes netting $200 a door I will never have the time to focus on my income growth. Even with a superstar PM.
Both strategies work it really just comes down to your personal goals and objectives.
I think it depends too on where you are in your investing career. Also, do you want REI to be your only job or have it be a secondary income? What % of retirement is it going to be?
Owning them outright is super appealing, but you lose your ability to scale quickly with leverage. One could save for 5 years and buy a 100k house. Then buy another 100k house in 3 years. Then another in 2 more. After a decade, one has 3 doors but can begin to scale faster after that.
Using leverage, one could potentially buy significantly more in that same 10 year period and retire after that.
I guess like most things..."it depends".
There is no rule saying you have to leverage at the maximum level. It isnt all or nothing. Get an equity loan or mortgage for whatever % you feel comfortable with. Not everyone can sleep at night owing a lot of money but it sounds like now you would consider borrowing some.
If you're worried about not being able to expand as quickly, then taking some of the equity out would be a good choice. If you're a conservative investor, maybe consider pulling out cash for some, but not all the properties. We are in the latter phase of the current economic cycle, so be careful of maxing your leverage. @Bobby Stener makes a good point in that there is a time to play offense and a time to play defense. But you need to make that decision based on the market you're in and what you're comfortable with.
BTW, I don't know how you're holding the title on these properties, but if they are all under your name you may want to consider transferring these into LLCs. Owning these free and clear make you a juicy target in the case of a lawsuit.
@Account Closed I commend you for starting your portfolio without leverage. Unfortunately our cash is finite and we come to this roadblock where you currently sit. If you can get lines of credit either on the properties individually or collectively I'd look into that. Also what I find as that many investors buy outright because it makes the deal more attractive as leveraging the properties either initially or post closing would leave little to no cash flow. Take a look at this - Plug some numbers into the Present value(PV) annuity calculator. You'll see that with inflation you are losing money year after year unless you are adjusting rents to keep up. All the best. Persist and you will WIN
https://www.realestateinvestmentsoftwareblog.com/understanding-time-value-of-money/
@Rob Bianco keep in mind you don't have to pull ALL the money out of your rental properties. What if you just pulled half of the equity out to fund a new venture? I'm sure your rents would still cover the mortgage, even through a rough patch... Best of luck!
I'm curious about this as well. I don't see a down side to owning my properties outright. Before anyone jumps in let me explain. I am not trying to build an empire. My goal is to replace my 9-5 income so I can retire early. I'm 55 now so its time.
For example, I own a house, I have about 45k in it. I own it. This house easily cash flows $1,000 a month. That money just sits in an interest bearing account until another deal I can't refuse comes along and I jump on it. A little rehab and then I am cash flowing another $1,000 a month. For some reason that 1k a month has become my goal. You really don't have to do this to many times before the monthly cash flow puts a big grin on your face.
Perhaps I prefer this method because of the low stress/slow pace it allows me. If I want to spend 6-8 months doing a simple rehab that is not an issue because I have no mortgage and next to zero cost while the house is empty. I think the difference here is that different investors have different goals. I've done my work, made my money, had a career I am proud of and now to be frank. I don't want to work and BRRRR sounds exhausting. Maybe its just laziness...LOL
This is a personal choice . In a time of economic crisis you’ll be glad you hold the note on those places , however it’s true your missing out on other opportunities because the money is tied up . It is a balance and risk is relative . Personally I like the idea of having a few properties owned outright , simply for safety / risk reduction to keep the wheels turning in tough times and there will always be tough times or massive expenses if your in this game long enough . It is also true that leverage will allow you to grow at a much faster rate .
@Rob Bianco
Warren Buffet bought real estate the same way you are. Snowball method your next purchase. Save cash flow for as long as it takes and put 30% down, then save the cash flow and put 30% down. You’ll be ahead in a decade.