The Pros and Cons of all Cash Purchases

17 Replies

Background - in 2006-2007 I owned a primary residence and 6 rentals. I did not study a lick and made every conceivable mistake that a newbie investor/landlord could make. I was over-leveraged, did no deep deal analyses thus did not know my numbers, not enough reserves, bad tenants, wanted to manage everything myself on the cheap with a full-time job and new family. The crash wiped me out. But I loved real estate. These past several years I’ve saved and invested well. Part of that I put aside as a war chest to get back into investing. My goal was to buy properties all cash and take the risk of being over-leverage off the table.

BP has been a wealth of information and I know that there are other trains of though. But I’m once bitten and now twice shy. Any strong opinions against all cash purchases?

I agree all cash purchase while we are at the top of the cycle now. Don’t make the same mistake twice.  We are at the top of the cycle today, like year 2006.  

You lose money from the start, and never recover.  You think you're ahead, but you're not.  If you have two investors, one pays $100k for a property and one pays $20k (with an $80k mortgage), the one that only pays $20k for the property is light years ahead.

The risk is in the cash, not the debt...just ask the lenders.  This means the less cash you spend to buy the property, the less you have at risk.

Based on your complete statement above, the reason why you lost everything had more to do with your lack of knowledge on how to analyze properties, and all the mistakes you said you made along the way.

After ten years, using a combination of reinvesting the cash flow (part of it) and exploiting the compounding effect, the REI that only paid $20k for the same properties the other REI paid $100k for, could have had 43 properties and $215k/year in cash flow. The $100k REI would end up with only 2 properties, and only $20k/yr in CF.

Now I'm not saying you should want to own/control 43 properties. The example is just to show the power that the $20k investor has over the $100k investor. At some point, I would assume the $20k investor would slide over to something like NNN.

@Geren Williams I disagree that using a mortgage is the biggest risk. As you mentioned, having buildings in bad areas with bad tenants or not having adequate reserves are MUCH bigger problems than having a mortgage payment. If I were in your shoes, I would focus on buying in the best areas you can afford. Get solid properties that are purpose built. Focus on getting the right tenants in place, and don't be afraid to maintain/over maintain your properties. If you have great buildings in great areas that have been well maintained, you will not lose them. 

Congrats on saving and investing well enough to have the choice to pay cash!

I will pay cash for tough to finance odd properties that don't quite fit into lenders little boxes (like mobiles on land or 2 houses on 1 lot), have too many repairs needed to appraise or need sold too quickly for a mortgage.  All with corresponding steep discounts.

I will then make them bankable and cash-out refi if I want to.  Most times I will just keep them free and clear and let the 'cashflow' (repayment of principle) restock my dry powder organically but rates lately make it tempting to finance some. 

If opportunities begin to pop up, I will, but the $4-5k in refi costs correspond to a couple weeks of napping to me.  Cost/benefit.

Prices have been high because interest rates are so low.  If you buy for cash, you have to pay the high prices without getting the benefit of why the prices are so high.

Leverage is not risky by itself...and it does not have to be max leverage or no leverage...can be in between.  Good locations, cash flow, add value, prudent debt, reserves...and leverage will be way down on your list of concerns.

Leverage is not what whiped you out, it was the combination of all the other issues you listed. By the way I really applaud you for your self reflection and looking objectivley at what you did. That takes a lot of spine!! And it is how you learn and grow! You have heard about failing faster...

Financing is a powerful tool, but it cuts both ways, so you need to be careful with what you do. In the wake of 2007 you could read a lot about a "stress test" for banks to make sure this would not happen again. (I own a good sice portfolio and we are leveraged with a very healthy equity share.)

A stress test for your portfolio is basically a set of distressing circumstances, like a worst case scenario and then you look at your bottom line.

What happens if:

- you loose 30% of your tenants

- rental rates soften

- your competition starts giving out free rent

- your adjustable rate financing kicks in

- your annual capex spikes (well, this should not come as a surprise)

- etc

Now you don't look at this statically and say okay now I cam cash flow negative. You can look at this dynamically, because you want to gauge your resillience to weather the storm and of course you have a set of counter measures.

- how much can you lower your rent to drive occupany up?

- how much capital do you have on the sideline to cover temporary losses

- how much equity do you have and can you sell assets at a steep discount and still cash out

- how much unused credit lines do you have to tide you over until you can sell assets

The result of this exercise is that you will get a feel for your resilience to weather an economic storm. When it comes to financing I follow the old saying "everything in moderation". Any heathly business should use leverage (not only money, also people and know how) to grow and prosper. Going from all OPM to all cash is a little bit emotional knee jerk reaction to a traumatic erxperience. There is a good middle ground, a sensible, measured approach, that leads to success!

You'll also need to evaluate asset protection strategies, LLCs, insurance protections, trusts, etc., as you don't want to expose that much cash to risk of lawsuits and other risks without having tools in place to protect it.  Purchasing cash is a great way to buy and can get you the best deals and open your options up to homes that may just have a few problems but would only qualify for renovation loans so makes your cash offer much stronger.  It's especially good if you've lined up cash-out financing where you can rehab, get it rented, then cash-out refi a good, cash-flowing unit (I think up to 75% of appraised value), then use those funds to buy another good deal.   

So many pros and cons of all cash purchasing. You can choose all cash to save on interest and also have instant equity in your home and eliminate the risk of foreclosure. But on the other side, paying in cash makes it more difficult to acquire new properties. 

Leverage didn't make you lose your properties. Over-leverage & not enough reserves & bad management caused you to lose them. 

Leverage is not evil. & Leverage is honestly one of the only reasons to invest in RE in the first place.


This time around, learn from your mistake. Use moderate leverage, keep a healthy reserve, underwrite conservatively, & either learn how to manage it yourself or get an amazing PM (Don't cheap out). 

Why would you want to tie up so much of your funds when you don’t have to?

Leverage responsibly.

Make smart purchase.

Take necessary actions to maximize returns on those purchases.

IMO - Buy and finance a nice solid MF property in a good appreciating neighborhood.  You will have less cash flow then a high risk area but in the long run its worth it especially with resale value. Then, you can sell and upgrade if you want.



   

@Geren Williams All previous posters have made valid points for both sides of the cash vs. finance debate.

I can tell you from personal experience having a rental paid for is a great feeling. You feel no pressure to rent it out to someone that’s not right since you don’t have a payment.

My only gripe with a paid for house is I wish they’d mail me a title, like they do with my cars, showing I own it (I know this can be had from title company).

Originally posted by @John Warren :

@Geren Williams I disagree that using a mortgage is the biggest risk. As you mentioned, having buildings in bad areas with bad tenants or not having adequate reserves are MUCH bigger problems than having a mortgage payment. If I were in your shoes, I would focus on buying in the best areas you can afford. Get solid properties that are purpose built. Focus on getting the right tenants in place, and don't be afraid to maintain/over maintain your properties. If you have great buildings in great areas that have been well maintained, you will not lose them. 

TWO Thumbs up for this one..  

 

Originally posted by @Matt J. :

@Geren Williams All previous posters have made valid points for both sides of the cash vs. finance debate.

I can tell you from personal experience having a rental paid for is a great feeling. You feel no pressure to rent it out to someone that’s not right since you don’t have a payment.

My only gripe with a paid for house is I wish they’d mail me a title, like they do with my cars, showing I own it (I know this can be had from title company).

its called a deed from the seller  and if you had a mortgage then its a deed of reconveyance  or a satisfaction or mortgage few different terms but that is the document that says you own it.. you already own it with the deed.. now you just simply have no debt..  

@Geren Williams

Cash purchases can make for great offers. Cash is king after all and can make your offer more competitive. I would look to do a refi or something afterwards to get most of my cash back out after though so I can put it into another rental.