Something a lot of people say in real estate is, “Cash is king.” What does it mean? Well, for an investor, it means that having funds readily available without debt hanging over your head has a couple of huge advantages. And if cash is the king, cash flow is definitely the queen. One of the reasons people invest in real estate is to get a regular flow of cash going. Investing in real estate with cash is less risky, and since it’s a readily available recourse, it provides flexibility, stability, and basically forms a solid foundation for your portfolio.
The two basic goals of investing are 1) to make sure that what you have isn’t lost and 2) to grow wealth. Putting your cash into real estate typically does just that. Investing is, and always will be, a risk-based approach to making money. People don’t like taking risks, and that simply means most investors look for stability and risk mitigation when investing. Check this out for an awesome stat: The National Association of Realtors’ research on cash sales estimates that about 30 percent of residential sales are pure cash transactions.
In cases like this, there’s nothing like an example to make a solid point. Say you buy 3-4 properties in a place like Ohio and put them up for rent. If you made your purchase directly with cash, your yearly net return would be around $24,000. This amount is close to half the yearly salary in the U.S. This nice stream of cash flow is all yours to keep. Now, imagine having a loan out for the same amount of properties. The numbers would look substantially different. Say, a property on the West coast of the US is available for $200,000. You go to a bank, ask for a loan, and then pay a total interest of $165,000 spread over 30 years at a loan interest of 4.5%. Sure, as you pay your monthly interest, you’ll probably not even notice it. Spread over 30 years, it usually comes down to a small monthly cost. But ultimately, you pay a big sum. That’s why buying a property with cash is such a favored approach for many real estate investors.
Note: I’m definitely looking forward to some heat from the example above, but please don’t be a keyboard cowboy. 🙂
But that’s not all—even if the market is taking a downturn or you simply have a slight cash flow problem, you are safe. After all, you don’t have any loans, and there’s no bank asking for a mortgage payment every month. You most probably have someone renting your property, generating a steady cash flow. Things like value of property going down during recession won’t matter to you, as your property is already rented out.
The 20 Best Books for Aspiring Real Estate Investors!
Here at BiggerPockets, we believe that self-education is one of the most critical parts of long-term success, in business and in life, of course. This list, compiled by the real estate experts at BiggerPockets, contains 20 of the best books to help you jumpstart your real estate career.
Getting a Mortgage is Difficult
These days, getting a mortgage is a difficult and cumbersome process. Apart from a thousand documents that need to be filled in and pieces of evidence that need to be provided, even the approval process takes a lot of time.
Home sellers prefer quick and hassle-free sales. Even if the investor is pre-approved for getting a mortgage, he could still be denied later on. Lenders are likely to drop any funding for real estate investors based on the home appraisal value. If that value doesn’t reach the same value you have agreed to pay for the property, lenders will not hesitate to pull out. Sellers often simply avoid buyers who have to apply for a mortgage. It’s also something that our company has recently implemented, as the loan process on most of our transactions has been long and painful.
It’s obvious that this isn’t a problem for investors who invest with cash. These buyers, who approach a seller with hard cash, don’t have to go through all the drama, and the seller knows that the deal is not going to be too difficult. And this alone gives the buyer some additional negotiating power. That means better prices, but also lower closing times.
Risk Mitigation With Cash Purchases
Related to the first point, home appraisals can be quite fickle, depending on the price of properties in the neighborhood. Lenders often assess the value of a property by making a comparative analysis with other houses in the neighborhood. If a few of them are sold at a lower price, the lender may also lower the amount he’ll loan you. Now, that might seem fair to you; after all, no lender should have to take on too much risk. The issue arises when appraisers make low ball estimates. It’s not uncommon for them to value a property too low, with negative consequences for all parties.
You can, of course, challenge a home appraisal, but that just means more hassle and a longer time before a deal can be struck. And that means that one of those “cash is king” investors can swoop in, offer the money the seller wants, and you’ve lost a great opportunity. When you’re buying a property with cash, you can really take advantages of situations like this. Unfortunately, I’ve seen too many appraisals go south due to estimates that make no sense. I have also personally been involved in a triple appraisal process due to the appraiser not liking one of my employees, and thus I ended up re-ordering for a new appraisal three times over. What a joke…
A Sense of Security
When you are putting your hard earned money into an investment, you can look forward to a certain peace of mind. Owning your house or any other property with a cash purchase gives you a much needed sense of security. You don’t have to worry about monthly payments when you’re facing financial instability. Also, if an emergency occurs that requires money, you know you have a completely owned property that you can sell any time.
Apart from buying through hard cash, there are also other ways of buying indirectly through cash. Two popular ways of using cash purchases for real estate investments include a self-directed IRA or/and a HELOC.
Self-Directed IRA (Individual Retirement Account)
This is an interesting one. Many people have an IRA; in 2013, four out of every ten households had one. That’s quite a lot, which makes sense because there’s very little risk involved and the portfolio is managed by someone else. Normally, money in an IRA is invested in either the stock market or a mutual fund. But there’s also something called a self-directed IRA. It’s far lesser known, but it presents some really nice opportunities to savvy investors.
All that money would just be sitting there, making small gains every year, if it weren’t for the SDIRA. This setup allows you to decide yourself how you’ll be investing your money. And under the Employee Retirement Income Security Act of 1974, investment in real estate through an IRA is completely allowed. So now you can re-purpose the money to actually start making you some additional cash on a monthly basis.
But that’s not all. There are a number of other benefits of using an SDIRA for investment purposes. Income generated from an IRA is tax-free. So, the income comes out as absolute profit. There are also no time limits for holding on to property. You can use that SDIRA both for flipping properties, as well as for investment purposes, so you can purchase rentals.
HELOC: Home Equity Line of Credit
Many people might confuse the HELOC with a normal loan, but although it has some of the same mechanics behind it, there’s quite a difference. To make use of it, you need to own a home already. What you can do then is get a line of credit using your home as collateral. You’ll get access to a sum of money that you can then use for a certain purpose of your choosing. You will have to pay a certain amount of interest, but you’re not paying the money back immediately. That payback only occurs later, after a predetermined period, which could range from 5 years to 20 years or even more.
This makes a HELOC a good way to purchase properties. It offers investors flexibility and upfront access to cash to make repairs or even flip. This means that you won’t be dealing with pesky gun-shy appraisers messing with your deals, and you’ll have the opportunity to use the money with the same flexibility as a normal cash investment. My fellow Aussies have a ton of equity in their personal places of residence now, with the median house price in Sydney at $1M. In my opinion this is an ideal situation to utilize a HELOC and invest in high net cash-flowing investment properties.
Save Cash and Buy Outright
Buying a house with cash is one of the easiest ways of investing with very little risk attached. For many, cash purchases seem a distant dream. However, if you save properly, you’ll be amazed that you’ll be able to actually invest with cash. Just make sure you’re not overreaching and keep within your predetermined budget.
If you have access to a very limited amount of cash, look for properties in suburban areas that yield good rentals or focus on those you can flip easily. This is exactly how I first started, working hard and being frugal. I saved my first $50,000 and was on my way. Here we are today, with over 300 deals under our belts, owning a million dollar real estate investment company.
Do you pay cash for your properties–or would you rather use other methods?
Weigh in with a comment!