Slow scaling with cash or faster scaling with mortgages?

Question

Hello BiggerPockets community,

I am a new Real Estate Investor and would love to get some feedback on our strategy.

Goal: Achieve sustainable income of net $10K/month, while the properties appreciate long term. I am a buy-and-hold investor and planning to hold long term (10+ years).

Strategy: Buy SFR, multi-family (duplexes and 4-plex) OOS. Currently looking at Tulsa and OKC in Oklahoma. Plan to buy a combination of new construction and turnkey to avoid large capex expenses in the near term. We plan to have a property-manager and in 3+ years we will likely be living outside the US in Europe/Asia.

Financing: I have about $1.3M to deploy right now and will have additional ~$700K (sale of primary home) to deploy in 3 years (total $2M).

Option 1: The more traditional approach with about 25 - 30% down can buy about $3-4M with leverage. With current interest rates around ~7% for investment properties the net cash flow initially with new construction or turnkey would be 1-2K/month (terrible CoC return). Hopefully when interest rates go down and rents go up in the next 2-10 years, we can refinance and have better cash-flow.

Option 2: Pay with cash right now (~1.3M) and with a ~7% cash-on-cash return we conservatively net ~7-8K/month and properties appreciate with inflation. After 3 years, deploying additional 700K cash should help us get over our 10K/month goal conservatively. This will also give us the option to refinance if the rates go down drastically. Our plan in the near term would be to use the cash-flow to buy additional properties every 1-2 years, increasing cash-flow so that we can live off that income after 10-15 years.

Given our modest goal of $10K/month, I am leaning towards Option 2 which is to use cash to buy properties and in a few years re-evaluate financing.

Here is one of the new construction duplex properties I am vetting right now:

Purchase price: $360K for a duplex.

Expected rents: $3300 monthly

Insurance + taxes: $500

Vacancy, Maintenance + Capex, Property Management (25%): $800

Net cashflow: ~2K/month (CoC ~7%)

David M. · Answer

@Sunny Karen

Notes can be done through broker/matchmakers. Can't seem to create link here, @beth johnson runs previously a whole note, now private fund, for private equity. Doing about 12%. That's very passive, and others will be nearly entirely passive.

As for what to do in real estate in your shoes? Neither / both of 1 and 2... buy "something" to try it out, figure it. Some people don't like it, or some also actually lose money. Its not talked about much, but it happens.

Learn from the first property, then go to the next one.

I didn't run numbers, but my "feeling" is that your 1 and 2 are sort of contradictory / uneven application of concept. In the end, give a set amount of capital, you'll end up with about the same amount of "property." #2 may make you "feel better" because your statistitc, CoC, looks better and getting some cash more flow, but you are still using money, more money, to make money...

I guess I'm more of a traditionalist... Cash flow isn't king. Granted, the market is dislocated these past 5-7 years. But, worry about building wealth/equity. Look for appreciating properties, which to me are usually single families. Any other the value will be partially dependent upon the rent by definition. Do what most investors actually do... When its time to retire, you rotate into cash flowing properties. If anything in 10 years you probably wan to rotate anyway for a myriad of reasons, including avoiding capex. Or, just change in strategy mindset. I've been liquating my portfolio.

In the future, they may not cash flow as well. Rents have skyrocketed up an unprecedented amount. Stats say they are already acutally coming down some. Maybe in 10 years the fixed expenses, not even the variable ones, will outpac eht e rent. Historically to my understanding, cash flowing properties and appreciation aren't linked. Its the yield trap that usually in commercial people want the high cap rate properties, but their cap rates are higher because they are riskeri in generally poor quailty areas.

I've really only invested around me. I have no idea about the OK market. Alhtough I hear OK and nearby states are growing from outpouring of TX, for example.

Of course, maybe getting both will work in 10 years... Who knows...

In looking over this. Since you are new to real estate, having a fixed plan NOW to work in 10 years seems foolish. "Things" change. markets change. your lifegoals and strategy changes. You don't even know the "business." its something like a asking a high school senior to pick their college major, first job, and first house before they graduate high school --- they don't know jack...

if you love it great. One caveat to remind you (maybe I'm a grinch...): don't forget that you have to pay back depreciation. In my opinion its "lemons and lemonade." So, you'll have to "swap until you drop" or pay the tax. I've run into so many people, that if you can have the serious discussion, keep swapping because they are unable or unwilling to pay the tax. they really don't want ot continue.

Chris Seveney · Answer

Happy to chat about note investing with you, as that is our bread and butter.

JD Martin · Answer

There's no right or wrong answer because it all depends on your personal goals. Without question, you will grow faster and richer using leverage. It is also a little riskier inasmuch as you need to cover the debt service, whereas buying all cash you only need insurance and tax money. It's also a matter of timing to some extent. If you feel that asset prices are high right now, and you think there's some reasonable chance they could recede, you may not want to grow that fast right now.

I will tell you what I did. I was highly risk averse from having lost a bundle of money on a new build (you can listen to my story in the podcast below). So I saved all cash and bought all cash. Then I rehabbed all cash. In hindsight, I was buying when house prices were stupid low, and I easily robbed myself of several million dollars worth of value by buying and growing so slowly. I should have been buying houses like they were candy bars when they were super cheap, and then worried about heavy rehabs and slowing down when prices (and rates) rose. Now, I'm not complaining - I've done pretty well for myself - but there is no question I'd be far richer if I had leveraged sooner. BTW, I did eventually see the light with leverage but not as fast as I should have.

David M. · Answer

@Sunny Karen

I'm not clear. Is your goal to create the income now, or in 10 years?

Everybody has their own crystal ball, but I wouldn't bank on net increase in rent 2-10 years. The past 5-7 years has seen an unprecedented rent increase. Nationally, rents are even finally softening. Also, you generally expect carrying costs to increase over time as well.

From your description of opt2, you re looking at 10 years... So, why now option 1 to leverage and grow your wealth? Then, in 10 years move to cash flowing assets, especially since the properties are 10 years old?

I've come to respect Seventy's and Woodruff's opinions. Not sure why I disagree with them. Its a little late for me. Maybe I'm missing something...

Are you tied to real estate? If you expect to have $2mil to invest and need $160k gross (120k net assuming 25% tax for sake of example), that's an 8% pre-tax yield. You could do private lending at 12% to stay in real estate. Public markets have income funds that were doing about that for at least the 15-20years before the fed raised rates...

Anyway, this is supposed to be a real estate investing forum... Either way, grow/accumulate some more wealth just in case. In either real estate or any other market you can still lose money.

Happy to chat if you are interested. Good luck.

Stuart Udis · Answer

@Sunny Karen My advice would be to focus on the quality of the real estate rather than the financing for the time being since you are not reliant on the financing to fund your initial acquisitions. Even though rates are beginning to come down, lenders remain conservative and are offering lower leverage on rental assets. I suspect as rates continue to decrease terms will begin to improve and more buyers will re-enter the market/ be able to pull trapped equity out of their recently completed projects. Therefore you likely have a window to be aggressive with your acquisitions with less competition in the marketplace. You will also be able to negotiate better terms without relying on financing contingencies.

Once you exhaust your capital you can take inventory of opportunities and determine when is most appropriate to add debt to recapitalize yourself.

Henry Lazerow · Answer

With your funds no reason to go into C class cities buildings. Go buy a few 4 units in class A/B parts of big cities where they run headache free. A lot of these the returns don’t even net positive after all the costs using managers. I would go 50% leverage.

Stetson Oates · Answer

Option 2 is what I'm doing now. I plan to pull some cash out once rates go down, but leave the LTV at 25% to 35% on each property.

Sunny Karen · Answer

@Chris Seveney - That's a good point. Given that our goal is stability with RE investments, we are leaning with paying cash.

@Bruce Woodruff - Good feedback, the workload and handling stress with RE investments is something we are not used to. Need to put processes in place even with property management. Are you referring to stress related to management (vacancy, turn-over, time commitment, ...)

@David M. - We plan to continue working for the next 10-15 years, so the income requirement is at that point in time. Having said that, my spouse and me work in high stress jobs and having some level of constant income coming from RE investments would be good psychologically if we want to take a break or lose our jobs. Our expenses today are about ~10K/month (with a large buffer) and when we relocate to Europe/Asia our expenses will come down to ~5K/month. Initially we plan to use the cash-flow to save up for more properties to purchase, which should increase the cash flow 10-15 years down the line, likely keeping up with inflation at least. I agree with not having a crystal ball, we are looking at current net cash-flow and not baking on appreciation or rent increase (which is likely to happen over the long-term).

I haven't invested in notes before and don't have a process to vet those investments out. Thank you, will look into it.

How would you go about investing in real-estate if you were in our shoes?

We do have other investments in the market with our non-taxable assets (401K) which we plan to use post retirement age (60).

Bruce Woodruff · Answer

Since you have a good chunk of money, I agree that Option #2 is a good way to go.

For people that don't have that much cash (say maybe $200k), Option #1 would be ok...getting into properties is what it's all about, as long as you can handle the workload and manage the stress....

Chris Seveney · Answer

@Sunny Karen

I agree with your thinking as you can always pull money out later. One argument is you could go 50% leverage and buy more properties, but with rates stabilized and expected to go down slightly in the future - I would do option 2 as well

Slow scaling with cash or faster scaling with mortgages?

Slow scaling with cash or faster scaling with mortgages?

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