Pay in Full or Just 20% Down?

[Account Closed]

Hi All, 

I have a lump sum of money and am not sure if it's smarter to use it all to buy one rental property out right, or if I should buy a few properties by going through a bank and just putting 20% down. 

Which approach have you guys taken and why? Do you wish you did it a different way?

Thanks!

Melissa 

[Steve K.]

@Account Closed, 

I'll give you my advice on leverage. I used to be on the bandwagon of pay off the mortgage early (or large downpayment). But I've rethunk it!

When interest rates were 8 to 12% APR 30 yrs ago, it wasn't such a sacrifice to accelerate mortgage payoff instead of an 8 to 10% expectation elsewhere in stock market, mutual funds. It felt safe to not be in debt, even if it was a slightly conservative yield on my money (and tax effects to boot). Now, I'm trying for 10 to 20% IRR on my real estate investments. Why would I put excess share of my precious capital in a mortgage to save 4% APR, when I could buy another rental and earn way more?

There is a continuum of perspectives on this. On the conservative end, I know of a widow in Denver that put her life savings into buying a $250k duplex for cash. She's thrilled that she has no mortgage payment and the entire rent (less expenses) is her net cash flow. She has benefited in Denver appreciating nearly 10%/yr for the last 8 years or so. So, her duplex may be worth $400k now.

However, a different REI could have taken that same $250k cash, and used it to put 25% down payments on 4 such properties. In our appreciating market, this person has $250k equity in $1 million of property. (75% loans/leverage). They could gain appreciation of value to 4x $400k each....now owning $1.6 million of property. Four tenants are also paying off 4 mortgages over the next 30 years. (granted, in the early days, the monthly cash flow is way less, due to 4 mortgage payments. So, you see, this investor is growing wealth faster with the leverage.

Have you read about the BRRRR strategy, that allows you even more leverage? What if a third investor took the same $250k cash, and used it to put 25% down on 4 duplexes that needed renovations....they can be bought and renovated for $250k, but they're really worth $350k ARV. (A fix/hold strategy of trying to buy at 70% of ARV). Because they did the rehab work, and gained $100k per property in the rehab stage, they own $1 million in property (at cost) that appraises for $1.4 million (or $350k each). Then, perhaps after 6 months "seasoning", this investor refinances all 4 properties to 4 new 75% LTV mortgages and get's to have a $262k mortgage on each. It more than pays for $250k each costs....so this investor extracts his original $250k, able to "repeat" and buy four more in the next year....and could actually have $50k extra profit in his pocket. If this is repeated in year 2, 3 and 4....after 4 years, the BRRR investor could have 16 rental duplexes, control $5.6 million in real estate, and have their original $250k back in their pocket. 32 tenants are paying off the mortgages. If 10% appreciation continued....it could be $560k extra equity per year.

Of course, admittedly, nice appreciation on the large portfolio works both ways....you could be subject to losing 10% of the larger portfolio if there was a down turn in your market or nationwide. And other BP investors would caution against having maximum leverage. Many BP investors love to have their rentals paid off early. But, the 75% leverage grows your wealth faster. The BRRRR is the fastest path to wealth.