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Updated over 1 year ago, 02/25/2023
Cash vs Financing on low cost properties?
Hello everyone,
I'm looking into buying my first property. Currently I have 25k in cash (with 2k added each month from my 9-5 job) and was looking to buy in the east (Milwaukee, Cleveland, or Detroit areas), because of how inexpensive these properties are. I want to buy and hold.
The question is, do you think it's financially better to buy a property in cash or use my HELOC (5.5%)?
Here's an example property, something like this is what I'm looking for:
https://www.zillow.com/homedetails/5524-Maryland-S...
Of course I will fly to Detroit and check out multiple properties while I'm down there. Also take time off of work to organize contractors for the light rehab that needs to be done. Check to see if there are any taxes or other expenses attached to the property before purchasing it. Hire a good property manager. Check the neighborhood (currently according to niche I live in a D+ area and I've been happy for the 2 years I've lived here.
So I really just want to know is it worth spending my 25k, buying and holding. Then repeating the process by saving up money from my 9-5 and rental income to purchase another house in cash? Maybe this time upping the price to 35k. Then 45k. Then 55k etc.
What do you all think?
Originally posted by @Matt M.:
Especially if they are far away from you.
I agree with the above statement. I think it is very difficult to invest in Class D neighborhoods remotely. They require a lot of attention and hand holding. I own some in Baltimore, but oddly I bought them not for cash flow (although returns are high), but for capital appreciation. It's more of a gentrification play.
@Pedro Torres cheap homes don't mean value. I would take one 200k home before ten 20k homes any day.
Cheap homes under perform regardless of their underwriting, and quality homes in good areas provide solid returns.
@Chris Mason #MindBlown. No seasoning period? Ex: Need to wait 6 months before?
Originally posted by @Joe Villeneuve:
In your case, if this is a rental, I'd say go with the cash...but try to get it out as fast as you can so you can use it again...as soon as you can. Your cash does you no good buried in the floor boards somewhere in your house. HELOCS are short term funding solutions. You can't keep it with a balance owed for very long...in most cases.
Now, if you had the option of normal financing (mortgage), then go with the loan...without question.
There's no contest between a property that cash flows with a mortgage vs all cash. The all cash property costs you the entire cost of the property. The property with only 20% cash, only costs you the down payment...since the rest of the money comes from the rent (tenant).
That means you would have 5 properties cash flowing instead of just 1....for the same cash our of your pocket.
I think theres a better way to look at it. Cash purchase will always cash flow higher. Your 5 properties bought with leverage may not cash flow much more than the one paid cash. But, if there is a good spread between your cost of money and the cap rate, then leverage helps boost rate of return. Otherwise, all you do is pay interest from rent and never come out too much ahead. So for example, if you borrow at 6% and the property cap rate is also 6%, your advantage to lever up is very small. For example, with 20% down on a 100K house with 6% Cap rate, you get 6000 in net income and pay $4800 in interest. So the net value of the leverage is only an extra $1200. For that you take a lot of risk of additional debt, multiple tenants etc etc. But if the cap rate far exceeds the interest rates, the relative yield leverage vs can be quite substantial.
Originally posted by @Justin R.:
@Pedro Torres cheap homes don't mean value. I would take one 200k home before ten 20k homes any day.
Cheap homes under perform regardless of their underwriting, and quality homes in good areas provide solid returns.
I‘m not trying to pick on you here, Justin, but how many cheap homes have you owned to make a statement like that?
Let‘s say you get $1300 a month on a 200k rental, on 10 20k houses (with a 10k rehab) I can get $700-$800 a month for each. And I don’t have to play the appreciation game. Guess what, I‘m financially free at that point. $6,000 a month! There are some points made earlier to be considered here. Being a remote landlord in a D area has more challenges than a guy like me who lives in the same but different part of the city. You need to know the demographics so you know what you are buying. If you had a few and a good property manager I think you are way closer to financial freedom than owning a $200,000 house that doesn’t cash flow much. The lower cost property may not appreciate fast, or any even, but you are touching the money quicker in cash flow. I have seen a lot more people here on BP post about becoming financially free here recently because they bought or partnered with people on a ton of 30k properties. Not too many people are saying, “I have retired from cashflow spending $200k a unit.”
@Steve Vaughan made a great point on looking at the cost to close a loan compared to the value of the lower cost property. I like to use cash on lower cost properties because it is less risky. I will partner with people in order to keep buying when I see a good deal so my momentum is not slowed. 50% of something is better than 100% of nothing. I might leverage a little bit with stable cashflow but get a couple low cost cash cows under your belt first.
PS. If you have a property rehabbed right initially- checked hvac, electrical and plumbing before moving a tenant in, it will cashflow like crazy. You need a tenant that pays the rent. I like Section 8 for these cheap properties, you can typically get above market rent.
The majority of my investor clients purchase with cash. It saves on closing costs, we close in three days (or as soon as clear title is obtained), and the ROI is increased. When paying with cash, assess a 2% cost of funds on that money when calculating ROI - as that what your hard earned cash would earn in a top paying money market these days. And, one more thing: congratulations on saving this money and giving yourself options for investing. I'm proud of you.
#3 Investor Mindset Contributor
- Handyman
- Pittsburgh, PA
I took the night off. The SimpliSafe went off, but I told the monitoring team I'd handle it and not to call the cops. I headed over to our latest renovation property project to find that a sensor had come unstuck. But the drive...here's me with my shorty 12-gauge, driving to a 3/2/1 I paid $25K cash for in December. It's on the edge of a heroin ghetto I know well. The house next door is abandoned and falling apart. There's a series of open lots across the street. Isolated as hell in the middle of a city. Dark as a forearm's length up a pig's butt. This thread kept running through my head. In Detroit I've heard there are places slumlords only go in with vests, guns strapped fore and aft.
I chose this life. There are incredibly rewarding parts for someone who grew up broke and knows what poverty does to people. I've helped more people than I've hurt, I believe. I've got my exit strategy mostly mapped out. I'm well on my way to hitting my modest numbers and putting the money into different, easier-to-manage assets. And I'm getting this done despite wasting years and making dozens of stupid money/career/life decisions.
Would I get into this twenty years ago with a job that allowed me to sock away $24K a year? Hell, no! Even with my handyman background, I'd househack a few duplexes in up-and-coming neighborhoods for my cost-of-life cashflow and tax advantages and start loading everything else into index funds. Stuff my 401K and IRA and every other tax-advantaged vehicle like a pinata, then quit once I hit my numbers, roll as much of it as possible into the IRA and start laddering it out into a Roth while I lived off the duplex cash flow and declared on-paper depreciation losses year after year.
Become a long-distance slumlord? Are you kidding me?
Originally posted by @Jim K.:
I took the night off. The SimpliSafe went off, but I told the monitoring team I'd handle it and not to call the cops. I headed over to our latest renovation property project to find that a sensor had come unstuck. But the drive...here's me with my shorty 12-gauge, driving to a 3/2/1 I paid $25K cash for in December. It's on the edge of a heroin ghetto I know well. The house next door is abandoned and falling apart. There's a series of open lots across the street. Isolated as hell in the middle of a city. Dark as a forearm's length up a pig's butt. This thread kept running through my head. In Detroit I've heard there are places slumlords only go in with vests, guns strapped fore and aft.
I chose this life. There are incredibly rewarding parts for someone who grew up broke and knows what poverty does to people. I've helped more people than I've hurt, I believe. I've got my exit strategy mostly mapped out. I'm well on my way to hitting my modest numbers and putting the money into different, easier-to-manage assets. And I'm getting this done despite wasting years and making dozens of stupid money/career/life decisions.
Would I get into this twenty years ago with a job that allowed me to sock away $24K a year? Hell, no! Even with my handyman background, I'd househack a few duplexes in up-and-coming neighborhoods for my cost-of-life cashflow and tax advantages and start loading everything else into index funds. Stuff my 401K and IRA and every other tax-advantaged vehicle like a pinata, then quit once I hit my numbers, roll as much of it as possible into the IRA and start laddering it out into a Roth while I lived off the duplex cash flow and declared on-paper depreciation losses year after year.
Become a long-distance slumlord? Are you kidding me?
This was quite an interesting read lol....
Assuming your mostly investing in areas closer to inner city? I think what many others have mentioned is key is that knowing the demographic and understanding the neighborhoods to avoid because you grew up in the area is probably a substantial piece when approaching these low cost houses. Many cities such as Pittsburgh and it surrounding parts have an abundance of low cost housing. While I could easily be picking up housing in Monessen, New Kensington, or Penn Hills I personally have made the conscious decision to look further out of the city. While these towns I am interested in are still what most would consider "slummy" they are much smaller and attract a completely different demographic (i.e. lower income blue collars). There may not be 100 houses for under $30k but there are still consistently always a handful.
Yes, it is hard to find good property management that will service all of Detroit, But I have made good relationships with property management companies here that do good jobs. I can send you their information if you need it. I wholesale, so I get properties at a deep discount, I would never have my investors pay retail for a house or myself in Detroit. If you have cash you can really do some negotiating to get it much lower.
@Jonathan R. Honestly I've done quite a few but let's not get into the chest puffing game. I'm not going you say you can't make money on cheap homes, several people have got into that niche and done well.
If you're still finding 20k homes bringing in 800 a month good for you. In regard to you remark, most investors would never settle for 1300 a month on a 200k home.
From my experiences this is what I have learned (as a general rule of thumb.)
1. Low end homes have higher turnover
2. More vacancy
3. More time spent doing Tennant checks attempting to find an approved Tennant
4. Much more maintenance
5. Much higher capital expense as a percentage. A hot water heater is going to be same cost at both homes, if your rent is triple the hot water heater is only one third of the cost based upon a percentage.
6. Harder to find quality property managers
7. Harder exit strategy, as many primary home owners won't be willing to buy in war zones
8. Lower Tennant pool, as families will most likely seek better school districts
9. Less likely to appreciate (unless your in the pathway to gentrification)
10. Less principle paydow.
I know this isn't the question the OP asked, but it's relevant as paying cash for a cheap home would take similar capital to a down payment on a quality home.
The trulia crime heat map shows that this is a low crime block (most of the crimes were fraud and not violent crimes like shootings and robberies) and if I look at Google street view the houses on this block look kinda nice. I also like the $82 a month estimated mortgage payment lol.
Originally posted by @Justin R.:
@Jonathan R. Honestly I've done quite a few but let's not get into the chest puffing game. I'm not going you say you can't make money on cheap homes, several people have got into that niche and done well.
If you're still finding 20k homes bringing in 800 a month good for you. In regard to you remark, most investors would never settle for 1300 a month on a 200k home.
From my experiences this is what I have learned (as a general rule of thumb.)
1. Low end homes have higher turnover
2. More vacancy
3. More time spent doing Tennant checks attempting to find an approved Tennant
4. Much more maintenance
5. Much higher capital expense as a percentage. A hot water heater is going to be same cost at both homes, if your rent is triple the hot water heater is only one third of the cost based upon a percentage.
6. Harder to find quality property managers
7. Harder exit strategy, as many primary home owners won't be willing to buy in war zones
8. Lower Tennant pool, as families will most likely seek better school districts
9. Less likely to appreciate (unless your in the pathway to gentrification)
10. Less principle paydow.
I know this isn't the question the OP asked, but it's relevant as paying cash for a cheap home would take similar capital to a down payment on a quality home.
For some areas even $1300 a month is considered on the higher end of rent market (i.e. we are not all in CA or NY where absurd rent numbers can be had). As you stated @ $1300 a month on a $200k loan you would barely be making your mortgage payments on a 30 yr. Not to many people in Western Pa want or can spend $1500+ a month on rent. So assume you can get $1500 you are basically getting break even and have to manage a house for 30 years. Again I am sure it make sense in some areas but this model would not work in a lot of areas. This then further exploits the vacancy discussion in that if your rent is so high the population interested may be substantially less because most can't afford. To many variables to say but I think one of the biggest things is understanding the market cap in the area you are interested and then setting price points accordingly. If I am going to struggle to get $1200 in rent no reason to spend over $125k when I can make $750 rent spending $30-40K. People are to quick to assume that just because the house sells for $30K it is a pile of junk in some run down neighborhood.
@Pedro Torres I've got a connection with a commercial lender at US Bank that will do 20% down commercial financing on any rental property regardless of unit count at 50k purchase price or above. They are limited to markets where they have branches to drive by the property, however. I operate in Indiana right outside of Chicago and it works there, I don't think Cleveland or Detroit are options for them though. Maybe Milwaukee but that's a more expensive market relative to rents so your 25k may not go as far there.
(check out some secondary and tertiary markets in those midwestern states, some may surprise you. Let me know if you're ever curious about them)
@Pedro Torres
I prefer paying cash when possible especially when the market is competitive as I think it gives you an obvious advantage. I can’t tell you how many deals I have been outbid but the other buyer “had issues” with their financing and then the seller comes back and tries to re-engage.
I think there is a delicate balance to strike between being over AND under leveraged, though. You won’t generally get the best cash on cash return possible just paying cash as you would with financing. For those reasons I generally like to do cash out refis at my leisure when not under the gun to meet financing and closing deadlines. After all, leverage is what makes real estate investing so attractive but too much of a good thing can leave you vulnerable and perhaps unable to ride out declining market conditions.
Originally posted by @Nat Rojas:
@Chris Mason #MindBlown. No seasoning period? Ex: Need to wait 6 months before?
Most lenders do not offer the "Delayed Financing Exception," some do. You can make your "dialing for dollars" super efficient by just putting the LO on the spot within the first 30 seconds of the conversation and asking them to describe. Dumb/blank look on their faces -> move on to the next, don't waste another 30 minutes on the phone with that particular LO.
Originally posted by @Chris Mason:
If you can be a cash buyer, be a cash buyer. They get their pick of the litter of homes AND generally can expect a discount relative to what a financed buyer would pay.
Then, the day after closing, go apply for a cash out mortgage to recoup your capital.
Thus you enjoy all the advantages of leveraging with a mortgage and all the advantages of being a cash buyer.
I agree with Chris.
Thank you again for everyone that responded.
@Dennis M. - I'm not worried about anything. Not worried about finding a PM willing to service, finding tenants, or being the most knowledgeable about the area at the moment. I'm not pulling the trigger on any deals at the moment, I haven't decided on what area I'm going to invest in yet...it might not even be for another year before I buy a property. It was buying cash vs financing and I used the money in my bank account as a starting point (25k) Maybe I should have just made up a number and said 50k instead. "You think because you're flying out and touring the building or driving around for a weekend it's going to make you a knowledgeable investor for the area lol?" - First of all, I never made that claim that just doing so would make me knowledgeable in the area. I also never said I'd be up there for just a weekend either. I understand the power of doing research and making connections in the area of where I invest before just rushing in to buy a property. So don't insult my intelligence with your assumptions on what you think I believe, if I thought I had all the answers and a solid plan I wouldn't be on this forum asking questions.
@Matt M. - I can see how that experience would be an issue. I haven't seen the properties with my own eyes for 25k and below yet, I could have the same experience you did and not want any of them then save my money to possibly purchase 50k or 75k. That's the real idea behind this, save and use cash vs financing.
@Jim K. We would all do things differently if we went back in time. With my current life I'm past the point of being willing to house hack, yeah if I went back 13 years I would have done it easily. We also have a different investment/retirement goals from the sound of it, I think 401ks are a joke unless your employer is matching (and even then, what's the point if the goal is to quit my job sooner rather than later) and same with an IRA. I'd rather spend that money on the possibility of gaining an income generator instead of having a retirement fund that penalizes me for taking gains out early. Don't get me wrong though I am taking your advice into consideration, I know there are people that have had terrible experiences with 25k properties...but there are also people that have made it work. I'm trying to do as much research to tip things into my favor and like I said before maybe that does require me saving more money.
I'm still on the fence on this cash vs financing thing though. Let's use 35k since someone else mentioned that number.
I purchase a property for 25k and put 10k into rehab, all cash. I rent out the property for $700 a month ($8400) a year. Property management takes 10% ($840 a year) leaving me with $7560 for the year. Let's assume that it's vacant for 3 months while trying to find a tenant -$2100, now I have $5460 for the year. During the rehab I fixed the major issues with the property, so lets throw out -$1000 for repairs throughout the 9 months it was rented to a tenant, leaving me with $4,460
Is that so bad? (I know the numbers are made up, if someone can give me a real life example of how their property is doing that would be a big help) It's nice to know that since I paid for the property in cash that I don't have to cover a mortgage while it's vacant. I'm also not looking for appreciation since I would have purchased in cash, it would be a bonus though to land a property near a gentrification area.
I forgot taxes and insurance but you get it. I'll still come out making money.
@ Pedro Torres Like a lot of people are saying here if you do invest in a D area there are a lot of pitfalls and hidden costs that new investors do not factor in.
For starters one thing negative in my market which is Baltimore and DC is voucher recipients doht want these homes because the voucher allows them to get better even if you fix it up. I would look into the Detriot area voucher programs led by section 8 to confirm these issues. If they are similar then you are dealing with market tenants. There will be no backing from the government for a tenant in a neighborhood it will be hard to find someone with a 600 credit score or good rental history.
Another thing is not only will there be higher vacancy from people leaving early or evictions but the amount of work per turnover will bump up. To repaint a whole house, throw all the trash which is a lot, cleaning the house, and some miscelaneous repairs can cost into the thousands. In the d neighborhoods every other turnover will be that bad vs better areas where they will not trash the place. Since many times the d area tenants know this they use the deposit for the last month rent and thats iif therevnit getting evicted so you are stuck paying all of it. It would not surprise me if a d neighbrohood house averages 5 times the vacancy and 3 or 4 times the maintenance killing any chance of cash flow.
There is also the water bills where im at the tenants have to transfer electric and gas but the water bill stays with the property. If 15 people live in a 3 bed gouse the water will be high and chances are they arent paying it like they will in a c grade neighborhood or above. This can be voided in a condo-hoa or an area where tge bills are low. Ofcoursecan additional condo fee is an expense.
Good pms know this and do not take properties like these unless you already gave them better properties to manage. Thus finding someone who will help you is going to be difficult that is fair and reliable. I manage portfolios with a few of these though most are better and these types of properties drag down portfolios as they hemorage money. I would never manage 1 property like this for someone again. Yes you can get that good tenant and it will work if they stay a long time but there is too much of a chance of bad ones. Drop your prices to get your pick of tenants. The wrong tenants will have you lose $.
Also there is much higher chances of a lead lawsuit though I'm unfamiliar with Detroits rules unless your property was built post 1977.
Lastly get an alarm system. I think adt base package will run 1000 over 3 years. The first time someone breaks in and takes the fridge it will pay for itself when combined with the insurance discount and the tenants will really appreciate it.
With all the pitfalls and hidden costs even if you get a good tenant it will be more profitable in the c neighborhoods.
Make sure to but on a block without too many border ups and has no stores on that block.
Good luck if you go this route.
Hello Pedro! It usually works best on which way makes you happiest. There is such a thing as "good" debt you can finance and still have a positive cash flow after paying your debt payment. You might get more acceptances when paying cash mainly because you can close quicker. Good luck!
@Pedro Torres I would add another 1000 to maintence , 1000 to the water though this is dependent on the area, 300 for the alarm system, and 700 for the leasing. Maybe a few hundred fir power bills during vacancy. Also 300 for lawnmowing and maybe that for sno removal in Detroit. Where I am you can get fines for not cutting the grass which can lead to property fines. Maybe its different there but I wouldnt trust the tenant with it.
See my response above for more clarification
Hi I currently live and am from Detroit! A little off topic but please do your due diligence and get those houses that youre looking into to be inspected thoroughly!!! I know its a good market for cheap houses but they are cheap for a reason! These houses are really old and the maintenance is atrocious! Im not saying its a bad idea just make sure you know what you're getting yourself into.
Some out of state investors have bought these houses and they're doing fine! I WISH YOU THE BEST OF LUCK:)
@Tim Jacob - Thank you for the insight. These are things that I'm going to have to look into depending on where I invest, still not set on the city yet. How would you handle the water bill? Charge them slightly more rent or have them pay for it? I've heard both ways. Didn't even factor in an alarm system. In your experience what's the vacancy rate in lower end areas? Are we talking about a few months between tenants or 6 months?
Also where does everyone find an accurate measure of an area? I know we talk about A B C D ratings but even the property that I liked before is in a C neighborhood according to Niche.com
https://www.niche.com/places-to-live/n/morningside...
Or lets look at a property like this:
https://www.realtor.com/realestateandhomes-detail/...
https://www.niche.com/places-to-live/n/east-englis...
These are all considered C or C+ areas...but how accurate is that really?
Hello Pedro! Love that you're going down this road and thinking about investing.
You seem to have a good idea on what you would do if you went down that path. You can also consider investing passively to seek those returns and work with a syndicator who can align with your investment goals. The passive approach could be easier if you want to collect passively into a business and get the benefits of tax incentives and returns with a hands off approach. This could help you build your fund while you gain more knowledge and venture off on your own. There are other lending options to get returns on your funds as well such as lending to flippers for a percentage and such but that doesn't sound like the approach you are seeking.
You have a few options that you can work with and I am excited that you are exploring. Happy investing and God bless!
@Jared McCullough please don't tell people this method doesn't work, it has worked well for me, and created financial independence. I post on here to give back to the newer investors, as I was just in that position 10 years ago. I would never suggest purchasing your arbitrary and theoretical scenario of a 200k home that brings in 1300 a month (unless there was a development opportunity for a higher and better use.)
What I am simply stating is that a single 200k home that has a "cap rate" (I hate using that term in non-commercial) of 11 percent, will yield much more than ten seperate homes in war zones purchased 20k range with a similar "projected" cap rate; as well as be MUCH more "passive."
If what your doing works for you, by all means continue that path and I wish you much luck!!
Originally posted by @Justin R.:
@Jared McCullough please don't tell people this method doesn't work, it has worked well for me, and created financial independence. I post on here to give back to the newer investors, as I was just in that position 10 years ago. I would never suggest purchasing your arbitrary and theoretical scenario of a 200k home that brings in 1300 a month (unless there was a development opportunity for a higher and better use.)
What I am simply stating is that a single 200k home that has a "cap rate" (I hate using that term in non-commercial) of 11 percent, will yield much more than ten seperate homes in war zones purchased 20k range with a similar "projected" cap rate; as well as be MUCH more "passive."
If what your doing works for you, by all means continue that path and I wish you much luck!!
Just wanted to give you real life example since I have them around here.
The houses I bought for for $13-14K plus updates and all-in @$20K each, bring every month$825-925/mo and it's not ghetto. My tenants are nurses, Amazon workers, social workers, teachers etc. the ROI on these houses is 25-30% after all expenses excluding repair and maintenance.......these are generally depends on the quality of finishes and account 0-12% of rents.
There is no way it would be cap rate 11% on cheap houses.
Next: houses for the price $200K never will bring 10% ROI, however, if you catch the right wave, the gross Rent will be 10-12%. After accounting taxes, insurance, and some repairs, it's 8-9% ROI. Yes, it's the best schools, very nice neiborhoods but you're not making money when you factor CapEx - these are more expensive in such areas (city won't let you hire anyone not approved by the city).
The houses which brings $1300/mo rent, usually bought for $90-110K and in good areas but not super extra nice. After taxes and insurance you'll make maybe 10-12% ROI, however, nothing close to the areas with $30-40K houses in 2012-14 and $50-70K now.
There is markets for everything and it's smart to start with cash purchase, create the system and then try to buy better areas with financing.
I agree, that the higher the rent, the better the quality of Tenants but there will be other problems: threatening with legal actions, trying to buy your house against your will (true story at $3500/mo rent).
This is very diversified business and plenty of room to make money for everyone