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Updated almost 2 years 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?
#3 Investor Mindset Contributor
- Handyman
- Pittsburgh, PA
Pedro, you've raised some good points. This website really doesn't go into detail on D-class investing pitfalls. Let me get home off the phone and write this up.in meantime, please look up "Roth IRA ladder conversion" on the Mad Fientist's blog to start seeing why I like 401Ks and IRAs so much.
Originally posted by @Pedro Torres:
@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?
I am guessing niche.com is not all that accurate, this is the first time I’ve seen it. I typed in the area I invest in and it said it’s a B+, lol. I would call mine a D+ maybe. To find an accurate measure you really need to spend some time in the area, see who is walking down the street, see what they ask you when they approach you, fill up your car at the gas station down the street, buy a six pack of beer at the closest liquor store, ask the mailman what his experience on this street is compared to other streets he’s worked etc. The vacancy rate might be higher in a D area with a cash tenant but my tenants are sticking around for a long time on Section 8. I liked the comment above that said you’ll want to get a feel for the Section 8 program in the market you are investing in. In Detroit maybe a voucher tenant does have better options than a 25k house, in my area all the Section 8 properties are all in the same general area. If you go to gosection8.com you can look at what is for rent now to see what you would be competing against.
@Jonathan R. - Well that doesn't help that there isn't a universal system in place. I'd consider where I currently live to be a C+ neighborhood, but I have friends that say I live in a ghetto and some are legit afraid to come to my house. Then I have other friends that say I live in an amazing neighborhood and wish they had my house. I did some searching on gosection8.com just now and saw the competition (I used 48224 as the example), the impression I got is that with a decent street and a good internal rehab they all kinda seem the same around $850 rent.
@Jim K. I'll check into the "Roth IRA ladder conversion." Seems like another big issue is that the rating system is different for each person, one persons D-class is different than another.
Cash is king. However, consider what renovation $$$ you will need. If you are tapped out after the purchase, where does that leave you? Also consider that you will be a long distance investor and will need to hire local contractors and property managers willing to with you and your property. If this is your first purchase, I would suggest partnering with someone in your local area. Find the deal and the money will show up...
#3 Investor Mindset Contributor
- Handyman
- Pittsburgh, PA
The Roth IRA ladder conversion is a legal way to get money out of your tax-advantaged retirement accounts for a minimal or zero tax hit before you hit retirement age. It is especially useful to those living off rental income who are able to use depreciation to show an overall loss on their rental properties.
Property classes A,B,C,D are highly variable among investors and their aspirations, but I tend to use Brandon Turner's blog entry as my base: Class A, B, C & D Real Estate: How to Know Where YOU Should Invest The key distinction that not enough people make in the entire Rust Belt area is thinking about the age of the properties -- where I operate, older properties predominate, and newer properties are rarely built to anything close same standards as the best of the older properties, and that leads to a lot of people confusing A and B and C (because they know pretty much bupkis about residential construction).
The other problem is that there is a lot of aspirational wishing and hoping about D'class areas magically turning into C'class areas.
Working on your real-world example...
@Pedro Torres. I would only buy these in cash and to an area where you’re local. In your case you’re not local, I wouldn’t buy this
@Jim K. I was gearing up to write my thoughts, but Jim K beat me to it. Very good post.
There is a reason why properties are so cheap in these areas. A good chunk of Detroit is not desirable to live - both for renters and owners. Investing in this low segment is done, but the hurdles for an out of state investor are high.
"D" tenants are not going to take care of the property nor pay rent on time (or at all). Section 8 voucher holders is a better bet, but they are often able to get access to better housing stock because their vouchers are sought after in a place like Detroit. Lots of these tenants prefer to live in the suburbs these days.
The house you targeted is located on the back of the lot. The roof looks quite worn and the windows appear to be original and may have lead based paint. Parts of the interior look functional, but rather plain.
I advise a different path: Purchase something locally. You seem to have the down payment. And since you're in a growth market, the value will be retained.
While a small part of Detroit is making a comeback, the under 30K houses are questionable investments. The values became this low because Detroit depopulated itself the last 50 years and losing its middle and working classes. So many of these neighborhoods are impoverished.
Many of the cheap houses in Cleveland are a similar story. Milwaukee, on the other hand, looks more appealing to me.
@Jim K. Well said and great advice to a newbie investor...not that im all that experienced. But...he that has ears/eye... let them 'hear/read'
#3 Investor Mindset Contributor
- Handyman
- Pittsburgh, PA
I'm going to connect with you on this one and do this privately -- it turns out giving you a really good real world example in my area I've got here would apparently piss off some people I would prefer not to. Sorry, readers of this thread. My first shot at explaining the particulars of the snake pit is going to have to be anonymous. This took me a bit by surprise.
@Joe Villeneuve
Agree with Joe. Turn that money into multiple properties
Ok hi all and thanks to everyone for posting I like reading everyones different perspectives. So here we go I have my last deal to tell you about. The property is found here https://www.zillow.com/homes/for_sale/Lima-OH/3313... . Here is a link to the auditor's page for the property http://allencountyohpropertytax.com/Property.aspx?... .
The asking price was $35k we paid $30k using a Heloc @ 6%. We closed on the property December 2018. Had a tenant in place Jan 2019 @ $600 month because Im a nice guy lol. I guess I could have bumped it up to $700 but that sounded like a sweet spot. So this will be my first property to use Delayed Financing on the guidelines can be found here https://www.fanniemae.com/content/guide/selling/b2...
I actually have the appraisal scheduled for tomorrow and the closing set for Feb 22. So the total time from closing to refinance will be about 2 months. Which actually is about a month too long because Fannie has some reserve requirements you need to adhere to found here https://www.fanniemae.com/content/guide/selling/b3... . I hear people ask about reserves for Cap Ex, Vacancy, Maintenance, Taxes all the time. Maybe we should add a category for reserves required for financing crazy fannie lol. I guess if you are using private financing it may not matter as much.
I talked to the lender a few weeks before the purchase at a local credit union here. So I started the ball rolling a little early with all my financials. The loan details would be $30k @ 4.625% 30 year term with about $3805 in closing costs which I will try to negotiate. The payment PITI would be $249.24. So I guess that's about $350 in cash flow minus normal expenses.
Before I would have just let the money stay in the property and be making $504.24 in cash flow instead of the $350. Of course I wasn't using a Heloc then I was saving cash. I figure without the refinance it would take me about 12.5 months to payback the Heloc. So now I can repay the Heloc in 2 months and repeat. When I first started my credit wasn't the best so I couldn't have really financed even if I wanted to. So I have been building my credit and learning about the BRRRR strategy. So I decided to give it a shot.
You can tell this adds to the velocity of your investing. Cutting down on seasoning requirements and time it takes to repeat a deal. I was a bit nervous about getting debt in the beginning but have found that if you are cash flow positive it's not that bad. Hope this helps and good luck with everyone and their investing!
@Chris Mason
Can you please explain the cash out mortgage?
@Kevin Rodriguez just curious -why beware of MLS listings?
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!!
I never once implied that the method you suggested does not work. I as well as many others I am sure are very happy that their are experienced individuals who post on here on a regular basis. All I was suggesting is that in many areas finding a 200k house that can generate a cap rate of 11% is going to very very hard if not impossible. I completely understand your argument I was just suggesting that for those that have specific target areas (i.e. not willing to invest all over the US) getting a monthly rent value high enough to reach the 11% may not be realistic. To reiterate what works in some areas does not work in across the country but never did I imply it does not work at all.
@Jim K.
Concur as a long distance landlord in Hawaii Florida and Missouri. We live in Texas and FL at the moment. And moving full time to San Antonio this year.
We have B/C homes that are extensively rehabbed.
At least 60k each and now they Cashflow amazing. And commercial Refi allows us to cash out capital and move on to new Cashflow Opportunities.
@Ed Moran MLS deals are often overpriced and most of the time get multiple offers because they are the easiest deals available to the public. Manny foreclosures sold as is with tons of problems, tight margins and getting priced close to market value; meanwhile new guys underestimate the rehab budgets and run into problems later on. The demand of new real estate investors has increased enormously at this point or at least on my market.
Ofcourse, you can find a unicorn once in a while in the MLS but they are hard to come by and really have to be distressed enough to the point no one looks at it the same way anymore. I'm not trying to discourage anyone from buying a deal in the MLS, you should definitely look at the MLS everyday; just be careful when analyzing the deals and creating a rehab budget.
Originally posted by @Kevin Rodriguez:
@Ed Moran MLS deals are often overpriced and most of the time get multiple offers because they are the easiest deals available to the public. Manny foreclosures sold as is with tons of problems, tight margins and getting priced close to market value; meanwhile new guys underestimate the rehab budgets and run into problems later on. The demand of new real estate investors has increased enormously at this point or at least on my market.
Ofcourse, you can find a unicorn once in a while in the MLS but they are hard to come by and really have to be distressed enough to the point no one looks at it the same way anymore. I'm not trying to discourage anyone from buying a deal in the MLS, you should definitely look at the MLS everyday; just be careful when analyzing the deals and creating a rehab budget.
This might be an obscure question that I am sure has been answered many times but if not the MLS then what is the best option for finding real estate fairly readily? I ask because I would love to avoid the MLS due to inventory and as you stated exposure but would not even begin to know how to find houses other than spending the time to find what look to be vacant properties and then making cold calls.
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.
Excellent comments and totally agree with you.
In saying this there is cheap housing that is not war zone, does not mean it does not have its own set of risk, however, it comes back to what you buy, where you buy and how it is managed. Get these right and you are on your way to success from my humble experience.
Chris Mason said:
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.
I'm a little confused. You're suggesting you do a cash-out refi before you do any repairs?
So, if you're using the brrrr method, you would do two cash out refis? The last one being after you've repaired/rented the home?
Is this common? I'm going to go crunch some numbers on some deals I've lost and see how this would have worked if I had paid cash with my heloc.
@Jared McCullough Well Jared you have to ask yourself, what is it that you are trying to accomplish. For me is always been about creating value so that means you have to acquire property that is in real bad shape because those are the deals that have the most potential and people often overlook. Whether that is driving around your neighborhood or doing direct mailing it is your duty to find out what works in your market. If you're not into spending time into looking for them you can leverage this by spreading the word, through social media or other means, about you buying real estate and offer people cash if they can find you potential leads. This can be friends, family members or people you just met; aka bird dogging. Having said that you have to do the most important part which is getting that potential lead under contract and closing. The main reason why this technique works so well is because you are dealing straight with the seller you don't have an agent or intermediary to go through making it a hassle.
Now, you could find deals that are fairly readily but those will be tougher to come by and the margins will be smaller because people see the demand and the overpricing of properties and they want to do the same. The main thing to focus on is people that are in need of help with their current situation. You need to find people that need to move quick and are motivated to sell.
Originally posted by @Marisa R.:
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.
Excellent comments and totally agree with you.
In saying this there is cheap housing that is not war zone, does not mean it does not have its own set of risk, however, it comes back to what you buy, where you buy and how it is managed. Get these right and you are on your way to success from my humble experience.
Obviously my comment sparked some frustration with other BP'ers (even sending me PMs.) I never meant to offend anyone, or suggest there is no money to be made in purchasing cheap homes. Many people have been successful with cheap and low income homes.
What I am saying cannot be argued against though. If you had two properties both with the same cap rate (Yes with work you can still get 10 cap in the US with higher end properties), the property that cost more will be less effected (by percentage) for the same repair, thus making a more stable return; simple math. The other line items I listed are just frosting on the cake.
This is subjective, I know and I am not saying there is zero possibility of a good outcome but the odds are stacked against you-- but something to think about:
Detroit is the textbook example of the worst real estate market in America. The city has a long history of racial, crime (murder/drugs etc.) and employment issues. Think about this: what kind of tenant who has no job is going to be able to maintain the property and pay rent on time?
Some investors like section 8 tenants (pays the rent) but you will at least have triple the maintenance costs. Tenants who don't have to pay rent from their own pocket also don't have the mentality to keep the property clean and safe - usually the opposite. They tend to have no problem using it as a trash can (at your expense).
Do your homework! Your research should reveal most of the issues. I know it looks like easy money, but it actually looks like money in the toilet.
@timjacob response was spot on. Here in the Chicago area I added a 3rd bedroom to a 2 bedroom apartment to get the premium Section 8 rent ($1,300/month). What I discovered to my dismay is that. in at least the Chicagoland area, people with 3 bedroom vouchers ONLY WANT HOUSES! With STAINLESS STEEL APPLIANCES! The program has made them picky as hell! They’ll wait months rather than “settle” for an apartment. This forces you to either take a 2 bedroom voucher or go to market rate tenants. I settled for a market rate tenant but for ($1000) $300 less than I anticipated but $300/mo more than the property demanded before the renovation (It was the lean winter time). If you’re in a D area you are virtually dependent on the Sec 8 program to make your investment work. Or you have to be lucky as hell to find a reliable long-term tenant. Good luck.
Cash is king
The cost of capital is very high for 2023