COC hit when purchasing with cash

[Kevin Nichols]

We've recently started investing in rental property. We're closing on a duplex this month.

My question is about purchasing rental property with cash. There is an opportunity to purchase another property for about $30K and I feel a cash offer would do better.

But when I run the numbers, the COC is about 10%...about $280/month cash flow after taxes, insurance, and a small maintenance budget.

House: $30,000 cash
Rent: $500/month
Taxes: $1300/year
Insurance: $490/year

Long term, I'm tying up $30K and won't get back to even until 9 years into the rental...and the property appreciation is minimal...properties in this area never appreciate a lot...maybe in this case $5K to $10K in the 9 year period...I would estimate.

So...explain why paying cash is better?

Kevin

[David Roberts]

It seems that a lot of investors that do all cash in on a property they couldn't get with a bank initially, will buy it cheap, fix it up, then end up refinancing their cash back out.

So if your property is cheap at 30k, and you add 10k to fix it, now it's worth say 50k (no idea what the values are in your area but 500 / month for a 50k home seems low no matter where you are lol)...you refinance it at 75% of actual repair value, which is 37.5k back out.  You are 40 in at first, and now you're only 2.5k in after the refi. 

By your numbers you are cash flowing 351 a month, or 14% before the refi.  After the refi you are cash flowing at 155.21/month, with your risk (cash still in) at 2.5k. 155.21x12/2.5k = 74.5% cash return, and you have almost all your initial investment back in your hands.  

[Jean Bolger]

well it's not better, for exactly the reasons you outlined.  You could always buy with cash if you think that will be accepted more easily and then mortgage the place at a later date. Of course, getting a mortgage that small might be a problem as well (that could be another reason for doing cash, I suppose...) And it's going to be hard to get much cash flow out of that place with financing on it.  So maybe it's just not the best deal to pursue?

[Joe Villeneuve]

Why don't you just refinance to get the cash out?

Joe Villeneuve
REcapSystem
A2REIC

[Elizabeth Colegrove]

Personally I don't pay cash. I put as LITTLE down as possible. Personally I want my tenants to pay off as much of loan as possible. The less downpayment I put, the happier I am! 

[Robert Leonard]

@Kevin Nichols 

The idea that paying cash is better is a generalization that is accurate in some markets/cases and not others.  In my market, it's better to buy with cash when competing with other buyers.   And it is indeed competitive!  The financed buyer can have a deal derailed by a lender/appraisal/inspection/credit problem, rule change in a borrowers program, etc, etc ...

@Jean Bolger  made a good point too about the price point and the ability to refinance.  That's an important factor.  Hopefully you can use your own analysis and this feedback to refine your strategy for what properties you want to target and what's the best way to finance them!

You always have to do the math to know if the deal makes sense.

[Kevin Nichols]

Thanks all for feedback. Our first duplex is getting 38% COC and when I ran the numbers with paying cash on this 2nd property, it's just not as good.

Plus, the property is in the middle of a botched rehab and the owners are absentee (Canadians with this property being in SC).  I was hoping to lowball the offer, but I don't think a mortgage could be obtained on the property. That's why I was thinking about a cash bid. 

If I could talk to the sellers, I think I could sell them on the offer. Would it be OK to share a letter in our offer outlining why we offer what we did?

Kevin

[David Roberts]

It seems that a lot of investors that do all cash in on a property they couldn't get with a bank initially, will buy it cheap, fix it up, then end up refinancing their cash back out.

So if your property is cheap at 30k, and you add 10k to fix it, now it's worth say 50k (no idea what the values are in your area but 500 / month for a 50k home seems low no matter where you are lol)...you refinance it at 75% of actual repair value, which is 37.5k back out.  You are 40 in at first, and now you're only 2.5k in after the refi. 

By your numbers you are cash flowing 351 a month, or 14% before the refi.  After the refi you are cash flowing at 155.21/month, with your risk (cash still in) at 2.5k. 155.21x12/2.5k = 74.5% cash return, and you have almost all your initial investment back in your hands.  

[Ali Boone]

I've never figured out why paying cash is ever better. Lower returns, higher risk... But it's a famous debate. Most people are either pro-cash or pro-leverage. It's all individual to the person. But if you decide you are pro-leverage, you definitely won't be in that group by yourself. 

[Joe Villeneuve]

@Ali Boone I'm with your group. There's more risk to the investor when they have cash (their money) in the property than when they have all debt (the Lender's money).  Why else would the lenders want the investor to have "skin in the game"?

Joe V

[Ali Boone]

I totally agree @Joe Villeneuve. I've never understood why people think using leveraging is more risky than putting all your own cash up. Worst case you foreclose and have a ding on your credit. I'd prefer that over losing all that money.

[Sylvia B.]

Originally posted by @Ali Boone:

I totally agree @Joe Villeneuve. I've never understood why people think using leveraging is more risky than putting all your own cash up. Worst case you foreclose and have a ding on your credit. I'd prefer that over losing all that money.

 If you don't have a mortgage to get foreclosed on, exactly how are you going to "lose all that money"?

[David Roberts]

if you lost a house with a paid off 100k mortgage from a lawsuit,  you just lost 100k.

Versus, 20% down,  you only lost 20 %,  or 20k.

[Sylvia B.]

That's what insurance is for.

[David Roberts]

I don't trust insurance companies. 

[Joe Villeneuve]

Originally posted by @Sylvia B.:

That's what insurance is for.

 ...and lawyers, and court costs, and my time better spent, and the rest of the expenses that you'll never get back.

Joe V

[Ali Boone]

@Sylvia B.

Sorry, good clarification. If no mortgage, worst case would be you can't get tenants in the house, it gets destroyed in a way insurance won't cover it (meth labs), you can't make the tax payments or whatever the case may be. So if you end up with an empty house, or a destroyed house, or you lose the house for taxes... all the money you used to buy the house is gone. 

[Sylvia B.]

@Ali Boone 

I'm sorry, but that just sounds so unlikely it's laughable. Compared to the number of houses lost to foreclosure, those other scenarios are practically nonexistent. I don't think it's wise to take on a greater risk in an attempt to mitigate a lesser one.

[Ali Boone]

@Sylvia B.

Any investor who has $100k to buy a house outright with cash, is unlikely going to foreclose on the property if they go the mortgage route instead of buying with cash. Plus most foreclosures are from primary homeowners, not investors. Investors can foreclose too, for sure, but it's a lot likely and only if they weren't being smart when they bought. 

So to argue or debate on even ground here, we'd have to have to specify a target situation. Compare apples to apples, not apples to tomatoes.

The original question posted was..."why is buying with cash better?" Sounds like you would be a great one to explain that. You haven't done that yet.

[Ali Boone]

a lot *less likely. Type there...

[Joe Villeneuve]

@Ali Boone and @Sylvia B. 

The real benefit to buying with cash isn't to keep the cash in the equity.  I'm sorry, but equity is where your money goes to die.  If you buy a property for $100k cash, and want to do it again, how long will it take to acquire your next $100k in cash?  How long did it take to acquire the first $100k?

Here's the real question.  If you paid that same $100k for that first house, and then refinanced in 6 months to get it all back out, how long would it take to have the cash for that 2nd house? Answer:  6 months...and, when you refi that 2nd house, and get that cash out again, it would only take 6 more months to get the cash for that 3rd house.

So, in 1 year, that's 3 houses (cash flowing of course), using the same money on all three, never actually spending it since after the 3rd house refi you get it back (in the form of a loan now).  Even better, you don't have to stop.

I work with a lender that will give me, or my partners, up to 10 mortgages.  Let's just say that my partner can only get 6 due to existing ones.  If I can do 6 houses in 2 years (3/yr), and never spending the money, how fast could someone get 6 houses needed all new cash per house?

How much would my 6 houses cost me?  Answer:  $0
How much would 6 houses cost with new money for each?  Answer:  $600k

So I make a little less each month in cash flow.  At least I'm ahead, and not $90k+ behind on every house.

Joe V

[Ali Boone]

Couldn't agree more @Joe Villeneuve 

[Sylvia B.]

Originally posted by @Ali Boone:

@Sylvia B.

The original question posted was..."why is buying with cash better?" Sounds like you would be a great one to explain that. You haven't done that yet.

"Better" is subjective and depends completely on the situation and outlook of the individual. Which is better, chocolate, vanilla or strawberry? Which is better, a pickup, van or sports car? 

My situation and outlook is quite obviously different from the OP, so I didn't think it would be helpful to offer my opinion. But since you asked...

Buying with cash is better because

• I can close very quickly, usually in 2 weeks, occasionally as quickly as 7 days.
• Fast closings are attractive to sellers, often making them more willing to accept lower offers.
• What I buy is actually mine, not mine and the bank's.
• Owning a property outright gives me freedom of choice. I can insure the property fully, not at all, or somewhere in between. I can take title to it and change it as I please without worrying about triggering a due on sale clause. I can pass it to my heirs or give it away if I choose, without concern about what my co-owner (the bank) might have to say about it. Inspections and appraisals are done at my discretion, not the bank's.
• It is cheaper. Yes I've heard some of you spin tales about how you don't pay the mortgage, your tenant does, but it just isn't true. Every dollar of the rent that goes to pay the mortgage is one that could have gone in your pocket. If the mortgage fairy came along and waved her wand over your property, causing it to suddenly be paid off, would you reduce your tenant's rent by the amount of the payment you no longer have to make? No? Then be honest. Who is really paying that mortgage?
• It is less stressful. No tenant for a month or three? Not the ideal situation, but with very little money going out on that house each month there is much less pressure. No "Oh dear! How will we come up with the money to make our payment if we don't get a tenant right now?"

I have very good credit and could easily get loans on all of my houses if I wanted to. I could go on a spending spree and rack up $100k with just the credit cards I currently have. I could use the $150k line of credit that I have with my bank and make nothing but interest payments as long as I want to. I simply choose not to.

I've been in debt and out, and from where I sit, debt-free is better.

[Dawn Brenengen]

and the debate continues...

[Sylvia B.]

... and it always will, because each person's perspective is different.