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Updated over 8 years ago, 05/06/2016
Should I pay $100k cash for a rental property
My parents are willing to sell me a property below market cost to help me jump start my rental portfolio. While I could write them a $100k check for the full purchase of the house, my concern is that will minimize the amount of other properties I could acquire with the cash in the bank for further leverage.
On the flip side, not paying cash is going to require outlay of several expenses that will probably cost me $5,000 or more I otherwise wouldn't have to pay if I paid cash.
How do y'all go about making this decision? Is it an obvious answer to those out there with more experience?
Finance...use leverage!
You can buy it for cash and get the cash out later, cash-out refi or a HELOC.
So your suggestion is to not pay my own cash?
I'm new myself. But if I had the option for 100k cash payment. I would go against that and try and get a mortgage and put 20% down instead. You got to think of ways to get more rentals with the least amount of capital. Yes, there will be a far greater risk, but in order to get ahead in life you need to leverage yourself for the future.
So just scenario wise, you could purchase this out outright for 100k and not have to worry about a mortgage.
Or you could use that 100k as a down payment on 5 rentals valued at 100k each.
So with your original 100k, be able to finance it so that your now paying off the 5 houses principle, as well as profiting a small bit along the way. Its just a compounding rate of return versus having 1 home. just my 2 cents, Good Luck!
I agree with the gentlemen in this post, leverage is the way to go. I would also like to add the suggestion of perhaps initially procuring (3) rentals instead of (5), and using your remaining capital for flips to strengthen your cash position. A lot of investors use the "flip-flip-buy and hold" strategy to steadily grow their portfolio. It's quite effective. Good luck man.
You could also buy it with cash. Then, establish a line of credit at a small bank for roughly 70-80% of the appraised value using this property as collateral. Use the credit to do the BRRRR method. One good reason to do this is to receive a high cash flow for this property while you are searching for your next deal (which can sometimes take a little while in this market). Save cash to use for more investments along with your line of credit.
Just another option:)
Steve S. Here is the answer you need to know. If you study finance, you will see you can substantially boost your turns by borrowing at a cheaper WACC (weighted cost of capital). The issue becomes, "are you earning more form the rental income and property capital appreciation than what it is costing you." Also, keep in mind leverage is risky in the sense that loans take priority over you. If a lender like us lends to you at 70%, property values can go down 30%. We are fairly break even, provided you pay. You have lost 100% of your equity though. As you can see, it increases risk. So, should you get leverage? The answer is, are you comfortable with the risk and the reward of doing so? And are you earning more money than you otherwise would? Eventually, you may want to do cash flow models and projections.
I am anti- mortgage. So I always go with cash, when possible. There are pros and cons both ways. You have to decide if you are comfortable on the debt wheel or not. Im not, so my potential for growth may be lower than someone who is. Leverage does increase your buying power but it comes with added risk.
Like it was said earlier, it's a personal choice about what your risk tolerance is. I personally am risk averse and want to take the mortgage. That may seem counter intuitive, so let me explain.
If I put the whole 100k into the property to purchase then I have no leverage left to get a loan if I need one. Additionally, I also now have no reserves to cover something, with the property or personally, should something come up. And I can't get a loan because I look bad on paper.
That's not too say that the mortgage is not with out risk. You can have a great deal, a home run, and Mrs it up because of your financing. Or lack there of. Bigger pockets has tons of great advice on how to analyze rentals. Use it. I do. But know that the property is only a third of the deal. Every deal is actually composed of three things.
The asset, the capital used to but the asset. And the capital structure. Just because you can get a mortgage on the property, didn't mean that is the right mortgage for you or the property.
There are a few key metrics outside of selecting a property that you should take into account. The first and most important is your reserves. Your need to have something that works for you. Next is the debt coverage ratio. DCR=NOI/Annual debt servicing. This number needs to be no less than 1.15. And the higher the better. Next you want to calculate the break even ratio. I forget the exact equation right now, but this needs to be no higher than 0.85 and the lower the better. The last thing is to calculate the loan constant for a given offering. Take the call rate and subtract the loan constant. If the number is negative don't do the deal. Look for new financing.
This is what I do when I've found property to buy. You should do what works for you, but don't just do something because of something you read. Look into it and check the numbers and make sure it works.
I'm happy to talk more if you have other questions. Good luck!
#4 All Forums Contributor
- Plymouth, MI
So let me see if I understand the bottom line of what you're asking here.
You want to know if you should:
A - Pay $100k on this property and have one property or,...
B - pay $1500 for expenses on this property and use your $100k to buy more (DP's)?
Originally posted by @Joe Villeneuve:
So let me see if I understand the bottom line of what you're asking here.
You want to know if you should:
A - Pay $100k on this property and have one property or,...
B - pay $1500 for expenses on this property and use your $100k to buy more (DP's)?
Yes
If you are unsure, you could buy the property for cash and rent it out to "get your feet wet". Once you get the feel for how it will perform financially as a rental and if being a landlord and REIer is a good fit for you, you could then do a cash out refinance to leverage up and redeploy the capital in other properties. Also, that way you could be more comfortable that the property would cash flow under the financing you choose, since you'd have a track record to go on. If on the other hand you need more time to work out the kinks with renting it, or you find you don't like being a landlord, you could either keep it without a mortgage or sell it a profit (if you bought below market; and you clear it with your parents who presumably sold to you below market to hold and not to flip).
With the little info we have and relying on the "bellow market cost" I would finance (instant equity) the property (use leverage) and with your $100K use it as downpayment for another 2-3 properties that need some work. Buy way bellow ARV so you can refinance when remodeled and tenants in place - try to do the numbers so you get your equity back (or some of it) so you boost your cash-on-cash and keep replicating it. Use Brrr (it's my favorite).
#4 All Forums Contributor
- Plymouth, MI
Originally posted by @Steve S.:
Originally posted by @Joe Villeneuve:
So let me see if I understand the bottom line of what you're asking here.
You want to know if you should:
A - Pay $100k on this property and have one property or,...
B - pay $1500 for expenses on this property and use your $100k to buy more (DP's)?
Yes
My question wasn't looking for an answer. My question was hoping to show your choices, and I would hope, it would also make obvious the correct answer. Please read the two options (A or B), and I would hope the answer to the question of "which one is best" would be fairly obvious.
I'm not a big fan of having cash tied up in dead equity. Money which isn't working for you making more money is essentially wasted, IMO.
Will your parents "seller finance" and carry a note on the property? What's THEIR need: cash or income?
David J Dachtera
"Success is not a destination. Failure is not an event. Success is a process, failure is a choice."
- DJ Benedict
Buy the house with cash and then get a home equity line of credit against it while you are still living in it. You don't have to use the line of credit but it might be nice to have it around especially if you are able to get a good rate. There is usually little or no fees associated with establishing a HELOC so you are not out 5 grand.
#4 All Forums Contributor
- Plymouth, MI
Originally posted by @David Dachtera:
I'm not a big fan of having cash tied up in dead equity. Money which isn't working for you making more money is essentially wasted, IMO.
Will your parents "seller finance" and carry a note on the property? What's THEIR need: cash or income?
David J Dachtera
"Success is not a destination. Failure is not an event. Success is a process, failure is a choice."
- DJ Benedict
I agree, but there is an explanation that goes with this.
The first 20-35% (depending on the refi lender) of your equity will always be there if you buy all cash, and refinance since every lender will only give you some sort of % of ARV on their loans. So for those assuming that there is NO equity in this system, you are missing that important part.
The rest of the equity (65-80%..see above) is the "dead equity". I refer to it as my money (cash), sitting on my recliner, with my beer in one hand and my remote in the other, watching the game on my TV, while I'm out working for more money to buy the next property.
Sorry, but that's backwards. I'm the one that should be sitting and watching in my house. My cash, should be going in the front door, and out the back, taking with it added cash in the form of either cash flow, profit, or cash out from refi, and moving through the next house, and out the back of that one, the same way, over and over and...
Originally posted by @Joe Villeneuve:
Originally posted by @Steve S.:
Originally posted by @Joe Villeneuve:
So let me see if I understand the bottom line of what you're asking here.
You want to know if you should:
A - Pay $100k on this property and have one property or,...
B - pay $1500 for expenses on this property and use your $100k to buy more (DP's)?
Yes
My question wasn't looking for an answer. My question was hoping to show your choices, and I would hope, it would also make obvious the correct answer. Please read the two options (A or B), and I would hope the answer to the question of "which one is best" would be fairly obvious.
Clearly you re saying option B is preferred so one could acquire multiple properties