If you have cash, should you use it or is it better to use leverage if you can? So far, I've almost exclusively used cash to build our small portfolio. My goal for the year was to fully replace my current after tax income with an equal amount of income (after expenses) from our properties. Based on my calculations, I'm one deal away from reaching that goal, but I'm at a crossroads trying to decide which path to pursue next and would appreciate input... Option A: Use leverage and ~$70k as downpayment/closing costs to buy a multi-family four-plex for $225k, gross income: $2,750/mos, net income: $1,375/mos. OR Option B: Use cash and buy a 3/1 SFR for ~$50k, gross income: $1,440/mos, net income: $1,000/mos - this has been the model we've used to build our portfolio thus far and we have a proven niche approach for this scenario My husband is advocating that we diversify and buy a MF and also use leverage while I can since I have a very solid "9 to 5" right now and struggled to get financing when I was freetired and focused on growing the portfolio. I see his point but am hesitant to take on debt if I don't have too since the cashflow really isn't a whole lot more on the MF. Any thoughts?

The best part about real estate investing is the ability to leverage other people's money. You buy a house with someone else's money (the bank) and then you pay off the loan with someone else's money (the tenant) Best business plan in the world!

Aside from the fact that your net income numbers are inaccurate (far to high based on real projected real estate investment expences) it is very clear that you do not fully understand the value of cash. When you put cash in a property you are essentially sentencing it to death. By placing no value on cash you are losing a great deal of potential income that would have placed you in a position to match your income far sooner. Rental properties have two separate income generating streams. The property and the equity or cash invested. Cash is at the lowest valued to investors at 10% return. If you have 50K in a property the First $416 of the monthly income is generated from the cash and is deducted as a expense. At best your cash otherwise is only saving you the very small amount of interest you would be paying on a 50K loan. For this reason cash purchases are the slowest and most uneconomical approach to investing. When you can borrow at 5% tying up cash valued at 10% in a property makes very little financial scenes. You spread your cash as thin as possible to own as many properties as possible each generating a return from Other Peoples Money. Money must be forced to earn it's keep not left to die in a rental property. The true value of your money lies in it's ability to attract other peoples money to work on your behalf.

@Ericka Grant I am always an advocate of using leverage whenever it involves building a portfolio. However, these 2 deals are not "even" I'd rather buy 4 of the SFR for 50k a piece that rent for 1440/mo, than spend money on a 4 plex, that for some reason is only renting for 900/unit, but literally costs more per unit. The deals are not even. Have you considered a compromise? Maybe put more like 50% down on 2 different SFR properties that are 50-60k and renting for 1400/mo. You don't incur a ton of debt, you make more money overall, and I would bet, that your husband would probably like that as well. Although, I am a big fan of multi-family. According to the numbers you gave me, SFR is what is hot in your area. I hope this helped, Good Luck!

@Isiah Ferguson @Ericka Grant Isiah you are NOT cash flowing on your duplex! you are receiving your money back at $1020 a month for 99 months. (81/4 YEARS!) your money is loosing value in that time frame. in 81/4 years that $99,000 will not buy near as much as it will today, so now you will need to wait even longer to have enough buying power to equal what you have already invested. In addition you are spending money to keep it in there. every dime in expenses is YOUR money going back into the property! As a young investor your goal should be to make your money grow, not shrink it!! now lets say the market falls. your investment is now worth $75,000. now you gotta wait another 24 months to get your $99,000 back. total 101/4 years. after that long I would have been looking at a cash out REFI, and taking tax free loan pay down back out. My tenant would have been paying the loan and all the expenses because when I bought the property I allowed some room to drop the rent. yes in that event my cash flow will go down but that's NOT profit. you are still waiting for the first dollar of profit. While I have been getting 10 years of loan pay down. If you are leveraged then you only had $25,000 in there to start, so instead of loosing $24,000 dollars you lost about $6,000 and the bank lost the remaining $18,000, assuming you sell at the lower price. Which would you rather loose? 24k or 6k? once again the money in RE does NOT come from a paltery few hundred dollars a month cash flow, a late fee here and there or a few pennys saved by managing your own property. You guys need to look up some of Ben Lybovich's posts on here. >>>Now a word of caution<<< Too much leverage and the tenant's rent wont meet all expenses especially if rents fall or values drop , you have to sell, or long vacancy's. pay too much, leverage too much and you will loose it all. Cash flow to me is the same as the margin of safety. if its cash flowing $100 dollars a month I can breath a little easier and hope the rent market raises. below $100 and im getting nervous unless I can raise the rent. Remember the numbers you start with should improve with time. if 3 years pass and now the cash flow is $300 a month I feel really safe. ( it increases as rent goes up) when its $500 dollars a month im gonna look at refinancing, 1031 or something. and if my equity (bought and paid for by my tenant) and appreciation have risen then ill take some cash out and look for another property. OOPS guess what just happened. my tenant just bought me another property!! At ten years The guy who paid cash is still saving money for another property and waiting to get his investment dollars back, and by now he will have to buy a cheaper property if hes going to pay cash because his dollars are worth less. <<< THERE ARE MORE VARIABLES HERE THAN WHAT IVE MENTIONED ABOVE, AND THE DOLLAR AMOUNTS ARE MADE UP AS EXAMPLES ONLY!! YOU GOTTA MAKE YOUR OWN BUISNESS MODEL BASED ON YOUR GOALS, AND RISK TOLERANCE!!<<< Now about the Bank. I show all rents all expenses and all profits on my taxes. after 2 years (sometimes less) and with portfolio loans the banker is able to add a part of the rent income from the property I am trying to buy as income for the loan. as you grow your ability to get loans grows as well. I watch my over all leverage as much or more than my individual property leverage. I try to get portfolio or commercial loans with 7-10 year arms and a 25 year amortization. these loans are way less trouble to obtain than a conventional loan, but usually a higher rate. I keep cash reserves on hand enough so the bank knows I can stand a vacancy or a new roof or something the rest goes to investing. Cash flow ( my own returning money included.) Pay those loans down at the end of your investing career not the beginning! Okay so im in a different boat than you guys. Im 63. I want to retire someday. when that happens I want to live on my rental income. okay now Ill try to get some stuff paid off, or refinance to lower payments. why? I know full on its not prudent, and I am loosing opportunity. but at 70 or so Im not going to care if its my money coming back to me or not. in fact at that point its kind of my heirs money cos they will get it when I check out of this world. if I put the same amount of money in an IRA it will eventually run out (around age 92) and they get nothing if I live too long. with a cash based retirement if I live to 93 I go on welfare, eat beans and live in a culvert. If its a rental that's paid off I still can take cruises go to the beach and, drink beer cos the money keeps flowing in, and yes its the money I put in there!! When I pass my heirs can sell without CG or refinance and they are off and running free to invest prudently again! if its all in an IRA they get whatever is left. If it's in real estate they stand to get a more valuable asset than when it started, plus all the money I invested in it. That's my story and Im sticken to it!! RR

There are different mindsets: Mindset of the poor - poor people don't have a plan for their money. They spend money. Mindset of the middle class - the middle class manages their money, saves, and seeks security. Mindset of the wealthy - money is to be invested. The majority of wealthy people use other people's time and money to make them money. The doomsday prophesies about how you can lose everything if it leveraged is a chicken little story about the sky falling. Don't get over leveraged and keep a reserve. Invest for cash flow. Then it doesn't matter if the market goes up or down you can weather the storms.

opm opm opm I love other peoples money this way my money can always be there incase of the worst scenarios double or triple check your numbers just to see what the investment will cost and how it will perform under differing conditions there is not a one all in real estate there is also no guarantees in the market so do a lot of home work before diving in enjoy

@Isiah Ferguson "With leveraging, lower cash flow per door after expenses doesn't quite make sense to me yet" The reality is equity(cash) does not increase cash flow it decreases cash flow which is a concept few novice investors actually comprehend. When you view real estate investing as a long term plan you will understand it is basic math. When you put cash into a property you are only saving the amount the interest would be on a loan. At todays rates you would be maybe saving 5%. If instead of paying cash for a property you put the minimum down on multiple properties your over all cash flow and return on investment is increased by using other peoples money. Your tenants would be paying the loan costs, including principal, and you would gain what ever appreciation takes place on multiple properties instead of one single property plus the positive cash flow. If you look at leverage as a way to spread your cash (making it work both harder and smarter) it would be similar to compounding interest. Over time you compound your cash investment and end up with Multiple times what you would have made by simply purchasing one property at a time with cash. Instead of saving 5% on your interest payments you would be earning 10-15-20% on your cash through appreciation, cash flow and tenant paying off your property. Paying off your properties is also a slow process to wealth growth and not desirable. Your tenants money needs to be pulled out and reinvested when ever possible to again multiply your investment returns. Leaving it in the property is again only saving you 5% on a loan instead of earning you the 10-15-or 20% (or more) it could be earning.

@Ericka Grant Another thing that may interest you is getting a business line of credit and leveraging the equity in your properties to do so. I just put my properties in Indianapolis into a business line and they gave me 60% of the value of each property on the line. It was a lot easier than applying for 4 separate loans. This way you don't need to use the line if you don't want to and there won't be a mortgage payment, or you can use the line to buy more houses and only have one monthly payment according to the amount you are using.

"How have you navigated the "risk" side of being heavily leveraged?" Personally I would be much more fearful if it was my own money at stake. Although I have never had any concerns about the turn in economy resulting in disaster I sleep far better at night knowing my investment capitol is spread thin enough using OPM not to worry about a loss. The reality is that regardless of the economy people will always need a place to live and the worse it gets the more people will be looking to rent. For myself, having a extremely high level of risk tolerance, I tend to have trouble staying awake. Risk is simply a state mind. The mind simply needs to be controlled to do your bidding.

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Updated almost 8 years ago on 04/03/2017. Most recent reply

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Posts: 279
Votes

Ericka G.Poster

Investor
Atlanta, GA

Buying & Selling Real Estate

Use Leverage or Stick with Cash?

Ericka G.Poster

Investor
Atlanta, GA

Posted March 24, 2017 22:15

If you have cash, should you use it or is it better to use leverage if you can? So far, I've almost exclusively used cash to build our small portfolio. My goal for the year was to fully replace my current after tax income with an equal amount of income (after expenses) from our properties.

Based on my calculations, I'm one deal away from reaching that goal, but I'm at a crossroads trying to decide which path to pursue next and would appreciate input...

Option A: Use leverage and ~$70k as downpayment/closing costs to buy a multi-family four-plex for $225k, gross income: $2,750/mos, net income: $1,375/mos.

Option B: Use cash and buy a 3/1 SFR for ~$50k, gross income: $1,440/mos, net income: $1,000/mos - this has been the model we've used to build our portfolio thus far and we have a proven niche approach for this scenario

My husband is advocating that we diversify and buy a MF and also use leverage while I can since I have a very solid "9 to 5" right now and struggled to get financing when I was freetired and focused on growing the portfolio. I see his point but am hesitant to take on debt if I don't have too since the cashflow really isn't a whole lot more on the MF.

Any thoughts?

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