Pay cash for total price or take loan?

Question

Hi there

Although I have been a landlord for three years, just recently I have given serious thought to get into real estate investment. I have a realtor who is an investor and seems to be very good at it. It seems there are two school of thoughts in investing for rental property

1- Pay cash or get loan as little as possible so investor has a good cash flow every month

2- Get loan as large as you can. Cash flow won't be large but keep the property and let tenant pays the mortgage. Then after sometime (10 years ???), sell it assuming property appreciates.

I do not have a huge lump sump so really if want to pay cash, most likely I can afford one house (normal size/price). However, if I go with option 2 I can have multiple properties but there won't be any cash flow.  My realtor advocates the #1.

I would like to have your comments on this subject and what would you consider a good investment for a beginner in Houston?

thanks a bunch!

Guy Yoes · Answer

Four years later-

Having my two properties paid off at the time of of my previous post I was able to 1031 each property for a duplex (thanks

@Dave Foster) with no cash out of pocket. I then used equity out of  the two duplexes to buy two more duplexes. I turned two doors into 8 doors in about 16  months. At the end of last year, I sold 1 of the four duplexes (paid 100K for it and sold it for 153K)  and did another another 1031 into two more duplexes (all on the same street). I bought my 6th duplex last week.

It has been three years to the month since I bought my first two duplexes. It was because of the equity in the two SFRs I bought and paid off that I was able to now own 6 duplexes with a market value of 975,000 with no out of pocket expenses. I currently have a contract on my 7th property.

I had no loss of rental income during covid and rent has increased 15% in the last two years.

Guy Yoes · Answer

I think it depends on where you are at in life. I'm 56 and just retired so my plan was different than most. 12 years ago I remarried (no debt) and we bought a house for 200K with 30K down. We paid the house off in 5 years. We saved up for 2 years and bought an SFR for 93K cash. We added the $900.00 rent to our house payment (we kept paying the mortgage costs to ourselves to buy the rental). In a little over a year, we had enough to buy a second house and pay cash (much cheaper than financing). Together they cash flowed $1200.00 a month after all costs. We spent some time learning the RE game and traveled some.  We bought our third property this past summer and again paid cash.

Being debt free may not be the best way to invest in RE, but I sure sleep well at night. We learned the RE game overtime with little risk and grew at a pace we were comfortable with moving. We made mistakes, but with a few properties, they were easier to fix.

All three properties are cash flowing VERY well and have appreciated between 20-30 percent.

My wife will retire in 2 years and we will cash out and move to notes only. We will relocate to a nice lake near the grandkids. Not sure what the wife will do, but I'll be fishing.

Guy Yoes · Answer

@Thomas S.

The fees for buying a house with cash is definitely cheaper than financing. How is paying higher closing fees to finance than sit a few years for it to appreciate and then refinancing (more fees) to access the equity of the property be the best route? Being highly leveraged in RE with low cash reserves or easy access to equity caused problems for a lot of people several years ago.  I'm sure some people built an RE empire with only 30K seed money. I started REI when I was 50 and didn't have the time to risk failing and starting over.

However, after following some of your posts to my comments, I looked at what I could do with that "dead" equity.

I ran the numbers for buying additional rentals or other investments with that equity. I am looking at using it to house hack a quad or buy first position notes. This would be a step up in my REI's. I would not be able to do this without the current equity in my properties.

Sometimes we don't know what we don't know. Thank you for the comments (even though they were a bit abrasive). You got my entrepreneurial juices flowing again.

Thomas S. · Answer

@Guy Yoes

"All three properties are cash flowing VERY well"

Doubtful your "properties" generate any true positive cash flow and most likely the only thing generating any returns is your own cash. You could probably earn higher returns immediately if you sold now rather than waiting 2 years. Either way 2 more years is not too long to sit on dead equity.

Funny when you mention that paying cash is cheaper than financing...the opposite is actually true when you understand the value of cash and the waste of having dead equity. Sleeping pills would be less expensive if your primary concern is being able to sleep at night.

Each investor to their own.

Dave Passey · Answer

Bigger Pockets has a lot of advocates for leveraging out as far as you can to be able to obtain as many properties as possible. I am a little bit more conservative than most, I think. I want to be leveraged to get as many as possible, but I also want to be able to have some decent cashflow. There is a balance somewhere between your option #1 and option #2 where you will feel the most comfortable. No one can decide that comfort level for you. I don't know too many actual investors that will pay full cash for a property without the intention of getting a loan after the property has had time to season with the renter in place. That basically just ties up all of your money and does not maximize your potential earnings. Kind of an all your eggs in one basket type thing as well.

The fortunate (or unfortunate) thing is that there are currently a lot of properties for sale right now in the Houston area. Depending on if you are willing to put work into a property, there is the opportunity to purchase properties well below market value that would an excellent amount of equity if you were to rent or sell.

Guy Yoes · Answer

@Joshua Janus

Thank you for the kind words !  It has taken a team. It also takes time and work to find the right people who are generous with their time and knowledge. I'm a big fan of @Dave Foster. His knowledge of the 1031 process is beyond compare. I went through several banks before finding the right banker who was willing to work with a small investor like myself. My title company has been with me through several delayed closings. They have done all the closings on our duplexes.

I have only been investing in real-estate for about 5 years and it has been a journey of faith. When I needed a realtor, accountant or insurance agent a door was opened. It's not what happens in life that matters, it how you decide to handle it that matters.

Alexander Felice · Answer

Those are the 2 methods of investing, but one is absolutely worse than the other.

if you care about lowering risk, maximizing returns, creating stability, and growing the biggest - use debt

if you want a higher risk, smaller returns, relying on small cash flow for stability, and growing the slowest - use cash

truth is people who pay cash (and keep it paid with cash) usually just don't understand the economics well enough, or are using emotion to make financial decisions. Almost no good reason to own paid off houses

Joshua Janus · Answer

@Guy Yoes That is really impressive! You used your leverage and ability to spot a deal very well and continued to grow while mitigating your risk along the way without losing any additional rental income.

Jeff Richardson · Answer

We buy all of our properties with Hard Money and refinance immediately after the rehab in order to limit our cash in the deal, our Cash On Cash returns are always above 20% and our equity Capture is always at least 50% of our cash outlay in Houston. Once you pay down/off a mortgage your tax liabilities go up drastically, because you no longer have the mortgage interest to cover the portion of the income that your depreciation doesn't cover. You also are limited with only 1/5th of the appreciation that you would receive if you used leverage and purchased a minimum of 5 properties with the cash you have in 1. Many people also don't realize if they have a paid off house vacant, it is just as bad as a leveraged house, for multiple reasons: if it rents for $1,300/month, you have essentially lost $1,300 if it isn't leased, you will also always have to pay property taxes and insurance and for the described property that would probably be ~$350/month. Remember, all you ever save is the interest that you pay of the mortgage, because you'd have to pay taxes and insurance already, and the principal goes back into your networth as equity. On a $130,000 house leveraged at 75% LTV at 5% interest, that is only $406/month, historically real estate appreciates at 5% a year, since appreciation is based on the total value of the property, not just the leveraged amount it more than makes up for the interest payments.

Thomas S. · Answer

Your realtor is not a investor, at least not a smart one. You can do as suggested above but the key is ultimately refinance to leverage as many properties as possible.

The reasoning being that cash/equity has a earning/opportunity value in the range of 10%. This means that all equity in a property is either losing money or killing your cash flow. This turns the investment property itself into a liability since it is primarily only your own cash injection that is generating positive returns. There are far more passive ways to generate similar or better returns without the issues related to owning real estate.

If you consider at a 10% opportunity value every 100K in equity is worth $866/month and you deduct that off the top of your rental income you can see how equity decreases cash flow rather than increasing it on a property. After all other expences the likley hood will be that th eproperty itself is negative cash flow if there is much dead equity.

To be a cash investor you must accept that money has little to no value and live with minimum ROI.

Pay cash for total price or take loan?

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