500k better to buy one STR cash or multiple with financing?

[Chris Elkendier]

Hello! My friends/investors and I are looking to invest into some STR properties out of state. (Currently I live in Wisconsin) I own my own home and a condo that I rent out yearly in Milwaukee but want to expand into some better markets with some STR properties. My question is, if one had 500k cash would you recommend purchasing one property cash or multiple properties financed? Why and why not?

I like the idea of owning one outright for risk purposes but am open to opinions (hence the post)

Thinking Palm Springs area. If there are other extremely healthy STR markets please fill me in as I am not paying $500 a month for Airdna services ...

[Kody Crouch]

Leverage is a tool.  You should use it to the extent that it helps you achieve your goals, but never to the extent that it puts your goals at risk. Ask yourself specific questions to find the right answer.

* What equity and cash flows do you expect to gain if you pay cash?
* How much would your cash flow and equity gains/losses be affected if you bought two houses financed at 50% LTV?
* What about 5 houses financed at 80% LTV?
* How else can you mitigate risk? Should you leverage 2-3 houses and maintain a large cash position?


Imagine some scenarios and compare the different ways to buy.  I'll go through some here, where all the homes are 250k, they rent for 2500 with pro forma monthly costs of $1350 with no mortgage, and $2370 with a 200k mortgage and $1960 with a 125k mortgage.

ways to buy
1) cash - Pay 250k cash for a single home.
2) high leverage -Pay 50k and borrow 200k each for five homes.
3) slight leverage - Pay 125k and borrow 125k for two homes.
4) hedge your high leverage purchase with a cash position - Pay 50k and borrow 200k for 3 homes. Keep 100k in reserve.


Initial scenario

1) cash buyer has 250k equity, $1150 monthly cash flow, and no debt.
2) The highly leveraged buyer has 250k equity,  $650 per month cash flow, and 1m debt.
3) The slightly leveraged buyer has 250k equity,  $1080 monthly cash flow, and 250k debt.
4) The cash position buyer has 150k equity, $390 monthly cash flow, 600k debt, and 100k cash.

Notice that for the slightly leveraged buyer there is not a tremendous cash flow difference from the cash buyer.

In a good market, let's say after 5 years, home value has gone up 20% and rent has gone up 10%.  

1) The cash buyer has 300k equity, $1400 monthly cash flow, and no debt.
2) The highly leveraged buyer has 590k equity,  $1650 monthly cash flow, and 910k debt.
3) The slightly leveraged buyer has 375k equity, $1580 monthly cash flow, and 225k debt.
4) The cash position buyer has 360k equity, $990 monthly cash flow, and $540k debt, and 100k cash.

The leveraged buyers (including the cash position) are all far wealthier, even after only 5 years, and two of them already surpassed the cash buyer's cash flow. If the cash buyer were to refinance and pay off 90k of his debt, he would also have higher cash flow than the cash buyer.

But how about In a major crash? Let's say after 5 years home value has gone down 40% rents drop by 10%.  With home values depressed, the guy who kept a cash position can purchase 3 homes that will cash flow $320 per month each.
 
1) cash buyer - 150k equity, $900 monthly cash flow, and no debt.
2) high leverage -  no equity (underwater 160k), Losing $600 per month. 910k debt.
3) slight leverage - 110k equity, $580 cash flow per month, 225k debt.
4) cash position - has no equity (but not underwater),  $600 cash flow, 900k debt, and 10k cash.

In this down scenario, the cash buyer is temporarily the best, but both the slight leverage and cash position scenarios are in great shape.  As the market turns back up the cash buyer will be envious of their positions.

So look at the high leverage strategy, and ask yourself - how would I survive this scenario? If you can not give a sensible answer then that's too much leverage for you.  Consider a less leveraged position or keeping a cash reserve as a contingency.