Purchasing an investment outright ~ Am I crazy???

Question

As I'm only new to these forums and have read a good deal of the advice given here am curious to know anyones' opinion on the following idea. There are many variables to the equation and I am aware of this but its more about the underlying idea of eventually gaining an income.

The Plan. Am in a position to purchase at least two properties of reasonable value outright, ie. Built within last few yrs, good condition, good neighbourhoods, reasonable rent (assuming occupied).
Would like to purchase the two properties A & B outright. Then borrow to purchase property C. Using the net leftover from A & B & C (rent - 50% for costs etc) to reduce the finance owing on property C and pay it off as quickly as possible then replicate it again with another & another thereby building a portfolio and gaining an income over time plus building asset wealth with capital growth regardless of how much it may be.

So far everyone has told me I'm crazy as I should be borrowing as much as possible for taxation purposes & to limit liability should the unfortunate happen.

The concern I have for holding then selling with the properties highly financed are: 1. Probably won't get the finance as I'm a non national and hence credit rating will take some time to acquire.
2. When I sell, I'm banking on capital growth that may/may not occur then paying tax on the profit.
3. I'm buying and selling in the same market, ie making say $50k profit only to have to buy the same type of property for $50k more than I paid originally.

I figure, with property A & B, at the very least I can cover all insurance, taxes etc with only one being rented.
I realise there are unknowns with major repairs, tenants trashing the place etc.

Is this idea completely nuts? Is there insurance available to cover the cost of malicious/wilful damage and/or tenants leaving without paying rent (after using up all the bond money).

Any advice would be greatly appreciated.

:mrgreen:

Jon Holdman · Answer

"Everyone" is stupid.  Yes, you get to deduct the interest paid on your taxes.  So you spend $100 in interest and get $28 (or whatever) back in taxes.  Still sounds like a $72 loss to me.

This has some merit.  If there's no value there, there's nothing to get in a lawsuit.  OTOH, this is only one piece of an asset protection strategy.  If you have a big pile of cash in the bank, a lawsuit can target that, too, without a carefully crafted asset protection strategy.

That said, do the math.  I think you'll find that owning real estate free and clear doesn't produce the same returns as having some debt.

Doing cash out refinances will probably take at least a year of ownership.  You'll also need good credit and good income.  You may or may not be able to include the rent as part of your income.

Landlord insurance will cover the rent if something makes the property un-rentable.  E.g. fire, water damage.  It doesn't cover tenant damage, nor does it pay rent when the property is vacant.  Those are just part of your costs.

Mitch Kronowit · Answer

The reason for borrowing is leverage, not to save money on taxes.

Edwin Brown · Answer

Paying cash for houses is a safer slower way to grow your business. Financing is a riskier faster way to grow. Know your comfort level of risk and growth and go with it. Hard to lose money on paid for properties.

Vikram C. · Answer

J M, your post has mentioned several things and you have received good answers from the others.  I am going to touch upon the non-national part in this post as it has not been covered in the previous responses.

As a non-national, you need to be concerned about FIRPTA because it will affect you at the time fo selling any of your properties, should the need arise.  Getting around FIRPTA is possible but it requires a little bit of planning on your part and more entities to create than you may think!  And you may still end up being stuck with USRPHC.  (I am sorry about these long acronyms - but that's what these laws are conventionally called and it makes it easier for you to do your google research.)

Regarding loans to foreign nationals, these are available but the best way to do it would be to have your entities set up, acquire the initial properties for cash as you plan, and then demonstrate the credit-worthiness of the entity through its history of income.  This may take some time but it will also give you a great opportunity to create a good relationship with your bank and that will help you in the future.

J M · Answer

Thanks everybody for their views and advice on this one.

I will definitely seek professional advice on the most productive/protective way to facilitate the building of a portfolio.

I note that some people here & at home mention the net asset value which I don't disagree is faster using debt. However, what concerns me with this method of borrowing heavily is that market forces dictate the house price not a bank valuation. It's only worth what someone is prepared to pay for it. Then whatever I take from the sale price less initial purchase costs, residual loan, selling costs, tax to be paid often winds up being a great deal less than the paper value profit I just made on the house.

Mike McKinzie · Answer

Free and Clear property is never a bad idea.  Yes, there is no leverage and no interest deduction, but there is also no mortgage payment to make when there is a vacancy.  It is a slower way to build "net asset value" but a faster way to build "cash flow."  If I had to chose between $100,000 in equity or $100,000 in cash flow, give me the cash flow all day long.  Even though there are worse tax consequences for cash flow, it is cash flow that "buys baby a new pair of shoes," as the old saying goes. :roll:

Kevin C. · Answer

Real Estate is illiquid, especially when one needs out due to financial distress.   Free and Clear property would not be quite as illiquid since at some price, any property becomes a no-brainer.   
                              
                              If you hold free and clear property you could always cash out relatively quick at some price - won't be the price you want, but you could cash out in a hurry if you had to.
                              
                              Free and clear properties would appear to be the most risk free path to wealth building and steady income from Real Estate - providing you have adequate liquid reserves to carry you through any rough times.
                              
                              With free and clear properties you can adjust rents down in a tough market and still cash flow, while those that are highly leveraged cannot.
                              
                              Risk is a factor that needs to be accounted for, and leverage, anyway you cut it, equals higher risk.
                              
                              In Real Estate, slow and steady really can win the race.

Mark N.A · Answer

Another factor to consider might be the direction you think our economy is headed in.

Both inflation and deflation punish those using leverage in different ways, and in both direct and indirect ways.

However, if you own a hard asset free and clear the 'purchasing power' should remain about the same.

One trick with real estate is to understand how very illliquid it is and to ensure that you have enough 'operating' funds to hold on to it through any lengthy tough times.

"Neither a borrower nor a lender be."  --Bill S.

Dale Osborn · Answer

When they had the Savings and Loan Crisis in the 1980's - many of the investors lost millions as they were simply over fincnced. We bought our first home for cash - later wondered if it would have been better to have bought 4 separate 4-plexes with the same funds. Thigs tirned out fine for us as later we sold our 2 free and clear homes and got a 27-unit apartment complex. 
Many right now are saying that "Cash is King" - if you have the cash to make some deals, you should be able to negotiate some great deals for yourself and your financial well being in the years to come. 
We on the other hand bought 2 properties in 2009 and if a good deal fell in our laps right now, we would not be able to act on it as we used all of our funds in 2009. 
Good Luck on your investing! Do what you feel is best for you and your family, not what others tell you is best for you!

Purchasing an investment outright ~ Am I crazy???

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