Why we should not use all cash to get 70-80% off market value

Question

A lot of experienced investors and non-experienced investors use  large sums of cash to obtain properties at great discounts (70-80 cents  on the dollar) via direct sales of pocket listings or auctions.  Paying  cash commands respect and is seen as a more reliable deal which is the  reason for the discount on the property.  The following will analyze the numbers behind this strategy and compare it to a typical 20% down payment conventional deal.

Scenario A: All Cash

Market Value: $100,000

Purchase Price = Money in the Deal: $75,000

Annual Cash Flow: $12,000 (assuming 1% rule)

Cash on Cash Return: 12/75 = 16%

Scenario B: Typical 20% conventional deal

Market Value = Purchase Price: $100,000

Money in the Deal (20%): $20,000

Annual Cash Flow: 12 x $1,000-540 = $5,520 (assuming 1% rule)

Cash on Cash Return: 5520/20,000 =27.6%

Conclusion: Using all cash strategy would yield 11.6% less return on principal investment.

http://theunconsensus.blogspot.com/2014/05/using-all-cash-vs-conventional.html

Account Closed · Answer

Lan,

I have no idea what the author of the blog is trying to prove. If his point is to pay retail price instead of paying all cash at 75% FMV with the example above, he didn't do a very good job at it.

After 6 months to 12 months of seasoning, the all cash investor can do a cash out refinance and take all of his money out. His return would be infinity after the cash out refi. The retail investor would be out of money after 4 purchases while the all cash investor can rinse and repeat with the same amount of money forever.

Real estate is about control and leverage. The all cash investor would still have all of his cash with control of a whole bunch of properties with equity while the retail investor would run out of money after 4 purchases.

Which conclusion do you like better?

Bill Gulley · Answer

Title seasoning isn't always at 6 months to a cash out refi, 12 months will be the general rule to go off the appraisal, prior is the appraised or cost, whichever is less. I believe in my area it's still 12 months but I'm hearing portfolio lenders are shelling out cash at 6 months

You're using guru or Enron accounting to say you made 25K on a purchase, if the property meets marketing and the definition of market value requirements, you bought a 75K house, not a 100K, market value is what you paid. If you buy at a distressed value, you may make money but you don't make it at the time of the sale, the phantom equity isn't realized for 12 months or upon an appraisal.

Yes, technicalities do matter. Financial statements have rules to provide an accurate financial picture for a reason, see the Enron case. You're cooking the books. It matters when seeking financing.

The blog might be made to justify selling a larger loan, LOL, I agree with Minh.

Your return is really more to the weighted average of cash and financed amounts, so the OP's simplified allocation is not correct.

There's an old saying, "figures lie and liars figure". :)

Kyle Hipp · Answer

I guess I wouldn't pay full price either way but I get your point. I think the main benefit is a confident seller that you can buy and close quickly without a bank blowing up the deal. I don't buy properties that do not need work because that is my focus but I always attempt to buy at roughly 70% of value minue repair costs. This allows me to refinance with cashout a couple months after ourchase once the work is done and tenant is placed and I have all my capital as well as genereting a monthly income. Buying wigh cash can provide you more options and options are good.

David O · Answer

This doesn't take into account a cash out refi and the fact that if the market value is 100K and the purchase price was only 75K, then you have 25K in equity right off the bat. You can buy cash for 75K and if it appraises for 100K in six months, you take out 75% LTV and you have your 75K back. AKA you bought the property for none of your own money.

I would always buy cash if you have the means. Do a cash out refi right away for the purchase price or wait six months and refi on the appraised value.

Account Closed · Answer

I like the cash buy, immediately refi strategy myself to keep my cash liquid and ready for the next deal.  Paying 12-20% should never be an issue, if it is then your margins are too slim!

Walt Payne · Answer

Almost all of my properties have had offers accepted because I was in a position to offer cash, and close quickly. Banks and even seller agents are wise to the game of abusing contingencies to the point that virtually all  non-retail properties will likely start going to cash buyers with minimal contingencies. So by your reasoning Lane Kawaoka  I should have sat on the sidelines waiting for someone to accept a financing contingency bid above a cash offer? Sorry, but having my cash tied up for a year on a rental beats having it sit in the bank while I wait for a good deal that nobody else noticed.

BTW the other flaw in your thinking is assuming equal purchase prices. A cash offer is likely to win out against an offer of 5-10% higher (or maybe more) when dealing with REOs and other distressed properties, so factor that into your equation before saying it is an 11% reduction in return. It won't effect the ROI a lot while holding, but then the extra appreciation upon sales balances out the lower return of the seasoning period.

But I hope lots of others buy your reasoning, it will make it easier for me to get my offers accepted

Lane Kawaoka · Answer

My initial purpose for the post was to just question the common thinking that buying with all cash is the best strategy (if you have the money).  I ultimately believe that the all cash strategy is the way to go but it is not all roses.  I think all to often the common thinking is 1) buy a home at 70% value and 2) sell to recover the forced 30% and recoup rehab costs... on an IRR basis the numbers are better than the 20% down strategy but the risk of the market turning in that 6 months to a year is not captured.

For those of who are Refi after the cash purchase...  how long are you waiting (6-12 months) are you getting conventional 30 year mortgages or are they portfolio loans?

Don Konipol · Answer

The analysis only compares expected cash flow. It does not identify risk, downside if income is lower than expected or expenses higher, or take into account the impact of the $25000 difference in purchase price.

I have personally used the buy for cash discount strategy very successfully throughout my real estate investing career.  Obtaining property at a substantial discount lowers risk significantly while increasing returns. Not saying that leverage can not magnify returns, just saying any valid analysis must account for value of purchase price differential and risk differential.

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Bruce N. · Answer

I agree, great thread, with tons of info to reflect on- some of which can be applied.

Tim L. · Answer

Great thread guys.  A lot of good info here.

Why we should not use all cash to get 70-80% off market value

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