cash deals: when should you buy a house cash?

Question

So I have been running my cash flow in Houston area for both SFH and multi's. I am pretty comfortable calculating the monthly cash flow, Cash ROI/CoC, cap rate and etc. I am seeing some good cash flow and some bad ones. If it cash flows more than 8%, then I take a further look at the numbers.

All my calculations for cash flow is based on 25% down payment, 3% closing cost and some estimated repair cost but what do I do if I come across a cash deal?

If a house is sold at 100k and I put 25% down on it vs. if a house is sold at 100k and it requires 100% cash to purchase, the chance for a cash deal to cash flow is very unlikely.

Are you supposed to treat cash deals differently? Is there any reason you would consider cash deal if you are a buy & hold investor?

Also, why would a seller want a cash deal vs. conventional financing?

would like to know your thoughts on these topics!

Kris Fox · Answer

Actually, the chance for a cash deal to cash flow is almost always 100%.  If you don't have a mortgage payment and even if your expenses add up to 50% of gross rent, you'll still have amazing cash flow.  The real metric you need to evaluate is the cash on cash return vs your ROI.

Assuming 100% down payment (e.g. all cash purchase), you would divide your annual net income by your purchase price and the resulting % would be your ROI.

Assuming financing with a down payment, you take your annual net cash flow and divide that by your down payment and your result is your Cash on Cash Return.

I like to go with a hybrid of both.  You have to assign a cost to your money even if it's only for internal metrics.  Whether or not you actually have to borrow money, all money costs something.  If you're using it for an investment, the alternative is to lend it out to get a return.  Let's assume we're all capable of lending at 8%. You have to assign your down payment an interest expense at 8% and subtract that from your cash flow before you get your CoCR.

Good luck!

Piet Strydom · Answer

One needs to distinguish between gross cash flow, and net cash flow, and then also between Return on Investment and Return on Asset

Gross Cash flow is your rental, net Cash flow = :

Rental - Expenses - Tax.

Where you put down 25% of the value of the house, you finance 75%, and the interest on that 75% is tax deductible. Because of that, your taxes will be lower. If you paid 100% cash for the house, your free cash flow will be a lot higher, even though you pay higher.

1. I do not therefor understand your comment that a 100% cash deal will not provide free cash flow, actually produces the highest level of cash flow.

2. You would consider a cash deal for multiple reasons - you could just want to get out as much cash as possible, or you could just not want to be exposed to the risk that interest rates could escalate, or you could be of the opinion that interest rates will drop in the near future, and you therefor want to wait for the rates to drop.

3. The reasons why you would want to finance are also many, two most important is probably to leverage your return on investment. If the rental is 10% in your example, then your gross return on asset would be 10%, and similarly, if you paid cash, your return on investment would also be 10%. But if you invested only $25 000, and borrowed the rest, then your gross return on investment, is 4 times more. (100 000/25 000).

4. HOWEVER, it is important to consider your net return, because if you pay more interest than what your rental is, then the leverage is working against you, certain recipe for pain.

Iman Yu · Answer

@Harriet Baldwin thank you for your feedback. That makes sense to me. Now I know when I need to consider coming in as a cash buyer. :-)

Harriet Baldwin · Answer

Big picture (beyond the calculations and financial definitions), buying for cash is most powerful when properties can't be financed (not habitable, too inexpensive for owner/occupant mortgage, etc.).  There are usually fewer cash buyers in a market, so you have fewer competitors.

I have come to believe that in most cases the ideal amount of leverage is as much a function of the risk tolerance of the borrower as it is a product of the financial calculations. In the same market and with identical bank balances, some folks will be happy with a 90% portfolio LTV and others with 80% or 60% or...

Gino Barbaro · Answer

@Iman Yu

Hi Iman,

Investors typically buy with all cash to get a better price on an asset.  It is much easier to close and shows the seller that the buyer is serious and closing will be faster and no complications from the bank.

If I am going to buy a property all cash, I want to buy at a discount, reposition the property, thus increasing the value.  By buying at a discount and increasing value, you may be able to go to bank and take out a mortgage for whatever money you have invested in the deal.

It all depends if you want to own a few properties free and clear or own several properties with debt.  Leverage works both ways.  It can create inordinate amounts of wealth or it can crush you.  If your goal is to create wealth, then I would mortgage properties.

Good Luck

Gino

Iman Yu · Answer

wow I can't believe how great of a community we have on BP. It's so wonderful to see how many people are willing to give me their thoughts on my post :-D

@Ray A. What you said makes sense to me. It has advantage is a multiple bidding situation or when the seller needs a quick close. From a buyer's perspective though, it's higher in risk so I would think cash deal should be offered only when the deal looks extremely attractive from cash flow/appreciation/location/some other reasons.

@Piet Strydom Thank you for your thorough feedback on this. After looking at my sheet again, and I realized I made a mistake. You are right. Cash deals will provide better net cash flow, cash ROI, total ROI (including equity). After looking at my analysis, I realized that cash deal would only  have a negative impact on the CoC ROI % because it takes total cash flow/total cash outlay.

you brought up an interesting point about ROA vs. ROI. ROA isn't something I've looked into before, but from what I read, it's an indicator used to calculate how efficiently I can generate using my total asset? If that's the case, ROA is higher when I finance vs. buying it in all cash?

In your last point, you mentioned 'paying more on interest than the rental will make it a bad investment decision'. The 'interest' you are referring to there is the 'interest payment on the mortgage' and the 'rental' you are referring to here is the 'gross rental income'?

@Dana Whicker What you said make sense. Have you done cash deals in the past for any buy & hold properties? Why did you choose that over financing it?

@Lyall Storandt Thank you for all the detailed feedback and examples. That really helped me to clear up a lot of questions and confusions I had on this.

"I know you know this, but your annual return as a percentage is your annual net cash flow divided by your initial cost basis."

That calculation above is what I use to calculate CoC ROI%. is that right?

I think you hit a great point on this topic. The amount of capital I have available to invest requires me to use leverage to my advantage. In my case, I would only consider cash if that's my only way to get in on a great deal.

Can I PM you with some further questions please?

@Kris Fox You are right. Cash deals increases on the net cash flow because the mortgage in that scenario is 0. Cash deal has no impact on gross cash flow, NOI and it has negative impact on CoC ROI.

Thanks for pointing out the ROI calculation for 100% down payment. That's something new to me.

As far as risk goes though, I would assume financing through down payment is less risky than an all cash deal?

@Scott Harlow what you said really peaked my interest! Have you bought a property with 100% cash and refi it later to get cash out? Is that something you can check with the bank on the particular property  before you make the purchase or this is where you need to know the true value of the property before you purchase and use that knowledge to refi later? Does it only apply to buy the house cash way under the market, fix it and refi it under a higher ARV? IF I buy the house cash, I wouldn't be able to get an appraisal on it before I purchase it then how would I know what it would refi for? I am a conservative buy & hold investor so I need a strategy that would work for that.

Michael Lee · Answer

Hello and welcome.  I believe that most of what you're u said is true.  I am 59 years old and have been around construction and real estate for a long time so I can say you're thinking right. . Yes, cash flow and cash is king.  It all depends what you're trying to accomplish in the short term or long term.  Just be careful and do your due diligence.  Be honest with your partners and your team and you will do fine with whatever you decide.  Good luck!

Lyall Storandt · Answer

There is a third option that's in-between paying cash and using conventional financing.

There are a handful of lenders in the Houston area that will finance the purchase of distressed property via a hard money loan and streamline the refinance process into long-term Fannie Mae conforming financing.

There are multiple benefits to purchasing properties via this type of financing. To answer your original questions, using this "temporary to permanent" financing would allow you to compete with other cash offers as you would be able to close in as little as 7 days. I can only speak for myself and our company, but cash, lines of credit, and hard money financing are all the same thing as far as we're concerned. (Yes, they're all technically different, but they function the same as far as a buyer's ability close quickly and relatively hassle-free. [Actual cash is always king.])

The answer to your second question depends on the amount of capital you're looking to put into play. If you have $100k to invest, by purchasing rentals using only cash it will take you some time to build up a sizable portfolio. However, if you utilize financing (of almost any kind) you'll be able to build your portfolio much quicker. If you have $10M and you're looking to build a rental portfolio, using financing might not necessarily make sense if you're trying to move quickly.

Cash deals are beneficial to sellers because they're more straight-forward and are therefore "cleaner" transactions. There aren't any of the issues associated with a lender, i.e. no inspections, appraisals, surveys, underwriting, loan doc. prep, etc. Cash deals typically close much quicker vs. a conventional loan, which can take upwards of 45+ days, especially with the implementation of the new TRID guidelines.

In general, your actual cash-on-cash return will be higher when you're leveraging your investments by using financing. @Piet Strydom hit the nail right on the head: you might earn less cash flow per month by using financing, but your cost basis for acquisition of the property will be significantly lower and therefore your cash-on-cash return will be higher. ($100k cost basis using cash vs. $25k using financing in your example.) I know you know this, but your annual return as a percentage is your annual net cash flow divided by your initial cost basis.

Feel free to reach out to me directly if you have any questions about the financing I mentioned above or otherwise.

Scott Harlow · Answer

In some instances it might make sense to buy a home with cash (maybe it will make a lower offer more attractive for reasons others have stated) with the plan that you will refinance for 70-75% of the value - extracting a majority of your cash out of the deal.

cash deals: when should you buy a house cash?

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