Sticking to Mostly Cash vs. Financing?

Question

Hi all!

We are new to real estate investing. Currently we have a home improvement/remodeling company, so the construction piece we have including many sub crews. We are looking to add flipping houses and have been diving into learning all about this area of real estate.

Our main question is - why not use your own cash for flipping vs. financing? Then taking any cash made on that project, reinvesting it into the next, and growing cash reserved over time. We hear a lot about hard money lending, utilizing the BRRR method for holding properties, etc. But at the same time, we also hear story after story of the investors losing almost everything at some point or losing large amounts of money due to the financing.

Besides it being much slower start up to self-fund, why not use cash instead of financing to avoid the risk? Yes, there's still risk of losing some cash but at that rate you could just hold the property longer if needed. You're not worried about monthly interest payments, loan origination fees, etc.

We are wondering if we are missing something here. Thank you so much in advance!

Chris Seveney · Answer

@Haley Elisabeth

You are not missing anything but there is what I would call good debt and bad debt.

For example if I buy a property cash, rehab it and it has a $300,000 value and can be used as a rental and provide cash flow - getting a $150k loan on that asset to buy another (not blow it on toys) say $300k asset I have 2x future appreciation than one asset.

Yes people lose it all, typically because of over leverage or crazy events like 2008 - but if you also have cash reserves you can offset any downside to minimize risk even more

When people start using lines of credit and seller financing at 90-100% you are correct those people have a very high chance of losing it all.

Katie Smith · Answer

Hey Haley!

It’s great to see your enthusiasm for diving into real estate investing and flipping houses, especially with your experience in home improvement and remodeling.

You raise an excellent point about using your own cash versus financing through hard money loans. Here are a few key considerations to help clarify why many investors opt for financing, despite the risks involved:

• Leverage: Financing allows you to leverage your capital. By using a hard money loan, you can take on multiple projects simultaneously rather than being limited by the amount of cash you have on hand. This can potentially increase your overall returns, as you’re not tying up all your capital in a single project.
• Cash Flow: Using financing frees up your cash for other investments or opportunities. This means you can diversify your investments rather than concentrating all your resources in one project. Even if you’re making interest payments, having liquidity can be advantageous in a dynamic market.
• Speed and Scale: Real estate deals often require quick action. Hard money loans can facilitate faster closing times compared to traditional financing, allowing you to secure and renovate properties quickly. This is particularly important in competitive markets where speed can be a key factor.
• Risk Management: While there is certainly risk with any form of financing, careful management and choosing the right lender can mitigate these risks. Hard money loans are often short-term and designed for projects with a clear exit strategy. Additionally, successful investors typically build a solid network and due diligence practices to minimize potential losses.
• Reinvestment: Using financing means you can reinvest the profits from one project into multiple new ones, potentially accelerating your growth. Reinvesting your profits quickly can lead to a compounding effect on your returns, compared to the slower growth from reinvesting your own cash after each project.
• Opportunity Cost: By using your own cash, you might miss out on other investment opportunities or market trends. Financing allows you to diversify and potentially capture more opportunities within the real estate market or other investment avenues.

That said, it’s crucial to do thorough due diligence and understand the terms of any financing you consider. Working with a reputable lender and having a solid plan for each project can significantly reduce risks.

If you decide to use hard money lending, it’s important to calculate your costs and potential returns carefully and ensure that the projects you undertake align with your financial goals and risk tolerance. Every investor has a different strategy, and it’s about finding what works best for your situation.

Michael Diossa · Answer

Using mostly cash reduces risk and simplifies transactions but ties up capital. Financing leverages your investment, allowing for more properties and diversification, but involves interest costs and higher risk.

Andrew Freed · Answer

@Haley Elisabeth - Good question! @Chris Seveney brought up a bunch of good points. At the end of the day, it comes down to leverage. With leverage, you can amplify your returns. You can also do more projects at once with the same pot of money, e.g. bringing 10% or 20% of the purchase price and getting 100% of the construction covered by a lender. Yes, with this comes more risk, but also more reward and ability to scale faster. Each person has their own risk tolerance, however what I will say is most people don't have straight cash to buy a couple hundred thousand dollar property hence are forced into utilizing hard money.

John Williams · Answer

I think many folks getting established simply may not have the cash. If you have the cash available, it is not a bad option, especially with current rates.

Mike Klarman · Answer

So, if you have like 500k in cash and you're looking at projects like picking it up for 80k putting 60k into it and getting its value over 200k and either sell or refi and get your 140k back, then I'd say yes use the cash.  You can probably get in two at a time and still have a safe amount of capital at 500k.

But if you're saying that use cash and sink every last dollar you have into a single project, I'd say no, do not do that.  Very risky.  You have all your chips on the table and you can lose in this game, believe me, I've seen people in spots where it looked like they had a clear 50k in profit coming there way and then things go sideways and you hope to break even.

Chad Shultz · Answer

Haley,

Glad to see you are moving forward and taking the next step in your investment journey.  Obviously, different people have different reasons for the way they approach their investment strategy:

Personally, I prefer to use personal funds and "pay" myself the interest.  The majority of my projects are rehabs that get sold, (fix and flip).  I find there is more profit to be made and more flexibility if you use your own funds.  I started my "official" journey in 2016 with only $35k of my own money.  Today, I can self-fund more than one project at a time.  When you invest smart and you are not paying out to everyone, you can grow cash quickly.

On the other side of the coin, there is a place for hard money.  I have used it on occasion, but it is rare.  If you want to scale, hard money is helpful.  It might allow you to go from 3-5 properties per year to 12+.  However, keep in mind interest does not pause.  If the market changes or costs go up, etc., your flexibility is limited and interest keeps ticking.  I know many investors who are much busier than me, turning more homes each year, but they never have any money.  I am not interested in making $10k-$15k per property, even if I do that 10 times per year.  I would much rather make $60k-$75k and do three to five.  The risk vs. reward margin is in my favor this way too.

My opinion is to start off with your own funds, if you can.  Learn the ins and outs of the projects and learn how to manage your money and maximize profits.  Once you have done this, it is easier to manage other people's money and keep your profits coming in.  Ultimately, don't be one of those people who jumps into the deep end without knowing how to swim.  You'll thank yourself later.

Sticking to Mostly Cash vs. Financing?

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