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The Pros and Cons of Purchasing a Rental Property with Cash

How you purchase your Baltimore rental properties is largely dependent on your financial situation and often a matter of personal preference.  You may prefer to finance rental properties and leverage your money to be used elsewhere, including financing additional properties, or you may have a stock pile of money that you want to use to purchase your property in all cash.

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Let’s take a look at some of the pros and cons of purchasing a rental property with cash so that the next time you decide you want to invest in a rental home, you will have a better idea as to which purchasing strategy will work best for you.

Pros of Purchasing a Rental Property with Cash

There are many advantages of  paying for your Baltimore County rental property in all cash versus financing with a traditional mortgage.

No Interest Payments

Even at a time when mortgage interest rates are expected to stay relatively low, if you finance a rental property, you will pay more for it in the long run due to the interest that is paid into the loan.  This is not the case if you pay for your property with cash.

Less Properties to Manage

Paying for a property with all cash usually means you’re investing in fewer properties..  For instance, let’s say you have $100,000 to invest in rental homes.  You might pay for one property in all cash at $100,000, or put $20,000 toward down payments to finance 5 properties.

With fewer properties to manage at once, you will have less tenants to worry about and fewer maintenance and repair bills.  This makes managing your rental(s) much easier.

100% Equity

Owning a rental property outright means one hundred percent of the home’s value is the equity you hold.  Without the responsibility of a mortgage payment, you are free to invest money into upgrading your property and increasing its value  for a future sale price (of more than you paid!) or to increase the monthly rental amount.

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Negotiation Power

Cash buyers are often given priority over those seeking to finance rental properties.  If you have the full asking price in cash, you may even have some negotiation power to lower the sale price or gain other favorable amenities (such as home upgrades).

Waiting on an approval for a mortgage loan does not always sit well with sellers (or their agents) because this can waste time that they could be advertising the property as available  especially if the loan does not get approved and the sale does not move forward.  With an all-cash sale, you can expect a fast close because there are no concerns about a pending loan and the deal can be done with little to no issues.

Immediate Cash Flow

Achieving monthly cash flow is not always possible in the rental property business.  Sometimes rental values are below your financed mortgage rates and you end up losing money while leasing your properties.  In fact, it is suggested that 70-80% of a monthly rent payment is usually going directly to a mortgage payment if the property as financed.  That leaves very little room for profit if you take into consideration general maintenance and repair bills.

By paying in all cash for your properties, you will avoid this significant monthly expense.  The money you receive each month from your tenants will be considered full cash flow, minus any minor expenses required.

Lower Risk

By purchasing a property in all cash, you essentially lower your risk as an investor.  You never have to worry about making a monthly mortgage payment should something change financially for you.  If your property goes vacant, there will be no financial strain on you and you will not find yourself headed towards a short sale or foreclosure because you can’t make your mortgage payment.

Cons of Purchasing a Rental Property with Cash

Though there are many pros to purchasing a rental property with all cash, there is a serious flipside that you must take into consideration.  Perhaps financing your rental properties isn’t all that bad.

No Leverage Power

Leveraging is using other people’s money for your investments so that you use less of your own money.  Although the risk may slightly increase by financing rental properties using other people’s money (i.e. the bank’s), you free up your own money to purchase more properties (or make other investment decisions).  You also increase your returns on the cash invested much quicker than if you pay for one property in all cash.  By putting all of your money into one investment rather than leveraging, you lose out on the ability to make other people’s money work for you.

Lower Cash-on-Cash Return

A cash-on-cash return is the return you see on the cash you have invested.  If you pay for a house in all cash, your cash-on-cash return will be much lower because you have invested a large amount of your own money into the property.  The same cash flow you receive each month from your tenant will see a higher rate of return if you initially invest a fraction of what the property would have cost to purchase with cash.

Example:

If you buy a house for $100,000 in all cash and receive a $500 monthly cash flow from your tenants, your cash on cash return is 6%. 

That same house financed with only 20% down (at say, a 4% interest rate) sees a monthly cash flow of approximately $118 (check out this cool calculator).  The cash-on-cash return for your financed property is now at approximately 7%.  That is a huge difference!

Reduced Buying Power

Financing multiple rentals can be greatly beneficial. For example, your cash flow increases because you are receiving monthly rent payments from multiple tenants, your equity pay down increases, the tax benefits increase because they apply to multiple properties instead of just one, your net worth increases if you are able to purchase below market value, and the diversification of owning in many locations creates a safety net of income should something happen to one property.

Less Tax Benefits

Come tax time, having a mortgage can work to your advantage as opposed to purchasing a property outright with cash.  Any money that you pay in interest towards a financed rental property can be deducted against the income from the property.  This means you may not have much tax liability come time to file taxes after all of your deductions are taken.  Keep in mind though it is best to seek advice from a certified tax professional to ensure you are compliant with all tax laws.

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Evaluating your personal circumstances is important when deciding whether to purchase a rental property with cash or to finance your mortgages.  Making sure that you have retirement funds set aside, emergency funds in a savings account, and sufficient health and life insurance policies in place are some of the considerations you should make before placing all of your liquidity into one investment.

While there are many pros to purchasing a rental property with cash, the cons are significant too.  Financing rental properties, if done carefully, are not considered high-risk investments and can actually be quite beneficial.

If you have multiple properties, whether purchased with cash or financed with traditional mortgages, and need help managing them, call Bay Management Group today to see what services can be offered you.  Freeing up your time is just as important as making money and Bay Management Group can do just that!