How to purchase rental properties largely depends on an investor’s individual financial situation and is often a matter of personal preference. Some investors prefer to finance and leverage money to be used elsewhere, including financing additional properties, and some prefer cash transactions. If you have a stockpile of funds to purchase in cash, there are many benefits to doing so. Join us below as we examine the pros and cons of purchasing rental units in cash and the realities investors should consider before deciding what is best for their portfolio.
Top Reasons to Pay Cash for a Real Estate Investment
Purchasing property for cash is not going to be right for every investor. In some cases, the financial liquidity just is not there, while others may be held up by fear of taking the plunge. Whatever each investor decides will inevitably be based on a variety of factors. However, here are some of the main reasons an investor may consider a cash transaction.
- Cash is King – In such a competitive real estate market, cash offers get a seller’s attention. Cash offers can generally close faster and do not come with the same stipulations as a financed offer. Thus, helping investors to beat out the competition. Also, if you have the full asking price in cash, investors may have some negotiation power to lower the sale price or gain other favorable amenities (such as home upgrades).
- Minimal Expenses – In uncertain times, not relying on the rent to cover your mortgage payment is a huge plus for landlords. This helps protect investors in the event the tenant stops paying or if there is an extended vacancy. So, if your property goes vacant, there is far less financial strain, and you are not likely to find yourself headed towards a foreclosure because you cannot afford the mortgage.
- Less Hassle – Dealing with the bank can slow down the buying process and cause investors to lose out on opportunities. Instead of the complex mortgage process, cash sales are much more straightforward for all parties involved.
Pros of Purchasing a Rental Property with Cash
There are many advantages to paying all cash for a rental property versus financing with a traditional mortgage. Let’s review some of these advantages in greater detail below –
- No Interest Payments – Even as mortgage interest rates are expected to stay relatively low, financing a rental property means paying more in the long run. This is in part due to interest paid over the life of the loan and loan origination fees. Thus, paying cash avoids such fees and interest.
- Fewer Properties to Manage – Generally, cash purchases mean investors are buying fewer properties due to the capital needed. For instance, if you have $100,000 to invest in rental homes – investors could buy one property for $100,000 or put $20,000 toward down payments to finance 5 properties. However, fewer properties to manage means fewer tenants to worry about and less maintenance and repair bills. Thus, making management of the portfolio easier, especially for DIY landlords.
- 100% Equity – Owning a rental property outright means investors hold 100% of the home’s value in equity. Without the responsibility of a mortgage payment, owners are free to invest money into upgrading the property to increase the value or increase the monthly rental rate.
- Immediate Cash Flow – Achieving positive monthly cash flow is not always easy in the rental business. Sometimes rental value falls below the financed mortgage payment, and owners lose money. In fact, landlords who finance can expect 70-80% of monthly rent payments to go directly to mortgage payments. Thus, leaving little room for profit after expenses. That said, paying in cash avoids this significant monthly expense. Instead, money received from tenants is full cash flow, minus any minor expenses required.
Cons of Purchasing a Rental Property with Cash
Though there are many pros to purchasing a rental property with all cash, there is always a flipside. Investors must take a hard look at their own finances, investment goals, and the potential of the property they are considering. In some instances, financing may be a better choice. Below are a few disadvantages to paying in cash.
- No Leverage Power – Leveraging means using other people’s money for investment. Although there is a risk to financing a purchase, investors free up their own money to purchase more properties. In addition, owners can increase their returns on the cash invested much quicker on a financed purchase. So, by paying cash rather than leveraging, investors lose out on the ability to make other people’s money work for them.
- Reduced Buying Power – Financing multiple rentals can be greatly beneficial. For example, cash flow increases because landlords receive monthly rent payments from multiple tenants. As a result, equity pay down and tax benefits increase because they apply to multiple properties instead of just one. Additionally, your net worth increases if you purchase below market value, and diversification creates a safety net of income should something happen to one property.
- Fewer Tax Benefits – Come tax time, having a mortgage can work to your advantage instead of purchasing a property with cash. Any money that owners pay in interest towards a financed rental can be deducted against the income from the property. In other words, investors may not have much tax liability at year’s end after all deductions. Keep in mind, always seek advice from a certified tax professional to ensure you comply with all tax laws.
Another Downside to All-Cash Purchases
Lower Cash-on-Cash Return – A cash-on-cash return is the return investors see on the cash they invest. So, if you purchase a property for all cash, the cash-on-cash return is 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 cash and receive a $500 monthly cash flow from tenants, the 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%.
Special Risks of Paying Cash
The risk of cash is tying up a huge chunk or even all of your assets in one investment. In addition, while real estate can easily appreciate, it can just as easily depreciate, resulting in potentially huge losses. Therefore, this approach may not be the ideal strategy for investors without significant stores of available capital.
How to Build Your Property Portfolio with Cash Purchases
Investors can use leverage to grow their portfolio of rental properties; however, that is not the only way. Purchasing property with cash provides free cash flow without the burden of debt. In addition, when properly managed, owners can use cash flow to reach larger investment goals. So, for investors looking to grow through cash purchases, follow these 3 simple steps.
- Accumulate – The first and most obvious step is to gather enough capital to buy your first rental property. Ideally, look for turn-key rentals at a reasonable price of $100,000 to $150,000.
- Funnel – Next, funnel 100% of the net rental income plus any savings you can spare into a special reserve account – earmarked for a future property purchase.
- Purchase – Once you can accumulate enough capital, purchase your next rental unit with the experience gained through the first purchase. From there, continue to repeat the process. As you gather more properties, cash will accumulate faster, allowing for faster growth.
Make the Most of Any Investment
Evaluating your personal circumstances is important when deciding whether to purchase rentals with cash or financing. That said, 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 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. However, you decide to finance, owning a rental property can be a profitable and rewarding experience. Savvy investors also understand that running a successful business requires experienced help. As the area’s leading property management firm, Bay Property Management Group assists owners with various rental needs. So, if you are interested in getting the most from your investment, call Bay Property Management Group today.