I was asked my opinion on whether someone should pay all cash for an investment property so they can borrow against it, or leverage it. I definitely don’t claim to be an expert, but based on my calculations and experience, I think leverage is the way to go every time. Two main reasons: 1. Your cash-on-cash return will be significantly higher, and 2. Your personal risk is less because you are using less of your own money and more of someone else’s.
After I bought my first rental property is when I got curious about this and sat down and did the math. I used that property as an example and calculated it with 20% down and a mortgage, and then with an all-cash buy. I don’t have my scratch paper handy to remember the exact numbers, but with this $55,000 house I bought, it had a cap rate of ~14%. If I bought the property with all cash, my cash-on-cash return = the cap rate, because the denominator in the equation is the same- the purchase price is how much I would have paid in cash. Then I recalculated everything assuming the financing, and the cash-on-cash return took a flying leap up to 32%. Woot! So my cash-on-cash return more than doubled. And isn’t the cash-on-cash return what I really care about if I want cash flow anyway? Cap rates are really only in relation to buy/sales price of a property, and while an indicator of how much cash flow you will receive (<7% not good, 7-9% good, >9% great), it doesn’t say exactly how much return on the money you actually put in you’re getting. The cash-on-cash return does. So while if I pay cash, it seems like I’m getting a lot more cash flow per month, which I am, but compared to how much money I had to put down to do that, I’m actually making a lower return.
Then for risk, I either put $55,000 of my money into one basket, or I only put say $15,000 into that basket. Which route has less risk to me? The one where I invested less of my money.
Lastly, using your investments to buy more investments. Let’s say you have $100,000 cash to invest. First example, the all cash buy. You pay $100,000 for one property. Then you pull out financing against it (the risk here is remember you may not be able to get the full $100,000 out of it, but for the purpose of this discussion we’ll pretend you do), and buy a second property. To keep it simple, we’ll stop here (but we all know the smartest thing to do is to just keep doing this over and over and buying more and more). So you’ve spent $100,000, you have two properties, and $100,000 in equity from the second property. Let’s say both of these are making that 14% cash-on-cash return from the example above.
Now, let’s use the same $100,000 and use leveraging. For a normal mortgage, you can get away with putting 20% down, so for that $100,000 property you only have to spend $20,000 (ignoring closing costs for this example to keep it simple). Well, you have $100,000, so that means you can buy five $100,000 properties.
The results of the comparison? Both scenarios cost the same amount of money out of your pocket. The all cash buy bought you two houses, gave you $100,000 in equity, and gave you a 14% cash-on-cash return for cash flow. The leveraged buy bought you five houses, gave you $400,000 in equity, and gave you a 32% cash-on-cash return for cash flow. As if that isn’t crazy enough, don’t forget one other income avenue you have on any investment property you own- depreciation. The amount of money you collect from depreciation each year can be substantial. If you only own the two properties, you only get to collect depreciation on two properties. If you have five, you’re collecting on five! Five!!
So my overall opinion? Again, I don’t claim to be an expert by any means, but all I see is that if I use leveraging, I get:
– A higher return on my cash investment
– More equity that I can leverage against to buy more properties
– Less risk because all my eggs aren’t in the same basket
– A lot more cash in my pocket from depreciation on my taxes
I don’t know about you, but…
Looking to reposition. After crash, I own 3 properties out right. Only leveraged 80k on one worth 400k. I am considering selling these 3 and starting over using leverage. The crash scared me. But I am not making as much as I could. Would like some advice.
Hi Leacy! Happy to chat. Email email@example.com or reach out on our Contact Page.
I noticed that you said if you put 20% down on a 100K property you would have 80k in equity in each property. This is not correct you would have 20K in equity, you can not have more equity than what you put in, unless you see instant appreciation but that will not typically happen in real estate.
But other than that this is a good outline of the topic.
Hey Kyle, GOOD catch! That was definitely a typo and I just took that out. Thanks for pointing it out, as that line didn’t even make sense with what it was written with, so may have been a copy/paste error.
Love all your articles.. Wondering if you can email me also on other possibly financing avenues.. At 4 and kind of hung up
Hi Scott, thanks for reaching out. You know you can get more than 4 mortgages, up to 10? The qualifications tighten a tiny bit but nothing drastic. So 4 shouldn’t be the stopping point. If it is, however, I do know of some 50% down private financing options on certain properties that you can qualify easily for. Otherwise paying all cash or working with investor partners is my recommendation. Hope that helps.
Just discovered your site. We renovate and sell houses (flip them, basically) in Alabama and have recently been looking into financing. So far, we’ve had trouble making the financing option work as the all cash deals (which is what we’ve done in the past. Would love to hear your ideas for creative financing to see if they would work for us. Thanks for the great site!
Hey Justin! Unfortunately I don’t have any experience with flipping so haven’t worked those methods for financing. I know there are ways to do it for zero down, but you’d have to talk to lenders. I know a good one in Atlanta but not sure he can lend for AL?
I own 4 properties that I have lived in then rented out. I would like to start buying income producing properties as a non-owner occupy. Can you please share your thoughts on getting past the 20-30 percent down payment through a mortgage bank? Thanks so much!
Hey Desiree, thanks for reaching out. Unfortunately I don’t know of any way to get past that down payment, sorry 🙁 I wish I did!
Found you thru a blog (real-life prop mgmt) from BP. Always wondered about the cash vs. leverage question, so this article breaks it down and makes it very simple to understand. Also, would be interested in knowing about creative financing you mentioned.
Thanks, Prashant! For financing, I do have access to 50% down private financing on some properties and other than that, I’ve done various things like borrow money from random places and/or use an investor partner creatively.
Hello Ali. I just joined BP today. I am from Chicago NE suburb. When I was searching for members from Chicago area I happened to find you. You will be my first member to follow. Leveraging is great when going is good but it is a double edge sword.
Many RE investors and builders/developers were brought to their knees and even worse, when RE turned south. Little bit of greed is good but too much can “kill” you.
Hey Peter! Glad you got on BP. Great stuff out there. I work with a lot of rentals in Chicago. Glad you’re getting tapped in!
Hi Ali, I am also an engineer who has been bit by the real estate bug… can you also forward the email regarding the creative financing. =)
Yaaaooo engineers! Sure, will email you now.
Your equity figures don’t make sense. Owning a single 100,000 home provides equity of 100,000. Splitting that into 5 homes gives you 100,000 in equity split across 5 homes- still a total of 100,000 and not 400,000 in equity.
I see what you are saying, G. The equity you have in a house is how much you have at your disposal based on the value of the house. If the house never appreciates, you only have equity with what you have already paid on it. If the house appreciates however, you have additional equity you never had to pay for.
I live in the Northeast where RE is prohibitively expensive. I would love to get into RE for investment purposes, I just don’t see it happening up here. How do you go about researching/buying properties in places where you don’t live? I’d also love to hear more about financing options that you use. Great site!
Hey Marc! I always use professionals for scouting out places. I work with a couple guys who focus primarily on long distance investing and they do all of the due diligence on the markets and check everything out on the ground and then relay the information back. Then knowing what I know about various cities, I add that to what they find and go from there. If you have a random investment opportunity in some random city, I would just Google the statistics about the city. I think the all-time biggest teller is population. If the population somewhere has been on the rise consistently for the last 20 years, you might be looking at a good market to invest in, assuming the numbers work. On the flip side, if a market’s population has been decreasing quite a bit, I’d stay away from it. The turnkeys I work with offer private financing, but if you do qualify for a mortgage I would go that route for sure because it’s by far the cheapest. Anything past that is just getting into creative methods. We can definitely talk more about those. Just let me know what your situation is and we’ll go from there!
This is great. Could you send me the same info, Ali?
Hi Ali, I read a couple of your articles on bigger pockets.com today. They were very informative and so is your website! Very well written!
I own 5 rental properties and currently have a short sale under contract(it has taken forever!) After I close this one I will need to start to explore other finance options as well. Could you send me what you mention above as well? Thank You!
Hey Gordon, you bet! Will email you now.
Ali, hello. I was at BP and saw some of your stuff and noticed you were also an Aerospace Engineer like me. I am just getting started and am buying the first property all cash but planning for more and am would also appreciate an email. Also, your website is well thought and nicely presented! I am working on mine now. I hope it presents as well.
Thanks for the compliment on my site! I’m far from a web developer of any kind so getting these things up and running tends to be a thorn in my side 🙂 I’ll definitely email you. Go Aero!
Hi Ali! I also stumbled upon your website recently. I bought my first property this year and have been bit by the real estate bug. I had a similar question to Michael’s – how do you find financing these days for investment properties? What are the channels (including private financing) that you pursue?
Hey Jenny! Thanks for reaching out. That real estate bug is a beast, isn’t it? 🙂 I’ll email you with more details.
Hey! Found your site looking for investment info. Im always curious how people get financing these days. Banks need so much info and don’t count rent/ cashflow as income. You have any tips? I’m in the process of renting my house out and want to continue buying rental properties but financing is getting me no where.
Hey Michael! Thanks for commenting. Man, I’m telling, the mortgage process has truly become repulsive in my opinion. I get they needed to tighten the lending requirements, but they have gotten really ridiculous with it. It’s almost a given they will ask you during the process for your left arm and your first born child. I hate getting mortgages. However, the terms they come with are unbeatable, so if you can qualify for a mortgage, that is the route I recommend from a cost perspective. I do work with a lot of properties where you can get 50% down private financing, and their requirements are very lax compared to the mortgages. I’ll shoot you an email with more details. Thanks again for contacting!
Great article Ali! So many beginning investors want to steer clear of the banks, but it clearly pays off to leverage. Really well laid out when walking through it!
Thanks for your comment Matt! I really appreciate the feedback. Also, I haven’t forgot about writing a new blog for you, and I’m actually working on one now, just fighting a little writer’s block and been swamped. I read all of those links you sent me though and they are awesome! Will be in touch soon.