I received an investment question which led to a long conversation.“Why do you prefer to purchase rental properties with leverage rather than buying them straight out with cash?”
The assumption was, for this conversation, that the buyer would have a million dollars to spend. Here are the highlights from that conversation:
“When investing for ourselves, we never want to tie up all of our cash, but prefer to remain liquid, for a number of reasons:
- You can never have enough cash in this business. No matter how much you have, you will eventually use it and need more. Hence the need for private and hard money investors.
- Life happens. You must be liquid to cover property damage, medical disasters, acts of nature, economic downturns, who knows what else. Don’t tie up all of your cash in anything, ever.
- No matter how good the deal, a better one will come along and, if you’re broke, you’ll miss out on it.
Possibly the most wonderful advantage of buying real estate is: leverage. Real estate is the best investment for using a little bit of money do a lot. As you explained, you could spend your million dollars to buy five $200k homes with $1500 per month cash flow, or you could buy 25 homes putting down 20% one each and getting bank loans (as many as your bank will loan against).
In your example, upon purchase you would have 5 properties with $7500 per month cash flow, and we would have 25 properties with only $5000 per month (assuming only $200 per month cash flow per property).
Our investment strategy really passes you up, however, over the next 15 years. If everything in the above example stops and stays the same, we would end up with 25 homes with $1500 per month cash flow ($37,500 per month) to your five ($7500 per month).
Our goal is long term cash flow and retirement. And all of this, when structured properly, passes on to the next generation at a stepped up basis meaning your heirs inherit at the value it is on the day they take ownership.
Which leads me to the final benefit of buying over time rather than paying cash. Taxes. In this country, there is still tremendous benefit to owning rental properties and even having mortgages. Many write offs and deductions exist in our tax structure to offset income on leveraged properties. By owning them outright with no mortgage interest deductions you will, no doubt, pay more taxes on your income. And don’t forget a huge benefit, you’re not making those mortgage payments – your tenant is.
There are certainly many ways to do real estate and you decide which works best for you. Once you’re investing and begin to learn more about the business, you’ll find that real estate becomes a sweeter and sweeter investment alternative.
To answer your final comment, the population is increasing and there is no more land being built. Interest rates are ridiculously low and so are housing prices. Do not wait to buy – you will be kicking yourself 10 years from now no matter what the market. Even without appreciation, you have cash flow, tax advantages, and someone else paying off your mortgage. Eventually, that property will be free and clear with pure cash flow. With an investment that sweet, start buying today!”
What’s your opinion on purchasing properties with leverage versus buying outright with cash?