Buying Real Estate with Leverage Rather than Cash – Why Would You?

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?

4 Comments

  1. My husband and I have a question about your article Why Buy with Leverage Rather than Cash. On July 24, 2012. We are both Realtors licensed in Nebraska and South Dakota and have purchased our first short-term furnished rental property. In your article you say: if everything in the above example stops and stays the same, we would end up with 25 homes with $1500 per month cash flow ($37500 per month) to your five ($7,500 per month). We don’t understand how the original $200 per month cash flow per property ends up being $1500 per month and the 4 properties with $7500 per month cash flows stays the same. We mainly don’t understand why the $200 cash flow per month turns into $1500 per month cash flow.

    Also when you say “cash flow” could you define what is really meant by that. Thanks!

  2. Hi Kaye:

    That is explained (I think) in the paragraph that begins “Our investment strategy really passes you up, however, over the next 15 years.”

    In that time, all of our properties get paid off so our cashflow increases over that time from $200 per month to $1500 per month on each free and clear property. I do say that everything else, for the sake of the example, stays the same. Historically, rents on every property have increased over 15 years, but I kept the numbers simple for the example.

    Does that answer your question?

    Thanks for reading and thanks for asking your question.

    Wishing you tremendous real estate success!

  3. Hi Karen,

    I listened to your podcast on Bigger Pockets today; good stuff! I am just getting started and I have two properties that my dad purchased a while back (with no mortgages owed), but that have been transferred legally into my name, as a means for me to have some collateral to get started.

    Are you aware of banks that will extend a line of credit with these properties as the only collateral? Or must I just look into some kind of cash-out refi to use that equity to go by more houses?

    Thanks for all of the great insight.

  4. Hi Reggie:

    It depends on your credit, the value, condition, and location of your properties – but, if everything checks out, the banks should extend a line of credit against that equity.

    The best thing to do is go to the lenders and discuss with them. They’ll tell you what they have to offer. I would check with a large bank, a local small bank, and a credit union to find the best deal for you.

    Good luck to you and thanks for asking! BTW, please let us know how this turns out!

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