Why Buying Rental Property in Cash is a better idea?
You have turned yourself on the path of wealth creation by investing in rental properties. However, there are two different roads you can take on the way to wealth creation. Traveling on the first road, you can buy rental properties with leverage. On the other road, you can buy rental properties with all cash. If you are to use some kind of leverage, there are various financing options available in the market today. But, if you choose the other road and have cash sitting in your pocket, you should definitely go for buying rental property in all cash.
Buying a rental property in all cash reduces the risk of your investment. Your invested money can generate higher profits if you are paying all cash for the rental property. Leveraging however is a great tool and can work wonders for a lot of investors. But for the investor who can`t risk their capital, it is better off to buy rental properties in all cash.
Why Buy Rental Property in all Cash?
Buying a rental property in cash has by far the highest advantages in terms of risk management and profitability as compared to leveraging. But for today`s investor, the chance of buying rental property in all cash is less. The market rates are at all-time high. Hardly have investors all the money to put in a deal unless you know the art of making big money by investing less in small income neighborhoods. However, if you can buy a rental property in cash; you can experience these benefits.
1. Good Deals
Having cash sitting in your hand, you can go and make a quick purchase if you want. But, if you have to do the same thing with a mortgage then there is a lot to be done before you can actually make a purchase. Furthermore, the chance of getting a good deal from a motivated seller is likely to be very high. You can easily negotiate for lower prices if you can make the purchase right away.
Having cash in hand and the ability to purchase it right away, the seller can allow a 10%-20% discount from the market rate. The seller likes to have a quick and smooth sale. And, you were having all cash for the purchase, the seller will have a 95% chance of making the sale. Think of a 10% discount on $200,000 property which can instantly save you $20,000. A 10% discount can be a sweet profit you have earned already because of paying in all cash.
2. Lower Monthly Expense
The monthly cash flow you get from the rental property belongs to you completely if purchased property in all cash. You need not pay any part of your cash flow in the mortgage payments. Your monthly expense goes down as you have no monthly mortgage payment.
But with a leveraged property in general, where you have put only 20% down; about 70% of your cash flow goes into mortgage payments. Every month, you need to pay the mortgage as your monthly expense. No matter if something goes wrong with your property; you still have an expense to pay off.
Think of occurring to a vacancy or getting a bad tenant on your property. You can really have a hard time coping up with mortgage payments in these cases. But with the cash purchase, all the money you make after deducting expenses is your profit. You are not bound to a monthly expense of mortgage payment.
3. Low Risk of losing money
The risk of losing money on a rental property with all-cash purchase is moderately low. A lot of new investors see rental investing as a virtue of leveraging and appreciation. Having money to put 20% down, you are ready to get a mortgage and start your rental business. You may feel the appreciation will favor you but that is not always the case. On the contrary, the investors who see rental investing as a recipe for leveraging and count on only appreciation already had their lessons in the past. Try and recall the 2008 Market Crash.
Consider a person who has bought a $200,000 rental property in all cash. And on the other side, you have bought a similar home in the same neighborhood by putting $40,000 as 20% down and leveraging other 80% from the bank.
Suppose for the first two years, both properties appreciate and the value of the property becomes $210,000. Your $40,000 now becomes $50,000 on paper. But what if depreciation hits after these two years? A depreciation of 10% and the value of the property now becomes $189,000.
Do you know how much loss you have suffered in comparison to the person who has purchased the property in all cash? The all-cash investor just sees a mere loss of $11,000 on the invested equity. But in your case, your $50,000 equity has now reduced to $29,000 only.
The equity loss of 42% happened in the case of leveraging. An all-cash investor may recover $11,000 loss but how will you cope up with a 42% equity loss? A rental property that was purchased in cash has less risk of losing money.
Suppose you are forced to sell the property at this point, how will you cope with the risk of losing 42% of your money? A small investor who has leveraged property always remains at a high risk of losing money.
4. No Need to Qualify for Loan
Buying a rental property in all cash is a hard thing but getting a loan and then buying a rental property is even harder. Qualifying for a loan is something that depends upon your credit score, income, and various other factors.
It is very hard for you to secure a loan If you have a credit score below 680. A foreclosure, bankruptcy, bounced payments or even a minute blemish on your credit reports in the past can mess up your chances of getting a loan. There is no better than having cash available for purchasing a rental property.
You got a deal, have cash; the deal can be closed instantly without the need of wasting time looking for financing. There are lots of formalities and paperwork to be done before you can get a loan for buying a rental property. This consumes time and you are always at a risk of losing a good deal at that time. Furthermore, it is a lot difficult to get finance for an investment property than a simple home loan.
5. Low Closing Cost
Qualifying for a loan and then getting the loan amount sanctioned is one difficult thing. But even after getting the loan amount sanctioned, you still need to bear a large mortgage closing cost. A homeowner who purchases a rental property has to spend somewhere about 3%-5% of the purchase price of the property in closing costs. A new investor who is using leverage to buy rental property can spend a lot of money at closing costs.
Not being prepared and hasn`t compared different loan estimates from lenders, you can have unexpected costs at closing. The investor who is buying rental property in cash can save a lot more in closing costs than an investor using leverage.
A lot of money can be saved with cash purchase as you now don`t need to pay any credit report charges, loan origination fees, mortgage insurance, and lender fee. You can easily save about $4000 on closing costs on a typical $200,000 rental property if you make a purchase with all cash.
6. Money Saved is Money Earned
It is a wise saying that money saved is money earned. Paying all cash for the purchase of rental property is far cheaper than what you pay for it by using leverage. On average, the investor pays about 85% extra for a property purchased through leverage having a 30-year mortgage.
For a typical $200,000 rental property, you pay about $164,000 more in interest on a 30-year mortgage at 4.5%. A $200,000 has now cost you $364,000. Do you think, you can anyway make up this 82% cost.
All the lending institutions have created a myth for the investors. These institutions play with your mind and make you believe that you are using good debt. But on the contrary, there is nothing called as good debt. Think yourself, how much more effort you need to do to earn that extra money you spend in the interest.
Furthermore, if you closely evaluate, the money you have saved is worth more than the money you are earning today. You need to pay taxes on the money you earn. But, the money you have today with you is the money you have saved after paying the taxes. It is always good to use cash for your purchase if you have the money sitting in your bank.
7. No-Risk of Foreclosure
Having an all-cash purchase; you simply had no risk of foreclosure. It is your property which is free and clear. The investor who uses leverage is always at a risk of foreclosure. For a pretty new rental investor, the risk of foreclosure is high.
If anything goes wrong with the rental business, and you suffer a hard time paying the mortgage. Your rental property will be gone and you are wiped out of the business. The Mortgage payment for most individuals is the biggest burden of their month.
And if you know, the rental business is always exposed to vacancies. The landlords who are operating at around break-even are at a higher risk of foreclosure. A $180,000 mortgage on a $200,000 for 30 years at a rate of 4.5% has around $800 of monthly mortgage payments.
A $200,000 home generally rents at a rate of $1500. Suppose you also need to spend $200 in maintenance and around $300 in taxes and landlord insurance combined. Then you only left with $200 cash flow. Now think if a vacancy occurs for just two months, you are behind $3000 already. You will need at least 15 months to cover this cost.
An investor paying more than 80% of his rental income in mortgage payments is at a risk. Even a two-month vacancy in your rental business can unsettle your chores. Being an all-cash investor, you need not worry about any vacancies and foreclosures.
The Bottom Line
Buying a rental with all cash can be a safe bet if you have money sitting in your account. However, if you lack the cash, you have to anyway use leverage. Some investors may also debate the risk of putting a lot of money in one asset if you are buying in all cash. But, knowing how to operate your landlord business, you can minimize the risk. For cash investors, it is much profitable to use cash for purchasing a rental property.