UnThreaded | Threaded | Whole Thread (11) | Ignore Thread Prev Thread | Next Thread
Author: footsox Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 127714  
Subject: Paying Cash for an investment property Date: 6/9/2013 3:14 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
I think this was touched upon in the previous thread but I wanted to start a new thread and toss this around. Here is our situation - we are going to retire in less than a year. We are hoping to buy a couple or rental properties (one of them, we have already made a cash offer and it has been accepted). Here is our reasoning - we have about 60% of our funds in the stock market and basically just wanted to diversify a little. So, we can either take money out of our credit union (which of course pays almost zero interest) and just buy the house with it. Or we can get a mortgage. We have been pre-approved for a mortgage on this investment property. Our credit scores are in the 800's, so no problem there. Interest rates on this mortgage will be in the 4% range, because it is an investment property (we have been told). If we buy it with a mortgage, there will be some additional closing costs - points, and appraisal, etc.

So, toss this around -- if we just pay cash for this house, it would be like getting 4% interest on our money (since no 4% mortgage) right?

So, where else would we get 4% on our money (if we are not putting it in the stock market). So, my question I pose, is why get a mortgage at all? This is almost like finding a CD that pays 4%... isn't it?

Well, I am sure I am missing a multitude of things here, so wanted to hear your thoughts. Some would say we should get the mortgage, so we could deduct the mortgage interest.. but if we are not paying any mortgage interest, there would be no need to deduct it. Can't wait to hear some thoughts on this. Thanks.

Footsox
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Print the post Back To Top
Author: inparadise Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125476 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/9/2013 7:16 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 3
we have about 60% of our funds in the stock market and basically just wanted to diversify a little. So, we can either take money out of our credit union (which of course pays almost zero interest) and just buy the house with it. Or we can get a mortgage. We have been pre-approved for a mortgage on this investment property. Our credit scores are in the 800's, so no problem there. Interest rates on this mortgage will be in the 4% range, because it is an investment property (we have been told). If we buy it with a mortgage, there will be some additional closing costs - points, and appraisal, etc.

So, toss this around -- if we just pay cash for this house, it would be like getting 4% interest on our money (since no 4% mortgage) right?


Either this rental is very cheap or you are keeping way too much in cash. I would look for a better investment for your funds. We are currently earning about a 12% return on our savings in an account that has been set up with a low risk philosophy, since we are also close to retiring.

Personally, I would get the mortgage. Rates are going up and this opportunity will not likely present itself again in our lifetime, particularly since you will be retiring soon and obtaining a mortgage will become more difficult. And when rates go up, rates on things like CDs should go up as well, with you having the mortgage locked in at 4%. But you will have the funds liquid in you accounts ready for anything you need or desire, including paying off your mortgage if you wish.

IMO, not getting the mortgage now will minimize future opportunities. I would have absolutely gotten one on the place we paid cash for if I could have, but it was too good an opportunity to pass up.

IP

IP

Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Print the post Back To Top
Author: ToddTruby Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125477 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/9/2013 7:54 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 1
So, where else would we get 4% on our money (if we are not putting it in the stock market). So, my question I pose, is why get a mortgage at all? This is almost like finding a CD that pays 4%... isn't it?

Your plan might be sound, but your financial analysis is not. Taking the money from cash and putting it in real estate is only giving you diversification because you have too much "CASH" (assuming you have enough cash after buying real estate) You can't compare your cash return of near zero interest to the 4% mortgage because that money should not be earning 4% to begin with, it should be invested.

Print the post Back To Top
Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125478 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/9/2013 11:37 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 3
So, toss this around -- if we just pay cash for this house, it would be like getting 4% interest on our money (since no 4% mortgage) right?

No, avoiding interest paid is not the same as earning interest. It would actually be putting your cash into an illiquid asset that has the potential to gain at or near the rate of inflation, unless you are in an area that goes through another housing bubble, plus provide you with some dividend type income in the form of the rent net of the costs of maintenance, repairs, improvements, property taxes and insurance. Of course, since there are those additional costs and work, it's not as simple as sitting back and collecting dividends.

So, where else would we get 4% on our money (if we are not putting it in the stock market). So, my question I pose, is why get a mortgage at all? This is almost like finding a CD that pays 4%... isn't it?

Again, avoiding interest paid is not the same as 'earning' interest. At a 4% mortgage rate, if your rental property can't earn enough rent to cash flow to pay for the mortgage, taxes, insurance, maintenance, repairs and improvements, and still provide you some additional income for the work and effort you will be putting in, it's not a good property for a rental.

And that will keep your cash available to invest in other things, like say, target date bond etfs, where you know the rate of interest you will earn, and the term you will earn it for, and what year you will be getting your principal back, assuming you hold to maturity. You will be taking on a risk that some of the bond investments will declare BK and won't pay the full principal back, but even in a BK, bondholders often get some type of a payment or equity in lieu of the full principal repayment.

Or you can do like I am doing, and invest your money in dividend paying stocks, preferred stocks and individual bonds. Even with all of the calls that I have had recently, and having to re-invest capital at a lower rates, I am still earning about 8% on my invested capital (with a nice capital gain), and almost 6% on the current value. Yes, there are risks that some of the issuers will stop paying and/or go BK. But if you have enough cash to buy 'a couple' of rental properties, you should be able to create a diversified enough portfolio that you will limit your risk. Since you will have the rental income to pay the mortgage, you won't need to use the income like I am - to pay the mortgage on my residence - but instead, can use the income for current expenses.

Some would say we should get the mortgage, so we could deduct the mortgage interest

That's a side benefit, but not a reason to get or not get a mortgage. The reason to get a mortgage is to keep your capital available for other types of investments that can pay more than the mortgage is costing you, and/or have the potential to gain more than the rate of inflation. I would agree with others, if you have enough cash to buy 'a couple' of rental properties for cash, you are exposing yourself to the risk of lost purchasing power by holding so much cash. By putting that cash into illiquid rental properties, the gain on your asset (the rental house) is likely to provide a return that's going to keep your purchasing power about the same, once you cash out, and it should throw off some nice rental income, net of costs.

If you aren't willing to put your cash into investments, and instead, would leave it sitting in a CD, then this might be a decent investment for you. But I would strongly suggest that you are taking a significant risk of having an illiquid asset that can't be easily cashed in, compared to more easily marketable investments.

AJ

Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Print the post Back To Top
Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125479 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/9/2013 2:26 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 1
Hi Footsox,

Interest rates on this mortgage will be in the 4% range, because it is an investment property (we have been told).
<SNIP>
if we just pay cash for this house, it would be like getting 4% interest on our money (since no 4% mortgage) right?

No, if that were true I would be making a "profit" of $90,000 every day I pass the local luxury sports car lot and decide not to buy one. Nice in theory... but not real money.

Your net return would be your gross rent revenues, plus gross appreciation, minus the costs of your cash (the alternative returns on an equal risk, equal timeframe basis... a conservative number is 6%,) minus management costs, taxes, and anything else nibbling at your cashflows.

And whenever you hear peorple talking about "depreciation" being in a landlord's favor... it is, but not the way most people describe it. 'Depreciation' is an interest-free loan that the government gives you to reduce your tax payments along the way... but they demand the loan be repaid back in full from yoru sales price when you sell. It doesn't even matter if you actually take advantage of their 'loan'... they'll keep track of how much *THEY WOULD HAVE* loaned you, and demand it all be paid back from your sales price (even if you didn't actually use their loan proceeds at all!)

After you figure your real net return (if its positive at all while foregoing the alternative safe return rates) then you'd divide it into your acquisition cash required, in order to determine your real rate of return.

So, where else would we get 4% on our money (if we are not putting it in the stock market).
Eliminating the stock market as an option, but staying in equivalent timeframe & risk, I can think of two places right off the top;
1. Fully leveraged SFR rental real estate (currently yielding 8-12%, depending on the market,) and much higher potentials for sharp, active investors that don't buy retail,
2. Indexed Universal Life contracts (which yield 6-8% tax-free, conservatively.)

There are most definitely other safe, high yield opportunities in specialty niches... often "insider deals" like when a doctor knows about a medical device startup that needs seed funding, or such.

So, my question I pose, is why get a mortgage at all? This is almost like finding a CD that pays 4%... isn't it?
No. The costs you avoid are not returns. They are merely costs you avoid. You have to include all the pieces of the picture to get the full view.

Some would say we should get the mortgage, so we could deduct the mortgage interest.
Deducting mortgage interest as a business expenses is just one item on the whole P&L... almost never a complete game changer by itself. If you incur a $1 of expense resulting in $1.50 of revenue, it might be a smart move to make.

Cheers,
Dave Donhoff
Leverage Planner

Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Print the post Back To Top
Author: sykesix Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125481 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/9/2013 3:29 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
As other's have said, I don't think you are looking at this at quite the right way.

What you need to do is look at the net income (not considering the mortgage) divided by the value of the property. Let's say you would make $9K/year and the thing is worth $100K, or 9%. That's conceivably how much your return on investment would be if you paid cash.

Let's do a thought experiment. Let's say you borrow 100% of that 100K at 4% interest in order to get the $9K. Your return on investment is...infinity. It is free money (not county transaction cost of course. If you borrow 90%, the ROI is no longer infinity, but it is still much higher than 9%. 80% it is less, but still higher than 9%, And so.

So as long as the first calculation is higher than the cost of money, you want to borrow as much as you can.

Print the post Back To Top
Author: reallyalldone Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125490 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/10/2013 4:09 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
As I said before, unless it was the only way to buy it(and maybe not even then), I wouldn't buy a rental property with cash.

Have you actually done a spreadsheet on owning this rental to see the expenses, tax implications and possible income ? What kind of insurance do you have ready to go on the property ? Will you be managing it yourself ?

There are lots of other posts in all the threads you have started about this. If you aren't getting the answer you want, you might consider that there's a good reason for that.

Print the post Back To Top
Author: footsox Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125491 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/10/2013 4:11 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Hi Inparadise - If you don't mind me asking, you mentioned you are getting 12% on your money. Do you mind telling me where you are getting that? Thanks.

Footsox

Print the post Back To Top
Author: footsox Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125492 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/10/2013 4:21 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Thanks for all the great posts. I surely need to do more homework. Back to work on it for me. Thanks for throwing our several things for me to consider. I appreciate it.

Footsox

Print the post Back To Top
Author: CCinOC Big funky green star, 20000 posts Top Recommended Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125493 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/10/2013 4:25 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
As I said before, unless it was the only way to buy it (and maybe not even then), I wouldn't buy a rental property with cash.


I agree with reallyalldone. One of the unique benefits of investing in real estate is the ability to use leverage to increase the ROI (return on investment). If you're not going to exploit leverage, there's not much point in investing in an asset that requires oversight to the degree that real estate does.

Print the post Back To Top
Author: inparadise Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 125495 of 127714
Subject: Re: Paying Cash for an investment property Date: 6/10/2013 7:33 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
If you don't mind me asking, you mentioned you are getting 12% on your money. Do you mind telling me where you are getting that?

We went with a financial planner a couple of years ago when we decided to lower our risk tolerances. He manages the account with a combination of stock funds and corporate bond funds, US and international. It has been really nice to give the work of managing our accounts over to someone else. I didn't know investing beyond buying stocks, and really didn't want to spend the time learning how to taper my risk exposure.

IP

Print the post Back To Top
UnThreaded | Threaded | Whole Thread (11) | Ignore Thread Prev Thread | Next Thread
Advertisement