Key Takeaways
- Financing Allows for Greater Growth and Flexibility – Choosing to finance a rental property instead of paying cash allows investors to diversify their portfolios, scale their businesses more rapidly, and keep more liquidity for future investments or emergencies. By leveraging a smaller down payment you can potentially acquire multiple properties with the same capital, spreading risk and increasing income potential across several rental units.
- Cash Purchases Offer Stability and Higher Monthly Cash Flow – Buying a rental property in cash reduces many risks and costs associated with financing, such as loan approval issues, lender fees, and long-term interest payments. A cash buyer also holds a stronger position during negotiations and can enjoy higher monthly cash flow, since there are no mortgage payments to account for.
- The Right Choice Depends on Your Financial Goals and Risk Tolerance – There’s no one-size-fits-all answer when choosing between financing and paying in cash. Each option has its pros and cons and depends on your personal investment strategy and comfort with risk. Partnering with a professional property management company can help you make the most informed and strategic choice.
Renting out a property can be lucrative to your bottom line. You can enjoy a recurring income, enjoy some tax benefits, build equity over time, and diversify your investment risk, among others.
But how do you finance a rental property purchase? In this blog, we at Blue Bridge Management will go through the two options so that you can make an informed decision!
Reasons to Finance Your Rental Property Investment
The following are some reasons why purchasing a rental property investment makes the most business sense:
You Can Diversify Your Investment Portfolio
Suppose, that you have $100,000 that you are looking to invest in real estate. One option would be to buy property worth that amount in cash. However, the other option would be to spread that money across different property investments using downpayments.
By diversifying your investment portfolio, you’ll be able to hedge against certain potential risks. An example of a potential risk would be renting to a difficult tenant who refuses to pay rent or causes negligent property damage.
You may Scale Your Real Estate Business Faster
Being able to buy multiple investment properties all at once can quickly set you up for successful real estate investing. Rather than generating rental income from one property, bought in cash, you could scale multiple properties.
This could help you quickly speed up your real estate success and returns. You’ll still enjoy benefits such as property appreciation, passive income, and tax benefits, just in a shorter time frame.
You’ll Have Easier Access to Your Money
One con to real estate investing is having capital tied to an investment. If you, for instance, use all the capital you have to buy a single property, you’ll have essentially locked it up. To access the cash, you’d have to either sell the property or take on some debt.
But this is different from property financing. With financing, however, you’d only need to pay a down payment towards the cost of acquiring the house. Downpayments are typically around 20%. You could then use the remaining money to invest in other properties or put it towards savings.
You Can Maximize Your Income
Using financing to purchase a rental property can significantly increase your return on investment compared to buying the same property outright in cash. For example, a $100,000 property purchased in cash with $450 in monthly expenses and $1,100 in rental income yields an annual net income of $7,800. This means you gain 7.8% ROI.
However, when the same property is financed with a 30-year mortgage at 5% interest and a $20,000 down payment, the monthly mortgage payment of approximately $430 reduces the cash flow to $220 per month. This results in an annual return of $2,640, which represents a 13% ROI based solely on the initial $20,000 investment.
While financing can enhance ROI by allowing you to leverage bank capital and preserve liquidity, it comes with additional considerations. Ensuring that monthly rental income exceeds all expenses is essential to maintaining positive cash flow. Investors must account for variables such as interest rates, loan terms, and potential vacancies when evaluating the long-term viability of financing.
Reasons to Buy Your Rental Property in Cash
The following are some reasons why you should consider this financing model in your next property purchase:
Minimize the Risk of the Deal Falling Through
Cash purchases are usually straightforward. You simply pay what the seller wants and own the property.
However, with financing, you’ll be relying on a third party for a successful purchase. And the deal is not always guaranteed, which could jeopardize your investment goals.
Better Negotiation Skills
Buying a property in cash can give you a competitive edge when it comes to negotiations. Sellers will usually go for cash offers instead of financing models. In fact, offering an all-cash deal can even convince the seller to lower their sale price.
Avoid Paying Certain Fees
When financing a property purchase, there are certain costs you’ll be liable for. One of these is lender fees. This is money you’ll have to pay for the processing, underwriting, and funding of the mortgage loan. These can quickly add up.
The other fee you’ll be avoiding through a cash payment is interest costs. With a 6% mortgage interest rate, you’ll most likely end up paying more interest than the loan itself.
Higher Cash Flow
Paying in cash means you won’t have the burden of paying any mortgage interest every month. This would mean keeping more of the rental income you generate.
Bottom Line
So, which option should you go for? Your choice should depend on your unique situation and investment goals. Consider things like your risk appetite, long-term goals, and financial situation.
Working with a property management company can be the best decision you can make. Blue Bridge Management can help analyze your situation for an informed decision. Get in touch with us today!