Should you pay cash for a rental property or use leverage? This is a long-debated question with pros and cons on both sides. While we aren’t going to answer the cash vs. leverage question here, largely because there’s no blueprint for successful real estate investing, we will share our top reasons for paying cash for a rental property and why. We’ll also cover the risks of paying with cash, investment strategies to minimize these risks and other helpful resources.
11 Reasons Why You Should Pay Cash for Rental Property
1. Lower Closing Costs
One perk of buying a house outright with cash is that it cuts way down on closing costs. Paying cash for a rental property will avoid costs associated with getting a mortgage. You won’t have to pay lender fees, origination fees, mortgage insurance, title insurance and other fees associated with financing a rental property.
2. Higher Cash Flow
Buying an investment property in cash will undoubtedly produce higher cash flow. This is because you won’t be paying a mortgage on the property every month. A rental property purchased with cash should immediately start seeing cash flow when a tenant moves in.
Calculate the cash-on-cash return to determine your potential return on investment. This figure will be the most helpful in understanding the cash flow or return on your investment.
3. Quicker Buying Process
Another reason to pay cash for rental property is that it expedites the buying process. Cash investors can purchase faster rather than waiting on the mortgage process. A typical mortgage process can take anywhere from 30 to 45 days to close.
Additionally, you don’t have to worry about qualifying for a loan. Your credit score and income are irrelevant if you pay cash for a rental property or home.
4. No Debt
If given the choice between debt and no debt, it’s hard to imagine a single person choosing to have debt. Obviously, it would be nice to be completely debt-free. And if you are, congratulations! You are one of a small percent. If you have the financial capacity to pay cash for a rental property, opt out of debt and start seeing monthly cash flow sooner.
5. No Interest Payments
As with any debt, a mortgage comes at a price. Financing a rental property will result in paying interest on the borrowed money. Your interest rate will depend on your credit score, liquid assets, how much you put down, and the length of the loan.
Paying for a rental property in cash allows investors to completely sidestep the expense of interest payments, saving thousands of dollars. Although mortgage interest is tax deductible, it can significantly impact your cash flow. If your rental income is the same as your mortgage payment, you won’t be making anything on your investment.
6. Equity
Buying a rental property outright by paying cash gives you 100 percent equity in the home. We can’t talk about equity without also talking about appreciation. Real estate appreciation is how the value of an investment property increases with time. Appreciation is why we strongly encourage a buy-and-hold strategy in real estate investing.
Let’s use an easy example. You buy a rental property for $100,000 and see a $15,000 equity increase due to appreciation. That gives you 100 percent equity in a $115,000 property plus monthly cash flow from rental income.
7. Attractive to Sellers
Most of the time, sellers will take a cash offer over all other offers. Some sellers will even give a small discount if buyers pay cash as it helps them avoid the financing process and close quickly. There’s also less risk of the deal falling through if the buyer doesn’t get approved for financing. Cash buyers simplify the process for both buyers and sellers.
8. Lower Monthly Expenses
Choosing to go the cash route to buy a rental property will hugely lower your monthly expenses. Of course, you won’t be paying a mortgage, but you will also cut out loan interest, mortgage insurance (if necessary), and title insurance.
9. No Risk of Foreclosure
Paying cash for a rental property allows a real estate investor complete ownership of the property. Because you own the property outright, there is no risk of foreclosure or losing the property.
Yet another reason to pay cash for rental property is that it is less likely you will lose your entire investment. Even if the market takes a downturn, you still have 100 percent equity. And as with any market, the real estate market fluctuates. Once again, holding onto an investment property long-term is our favorite investment strategy.
10. Vacancies Aren’t as Scary
A constant concern for real estate investors is vacancy. When a property is left vacant, the investor loses money. Vacancies are less scary when a rental property is bought with cash because you don’t have to stress about rental income covering your upcoming mortgage payment. If a property purchased with cash is vacant, you aren’t going to lose as much.
11. More Control Over Property
Not being at the mercy of making monthly mortgage payments and interest will allow for more control over your investment property. Almost all of your rental income will be profit, minus related expenses like management and property taxes. All appreciation gains are tied directly to the property with no interest.
Risks of Paying Cash for Rental Property
Please keep in mind that every investment comes with risk. Buying rental property in cash requires a large amount of disposable income, not only to purchase the property outright but to also have enough cash reserves to maintain the rental. With that in mind, here are a few risks of paying cash for rental property and how to minimize them.
1. Less Diversification of Assets
Tying up all or most of your liquid assets in one investment can be risky. One of the hard-and-fast rules of investing is the principle of diversification. In finance, diversification is the process of allocating capital in a way that reduces exposure to any one particular asset or risk. Reducing risk and volatility can be achieved by investing in a variety of assets.
Placing most of your liquid assets into one investment can be risky because that will limit your ability to diversify your investment portfolio. However, if you feel comfortable financially putting a large amount of money into a real estate investment, go for it.
2. Fewer Tax Deductions
Depending on your tax bracket, the mortgage interest deduction can save you a lot of money. Because you can write off a certain percentage of your mortgage interest, investors who pay in cash won’t see the same tax deductions and advantages.
However, some of these tax deductions are not as beneficial if you are in a lower tax bracket. For example, if you borrowed $200,000 at 4.5 percent, you will pay almost $9,000 of interest in the first year. In the lower tax bracket, you could deduct about $1,350, but that would mean you would still be paying around $7,650 in interest.
(Please note: These figures are estimates. I am not a tax expert.)
3. Less Liquid Assets
Pouring a good chunk of your liquid assets (cash) into one property may be considered risky, especially if you practice diversification in your investing. Another investment strategy, in an attempt to minimize risk (and diversify), is using the same amount of money to buy multiple properties with a mortgage. While you will be investing a large amount of money in real estate, your entire investment won’t depend on a single property. Rather, buying several properties through leveraging may appear to be less risky for some investors.
How RealWealth Helps You Learn & Invest
Whether you are looking for reasons to pay cash for rental property, researching different real estate investment strategies, or simply trying to expand your investing knowledge, our team at RealWealth is here to help. When you join RealWealth (membership is free), you have full access to our library of webinars, resources and the support of an investment counselor who is also a seasoned real estate investor. They can help you build a real estate investing strategy based on your goals and connect you with property teams selling professionally managed turnkey properties. Start diversifying your investments, join RealWealth today!
