5 Reasons You Should Only Pay Cash For Rental Properties

by Guest on April 14, 2010

rental-apartmentThis is a guest post written by Erik Folgate, an editor at Money Crashers.

Yes, you read the title right. You’re probably thinking that it’s ridiculous to suggest that you pay cash for a rental property (which I’m defining as a property you buy for the purpose of renting it out), because it’s unrealistic to think that someone has enough cash to pay for a rental property outright.

Buying rental property is especially appealing to those with an entrepreneurial spirit, because someone else is paying you a monthly income just to live in a home that you own. This makes financing a rental property sound easy. The financial risk seems low because you’re buying a secured asset that is “likely” to appreciate over a long period of time. However, I think it’s a very risky financial move to finance a rental property, similar to buying a single stock without much diversification, and I will outline my argument with 5 basic points:

1. Renting Your Property Is Not Always Easy

If your property goes a month or two without being rented, do you have the financial resources to cover the cost of the mortgage and utilities while you’re trying to rent it out? What if your renter is late on a payment? Would it cause you to get behind on the mortgage? These problems could be easily remedied if you had spent a few years saving up enough money to pay cash for the property. This way, you wouldn’t have to worry about covering the mortgage if a renter is delinquent on their payment or if you need extra time to rent out your space.

2. Being A Landlord is a Financial Risk

Many property manager amateurs that finance a rental property like it’s their primary home often make the mistake of not thinking about the worst case scenario of being a landlord. If something breaks, the renter is calling you and expecting you to fix it. If the air conditioner goes out during the summer, the roof leaks, or the water heater dies, you’ll be faced with a large, unexpected out-of-pocket expense. If you didn’t have the cash to buy the property outright, will you have the cash to pay for untimely repairs or will you finance that, too? Here are 5 more issues you’ll face when buying rental property and becoming a landlord.

3. What If Your Life Changes?

I know you don’t plan on ever leaving the area you’re in, but what if your job asks you to relocate or you have a kid and you really want to be closer to your family? Being a long distance landlord is EXTREMELY risky, and you’re asking for a disaster. So, now you have to sell at an unexpected time. You could end up losing money on your investment, because you’re forced to sell it quickly and cut your losses. If you had purchased it with cash, you wouldn’t be in such a rush to sell it, and you could wait until you received an offer that you were satisfied with.

4. You’re Banking On Appreciation

Let’s say you buy a $200,000 house as a rental property, and you put $10,000 down. The monthly mortgage is going to be about $1,100 on a 30 year mortgage, in addition to $300 a month in taxes and insurance, bringing your total expenses to $1,400. If the home is in an average suburban neighborhood, you could likely get $1,200 to $1,400 for it, so you may end up actually paying money out-of-pocket for the property over the year. The point is that you aren’t increasing your cash flow with this property. You’re merely breaking even and hoping for it to appreciate over a long period of time. If you own the property outright, you’ve got an instant stream of income that allows you to pile up a big chunk of cash in a hurry.

5. Foreclosure Is A Huge Blow To Your Personal Finances

If the worst happens and you need to let go of the property because you can’t rent it out and you can’t cover the mortgage payment, your rental property is going to be foreclosed on and your investment will be taken from you. Even though it’s just a rental property and you don’t count on it to live in, it will ruin your credit, and you won’t be able to buy another rental property or a primary residence for at least three to five years.

I know, you think I’m crazy for suggesting this…

Am I really, though? The reason this sounds so weird to you is because no one ever gives you this advice when it comes to rental properties. They tell you that you’ll always be able to get your money back out of the house if you need to go and sell it again. Tell that to all of the people who bought up properties on little money down in 2004 and 2005 and have been trying to sell off those properties for the past couple of years. If you want to get into the business of owning rental properties, you can do it with cash by setting your sights low. Look for a steal on a condo or a duplex for under $100,000. Pay cash for it, and you’ll have an instant stream of income that you can use to pile up more cash to buy your next rental property. Do this over a 10 year period, and you’ll have a nice portfolio paying you a monthly income.

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Discussion

Harold Dougherty
We have 11 units now with an average cost of $40,000 USD in South Texas. We've taken the advice you give and paid cash for our properties. Every issue you've mentioned above has happened to us. Many of the realtors and friends in the business think we are crazy. We have slept so well with our method of using cash only to purchase our rental properties. Raising the cash for our first property was the hardest. It's getting easier as the cash flows from owning all properties 100% is starting to have great synergy. Slow and steady....slow and steady...
August 23 at 09:14 am
Francis P Johnson
Why does 95% of articles on the internet give examples of buying homes for 100-200k for rental property? Who in reality spends that kind of money on rental property when they are just starting off? I would go out on a limb and say if someone is doing research on the topic, they wouldn't start out in that price range.
February 23 at 22:48 pm
Tim Thornton
Real Estate is different in every market. I don't think this applies to markets like Austin, where we are at a occupancy rate above 95% and rentals tend to go in 1 week (unless they are over priced or in bad condition). So, it really depends on the market. I would never pay Cash for an investment property in Austin. http://bit.ly/9RKc7Z Austin Real Estate Secrets.
January 2 at 17:13 pm
TC
I am 24 saving for my first investment property. At the same time, I am also financing the purchase a 2 million dollar floor covering company. If I DIDN'T finance my business, I wouldn't be able to afford a place larger than a tin can to generate CF. Nor would I have the prime location on a major road right next to Home Depot and Lowes (this is a good thing). BUT I would never finance a rental property (CRAZY) because I can buy one for under 50k and get 600 mo/ rent for it. Cash is King
September 10 at 10:22 am
Frank
Nancy,

100% of foreclosures had a mortgage. :-) One more reason cash makes sense.
July 25 at 13:33 pm
Nancy
I am surprised by the creative discussion going on over here. I agree with you Carl, Cash is King but we should not forget people are losing their money and even houses. Record number of houses are being foreclosed.
July 5 at 14:50 pm
Carl
This is why so many people struggle because they eat shut and breathe finance! They got your mind where your not suppose to ever come out of debt!! Cash is king.. You flakes
June 15 at 07:01 am
Jack
Crazy stupid to own your rental properties free and clear. People are more likely to sue when there is value. Not only should you get a mortgae you should title the property in a llc after closing. Dont ever pay cash when you can finance something for less than 7%. Most investors know you purchase one of 2 ways 1) large dp so the property cash flows or 2. Lower down payment and buy property in high appreciation areas ie a foreclosure or anywhere in the State of CA right now.
March 9 at 14:13 pm
Argos Properies
Never buy a single family as a rental. These are flippers. Duplexes if you live on one side or floor. 3-4 families are the cash cows! Paying all cash only makes sense because you have to! The banks want proof of funds on all the shorts and REO's. You won't get the deal if you need to get a loan. Happy Investing...
January 9 at 16:54 pm
Landlord
If your investing in real estate, or any business, it is ridiculous to do so without leverage. The tax advantages from debt far outweigh the benefits of paying in cash (finance 101).
January 5 at 23:08 pm
Brian
Also remember to be careful with HOA's there is additional risk in these types of properties, such as restrictions on renters, and having to pay extra money each month for a reserve that could easily be wiped out by a foreclosure within your HOA.
September 17 at 16:52 pm
The Investor
Real estate is a great investment and 7% of the worlds billionaires are billionaires because of it or are investing in it so I am for real estate and especially paying cash for it.
July 7 at 23:17 pm
pamela
Ineed help forcash tohelp pay for problem that accummillaed through out about 91/2 years.
June 15 at 15:52 pm
Parag
Those points a justifiable. The owner must make a legal agreement with the owee regarding all the expenses that needs to be paid during the course of staying at the house. For example: if at all the air-conditioner does not work properly, the person staying must be liable to pay the expenses for repairing it.
May 31 at 02:29 am
Finance
Real estate definitely is a great investment option !!

Finance
April 28 at 02:24 am
Finance
Real estate definitely is a great investment option !!
Finance
April 28 at 02:23 am
Alex
I agree that you should be careful on how much leverage you user, BUT ff you do not use leverage in real estate then stay away!
April 14 at 23:35 pm

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