This 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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