Stock market investors often brag about 15% or 20% returns. They hope to turn a $5,000 investment into $5,750 or maybe $6,000.
By contrast, a good real estate investor can turn $5,000 into $20,000 – a 400% return! That’s a lot better, but a great real estate investor can make $20,000 on the same property using only $500 of his own money.
The name of the game is not how much money you make, but how little of your own money you need to use in order to make it.
Leverage is the Key. One of the greatest advantages of investing in real estate is your ability to use leverage.
When a stock investor wants to buy $5,000 in stock, he generally has to use $5,000 of his own money.
Banks will not loan money to someone for the purpose of “speculating” in the financial markets. So in order to use a banker’s cash, stock investors have to take out personal loans. These loans are seen as riskier than loans for property and have higher interest rates.
Truthfully, stockbrokers will lend up to 50% of the purchase price of a stock – but only on certain, low-risk stocks, and since these stocks are comparatively low risk, they have less potential to really strike it rich.
On top of that, margin interest rates, while lower than personal loan rates, are still much higher than the interest you could expect to pay on a mortgage.
Instead of using $5,000 in cash to buy $5,000 worth of stock (or even $10,000), real estate investors can use $5,000 as a down payment on a $50,000 home. If each investment increases in value by 10%, the stock investor will have a profit of $500, while the real estate investor will have recouped his entire investment of $5,000.
Which scenario sounds better to you?
The Cash Perspective – Pros
There are real estate investors who use plenty of their own cash and scoff at the notion that doing so is in any way a bad idea. After all, cash allows them to get deals done faster, and often motivated sellers will accept a lower offer that promises to close quickly.
Cash also affords investors more of a safety net, as losses are limited to the amount invested. If an investor pays for a $300,000 triplex in cash, he is risking less than he would be if he put 10% down on a $3 million apartment building.
The Cold, Hard Cash Reality
The problem with using your own cash is that once it’s used, it cannot be applied elsewhere. While using your own cash limits your risk, it can encourage more dangerous investments. After all, if you’re really concerned about not being able to pay back the bank, then how wise is your investment?
If a lender won’t provide you with funds, perhaps your diamond property is more of a Diamonique. In fact, it’s said that experienced real estate investors often make their worst investment decisions when they have a lot of cash on hand – they are tempted to do things that they otherwise wouldn’t!
When to Use Your Own Cash
Of course, having at least a modest cash reserve makes doing business a lot easier. As stated, motivated sellers are sometimes more interested in getting a deal done quickly than holding out for the highest selling price.
Nothing moves a deal faster than having a suitcase full of cash (or more responsibly, a cashier’s check!), and if you’ve already got a new buyer lined up, using your own money this way can be a good idea.
The other exception to the “never pay in cash” rule is in the case of IRA (individual retirement account) money. Unbeknownst to much of the public, funds in self-directed IRAs can be used for all-cash real estate investments.
Unfortunately, most IRA custodians will not allow you to do real estate deals, but two that will are Equity Trust Company and Entrust Administration. See their web sites for more information.
The More Appropriate Question – How to Use Your Cash
The real question is not when to use your cash, but rather, how to use your cash.
The answer in real estate investing is no different from other start-ups: Marketing and advertising. If you’re able to put just $500 of your own money down on a property (on which another investor might have eagerly dropped ten times that amount), you can use the other $4,500 to drum up more business.
Real estate investing is a numbers game, and you need to reach a lot of people to find that one special deal. Using as little of your own cash as possible grants you the flexibility to be ready for the diamond property amid the sea of cubic zirconias!
Source: William Bronchick, J.D
Dy Associates is an Oakland Real Estate company specializing in commercial, home and investment property in the Oakland and East Bay Area. We provide real estate services including buyer agent, seller agent, short sales, commercial and investment acquisitions, loan facilitation, hard money lending, financing assistance property management. Articles are provided as information only. We do not provide legal or general investment advice.