A lot of people ask this question in forums for real estate investing. Usually, they already have one cash funded property and they’re thinking about going and get credit for the following properties, but are afraid the strategy fails. Sometimes, they already have credit funded properties and wonder if their credit is too large. However, what is not trivial to see is that all these investors suffer from the same problem: fear. In theory, we only buy rental properties where the demand for them is high. So if we do believe we’ll have tenants, what would on earth stop us from buying all credit, other than not qualifying for more?
Long story short, all cash funded properties are incredible tools, and so, it does make sense to buy some properties all cash. Why? Two main reasons: first you increase your income, which enables you to qualify for more credit in the long run. Second, you can borrow against these properties.
I tried to solve the question of the post, and here’s what I came up with:
Obviously, the perfect ratio depends upon many variables, and the only way you can define the perfect ratio for your specific case is by putting a weight on these variables. They are:
- The amount of risk you’re willing to take. If you’re young and healthy, you can probably go all in, but if you have already some properties and are in your mid thirties upwards, you’re probably not willing to risk much.
- The expectancy of having tenants in the next 40 years. There are short, medium and long term investors. Some buy flats they can pay in 6 or 7 years, because there is a factory on the other side of the street and the demand is such that you can charge whatever you want of rent and still have tenants. Even if the factory relocates to another country in 10 years time, you’re still fine with it (you’ve got your investment back, made some nice cash and you’re willing to cut down the rent). This is the time of property you probably don’t want to have a 40 year mortgage on.
- The cash flow you can make on your properties. Remember: don’t get winners paying losers. So even if you buy with credit, make sure that there is free cash flow. And make sure that with say a 50%-70% occupancy rate you can still pay all the mortgages and generate some (even if small) cash flow.
- Your strategy. Buy and hold is tailored for credit, flipping is not. Do you want to buy and hold, or do you expect to build a big portfolio and sell it? If your strategy is building passive income streams for the rest of your life (which is highly connected to early retirement), you can wait way more than if you want to pay off your portfolio fast and liquidate it.
- How much you can make with your own money. You should look at RE as an investment that delivers between 6% and 8% net ROI (if you’re not generating this, you are not negotiating your deals as much as I do – I need 6% minimum). If your other investments return say 4% a year, maybe you actually want to use your money on RE…
So, wrapping it up, assuming you are a RE investor like me, who buys and holds to create passive income, I think that you should aim at something like 50%-50% cash/mortgage- financed properties. Doing 25% cash and 75% credit is totally possible, if you know you’ll have tenants there for the duration of the credit and more, though.