021: Why Using Financing will Increase Your Returns in Real Estate with Mark Ferguson

The latest episode of the InvestFourMore Real Estate Podcast features me (Mark Ferguson) talking about financing. I know many people are scared of debt and feel cash is the best way to buy properties, but using cash actually decreases your returns if you are buying the right properties as flips or rentals. In this podcast episode I will talk about how financing is not as risky as you think if done right and how it can increase your returns as well!

Why isn’t financing as risky as you may think?

Society tells us debt is bad and we should do anything we can to get rid of it. However, the biggest companies in the world and riches people in the world almost all used debt and a lot of it to get where they are. Debt is an awesome tool if used correctly, but it can be dangerous if it is not used correctly.

If you use debt to live a lifestyle you cannot afford then obviously that is a dangerous situation and could cause serous problems. If you use debt to fund real estate deals that make you much more money than the debt costs you then debt can be an awesome tool. There are a few guidelines to remember:

• Don’t extend yourself too far with debt when you have no reserves or extra cash
• Don’t buy the most expensive house you can afford as a personal residence
• Don’t over burden yourself with car debt if you don’t need too
• Invest for cash flow with rentals and the cash flow will more than cover the debt payments and then some.

How can debt increase your returns on rental properties?

Whether you are flipping or buying rentals debt can increase your returns. At the same time it can also reduce your risk! Yes, reduce your risk as opposed to using cash. When you use a loan on rental properties you are able to buy three rentals for every rental you could buy with cash. You may make $800 in cash flow with a house that is bought with cash and only $400 a month on a house bought with a loan. However, you can buy three more houses with a loan, which would equal $1,200 a month in cash flow total versus only $800 paying cash.

Cash flow is not the only advantage to using a loan. While you own three houses you have more tax advantages, your paying loans down every month, you have more possible appreciation and the biggest advantage is more equity gained through buying below market value.

When I buy flips or rentals I always buy houses below market value. I get great deals by purchasing REOs, short sales, estate sales or auction properties. In some cases I will even use direct marketing. For every rental property I buy I usually gain at least $20,000 in equity because I get it less than market value. If I buy one house with cash I would gain $20,000 in equity, but if I can buy three houses with a loan I can gain $60,000 in equity.

How can debt increase your returns on fix and flips?

When you flip houses it is tough to get financing. Some portfolio lenders will finance flips as well as hard money lenders. Financing on flips can be expensive, especially if you use a hard money lender. I may have to pay $8,000 in financing costs on a $150,000 house I own for 6 months. Some people may look at that figure and want to pay cash to save the $8,000. But what are you giving up when you pay cash? If I can finance just part of a fix and flip I can buy at least one other flip or possibly two with the same cash I needed to buy one. I average about $30,000 in profit on each of my flips. While $8,000 will cut into my profit, I would much rather have three flips going that make $22,000 each than one flip making $30,000.

Why isn’t using debt riskier than using cash?

The biggest reason using debt is not as risky as using cash is diversification. I would rather have three rentals in different locations, instead of one rental. Plus if something happens to a rental I am better off the more I have.

• With three rentals if one goes vacant I am not out all my rental income because the other two rentals will still be producing income.
• With three rentals if one needs maintenance the rent from the other rentals will help pay for that maintenance.
• With more cash flow coming in I can build up my cash reserves faster.
• If one neighborhood goes down hill and prices drop, I am better off having other properties in other neighborhoods that might not drop in value as much.

Why does using cash limit your options for future purchases?

Using  cash seems like the safe bet when buying properties, but what if you need that cash later? You can refinance properties, but it is not always easy to do even when you have no loans. Lenders like to look at debt to income ratios and if you are retired or living off rental income you may not make enough to get a new loan.

You might buy properties when you are working and making good money. You paid cash then thinking it was a wise decision, but then decided to retire want to access that cash. But if you aren’t making any money you might not be able to refinance and access that cash without selling the house.

Using leverage to buy flips or rentals is a great way to increase returns and even reduce risk if you buy the right properties. If you buy houses that don’t cash flow then it makes no sense to use leverage to increase negative returns! Be sure to listen to the podcast for much more information or check out the transcript below.

I started a new Facebook group for InvestFourMore to discuss rentals and flips. You can check it out here: https://www.facebook.com/groups/1517605988563879/