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/
Products and coaching from Mark Ferguson:
I detail how to find financing for rentals and flips in my coaching program The Complete Blueprint for Successful Real Estate Investing. Use coupon code Secret25 to get $100 off!
[00:00:13] MF: Welcome to the InvestFourMore Real Estate Podcast. My name is Mark Ferguson and I am your host. I am a house flipper, I flip 10 to 15 houses a year, I own 13 rental properties with a goal to buy 100 by 2023. I’m also a real estate agent. I’ve been licensed since ’01, I run a team of nine, we sell close to 200 houses a year. So on this show, we like to interview house flippers, land lords and the best real estate agents in the business.
So stay tuned for some great shows. If you want more information on my rentals, on the numbers, how I buy properties, check out Investfourmore.com.
[00:00:59] MF: Hi everyone, Mark Ferguson with InvestFourMore. Welcome to another episode of the InvestFourMore real estate Podcast. Today, it is just me, I’m going to be discussing financing for rental properties and fix and flips. So, gonna have a very full pack show, lots of information, lots of different things to discuss.
The reason I wanted to talk about financing is because I see it over and over again where people want to use all cash for everything. And there’s nothing wrong with that, very safe way to invest, I’m not saying you shouldn’t use all cash when you invest. But I just want to point out a few factors, a few different things, a few advantages of using financing. You don’ t have to use 100% financing, you don’t have to borrow every single penny but there are definitely some advantages to using some financing. It could be very cheap if done the right way and it can increase your returns greatly if done the right way as well.
So I think a lot of people just assume because you’re paying cash or because all your properties are paid off, you’re making more money. The fact is, you might be making more money on one particular property, but what could you be doing with that money that you finance, where you could you invest that money, could you be making even more money if you had that money spread out to more properties, not just one?
That’s why I’d love to discuss, looking forward to a great show, before I get started, I just like to thank all the listeners, we’ve had some great results and feedback on the podcast and the readers in the site, we’re still doing very well. Did my first webinar last week and it was a great success so happy to do that. Be on the lookout for some more webinars we’re going to have, that was a lot of fun. Yeah, let’s get going here.
The first thing I really want to talk about is financing rental properties. So we’ve talked about kind of the basics of rental, good investments, some key points, I really want to dive deep into why financing is such a huge advantage when you buy rentals. We’ll use real, basic, easy examples of $100,000 purchase prices, maybe properties that rent for $1,200, $1,300 in that range — in some markets I know those don’t exist. But you can’t get those deals in some areas, hard to find but like I always say, if real estate investing was easy, it was easy to make a lot of money in it, everybody would do it and there wouldn’t be so much profit for those of us who do, do t.
So if you buy your rental property for all cash, you’re going to cash flow, it’s going to be basically impossible not to cash flow because you won’t have a mortgage payment, you’ll just be paying taxes, insurance, maintenance cost, and some vacancies of course when the house isn’t rented. But your rent coming in is going to much, much higher than those expenses. So even if you have a few vacant months, a few maintenance cost here and there, you’re likely going to cash flow and have pretty good cash flow.
But what you really have to consider when you’re paying cash or you have rentals paid off, is what is the opportunity cost of having all your money tied up into that one property? So you may be cash flowing $800 a month and that’s making you a good chunk of money every single year. But you’ve got $100,000 tied up in one property to make that $800 a year, which is not a bad return — you’re around 10% in that range, which is pretty good, you know it’s better than most investments out there.
But if you could finance that property, you don’t even have to do 80% loan. You could do a 70% loan. Take $70,000 and you could most likely buy two more properties with that $70,000. Maybe even three depending on the condition, what price range you’re in, but we’ll say two to be conservative. Take that $70,000, buy two more properties and obviously your cash flow is going to go down in the first property because instead of having no loan, no mortgage payment, you’re gonna have a $70,000 loan now. Your mortgage payment will be pretty low at $70,000 depending on what type of loan you get but probably in the $400 range, right around there.
So your cash flow goes from $800 a month to $400 a month. You just lost half your cash flow, seems like a pretty big hit but you’re still making money. You’re still making $4,800 a year and that’s not too bad when you consider you got $30,000 of your cash tied up into the property instead of $100,000 tied up in the property. So your returns, even though your cash flow is dropped from $800 to $400 a month, your returns on the cash investment has actually increased from around 10%, closer to 15% or more. So you’re making more on the money you have invested.
Plus you can take that $70,000, buy two more properties, maybe they’ll each cash flow $400 a month. All of a sudden, that same $100,000 that you had tied up into one property, making you $800 a month, now is in three different properties and it’s making you $1,200 a month. That really shows you, you can make more money by buying more properties with the same amount of cash. That just illustrates the one advantage of rental properties and that is cash flow with three different properties.
Something else to be considered, if you got one rental property, it’s a little bit risky. For one thing you have to go vacant, if you need repairs and you’ve got one rental, you’ve got no income coming in. While it’s vacant you have no rent coming in, because you just have one rental property. If it needs repairs, you’ve got just that one rental cheque coming in to help cover repairs and different things that pop up. But if you have three rental properties, it’s kind of like diversifying your investment.
If you got three rentals and one goes vacant then you’re still getting cash flow from the other two rental properties. They can help cover the vacancies, the different maintenance cost because not all of them are going to be vacant the same time, not all of them are going to have maintenance issues at the same time and it helps diversify your investment and your returns. If something happens in a neighborhood or you never know. It’s very rare, but one neighborhood can drop in value greatly while another one does not. If you have one rental that happens to be in that neighborhood, you’re out of luck. That’s not a good situation to be in. But if you have three rental properties that are spread out a little bit, that again diversifies your investment, a little safer than having all your money tied up into one property.
Something else to consider, which many people fail to realize when they pay all cash for properties is some unscrupulous tenants — there’s always going to be some bad people out there — they may look for opportunities to exploit people, to exploit landlords. Maybe they get hurt in the house, something happens, and all of a sudden they file a lawsuit against the landlord for not taking care of the property or causing them to get hurt, something happens like that. Well are they going to look for a property that has a loan against it and $30,000 of equity, or are they going to look for a property that has no loan against it in the $100,000 of equity?
They’re going to look for the property with the most equity, no loan against it and they’re going to see dollar signs thinking, “Oh look at all this money this landlord has because he’s got no loan, he’s got to be loaded, that’s the house we’re going to go after, try and sue him, and get some money.” Now it’s also important to know, even if you have a $70,000 loan and you pay it off down to $10,000 over years, and years, and year, no one can tell what you owe against that loan, they can just tell you have a loan against the property. So you may have taken out a $70,000 loan 15 years ago, now there’s only $10,000 left on that loan. To anybody looking up public records or what they can see with public information, still looks like you have a $70,000 loan.
Now, common sense says, it’s a 15 year old loan, it’s going to be paid down some, and you’re not going to owe $70,000 on it but it’s still going to show that loan on there. Where if you have no loan, property’s completely paid off, it’s going to say, “No loan, free and clear,” and that’s really where people are going to target. Not saying it happens all the time, it’s not extremely common practice, but it is something to consider when you have properties that are all paid off, no loans against them.
Alright, so now it’s not just the cash flow that really is increased without having a loan on a property. With one property, now I don’t like to invest for appreciation, and anybody who has listened to me or have read any of my articles will know, I’m not huge on buying for appreciation. I like to buy for cash flow and hope and appreciates. Love it when it does appreciate but I don’t invest for appreciation. But houses do appreciation on occasion, in Colorado, extremely hot market right now. My properties have gone up in values significantly in the last couple of years.
And if I had one property — there’s some properties I bought for $100,000, put maybe $15,000 of work into them a couple of years ago, those houses are worth $180,000, some of them close to $200,000 right now. Well if I bought one property, then I just saw an increase in equity of $80,000, $85,000. Awesome, I love it. But with financing, I was able to buy three properties instead of just one. All of a sudden that $80,000 increase has turned into a $200,000 increase, $240,000 increase spread over multiple properties. That’s really waste a huge advantage as well with appreciation.
Now it can happen the other way too, properties can go down in value, which if you have one, it will be less than if you have three — but again, when you’re investing for cash flow, when you’re investing to get that money in coming every month, you can ride out when prices drop. You can keep making money, wait till prices go up again if you need to sell some properties, you don’t have to sell them when prices go down. When prices do go up like that and you have multiple properties, you don’t have to sell them to see that return either.
I’ve refinanced multiple properties, used that money from refinances to buy more rental properties, just kind of keep snowballing, and snowballing. I always make sure I saw plenty of cash flow after I do a refinance. But I’m able to take out 30,000, $40,000 on some properties, which is enough for at least one property, sometimes one and a half properties. And I can increase my return so much more by buying more properties, just getting those great deals, the financing really helps me supercharge my investing.
Besides appreciation, there’s always buying below market value. So when I paid $100,000 for those houses it needed $15,000 in work, it went up to value to $200,000, that $80,000 was not all appreciation. Maybe I was being a little — say $50,000 of that was appreciation, the rest was buying below market value. So after I bought those houses, I paid $100,000, put $15,000 of work into them, they all were probably worth $150,000 at least, that’s kind of the ratio I look for. I have $100,000 plus $15,000 repairs, I got $115,000 into them, I want them to be worth at least 20% more than that after I’m done making repairs, if not more.
So if you buy one property with cash then hey, that’s great! You just drop below market value, maybe you gain $20,000 in equity, awesome, that’s pretty cool. I love getting instant equity, but if you’re able to buy three properties using financing, again, all of a sudden that $20,000 increase in equity is $60,000 increase in equity over those three properties. That really can make a huge difference in your net worth. Again, refinancing, taking some of that money out later on is also an option even if prices don’t go up, when you buy below market value, increase the value with making repairs, you still have equity and can use that equity to buy more properties.
But we’re not done, another awesome advantage with rental properties are taxes. We’ve talked about this too but you can depreciate rental properties over times, you can depreciate the structure. So that $100,000 property we bought maybe we say the structures is worth $90,000. Well we can depreciate that over 27 and a half years? And — I always get it mixed up. 26 and a half or 27 and a half years? But — I’m not a detail oriented person, I like the big picture. So you can depreciate it over one of those timeframes and that can be added very quickly. Usually it’s a couple of thousand dollars a year, even though this low end properties that you can deduct from your taxes, from your income. Which usually say is about $1,000 a year in actual taxes you’re paying, depending on what tax bracket that you’re in. If you’re the higher or lower tax bracket, that will change.
So if you buy one rental property with cash then you get that $1,000 tax savings a year or whatever it may be. You buy three rental properties with financing, again, now you’re saving $3,000 a year on your taxes. It’s a huge advantage to buy more properties over just buying one. And the question comes into play as well — actually before I get to that, there’s one more thing and that’s equity paid in. With cash, you’re making $800 a month cash flow, we’ll say, on that property paying cash, you’re making $400 a month maybe if you’ve got your loan on it. Well you’re making that $400 a month, that comes into your pocket, but you’re also paying the loan down.
Now it’s not money you see in your pocket, it’s not money you actually will realize unless you sell or refinance the property but that’s still a loan you’re paying off on the property over time and you may be paying off $100 a month, maybe $90 a month depending on the loan amount. That’s another $1,000 a year that’s coming into your pocket by financing those properties. If you got three properties, there’s $3,000 a year that you’re paying off on your loans versus the cash one where you’re simply not paying off anything.
So once you add up all the benefits of financing rental properties, I think it’s really a no brainer for me. Now everyone’s got their own personal goals and levels of what they can handle as far as stress and money and risk. For me it just makes sense to finance my properties because the returns are great. For other people they say, “Hey, you know, I don’t feel safe financing it, I don’t want debt, I don’t like debt, I have to pay cash.” So I understand that, people have different comfort levels but let’s look at the risk of financing it. If it is a lot riskier to finance properties than to pay all cash for a property.
So let’s say we’ve got this $70,000 financed versus all cash property and prices go down. If you’ve got three properties and prices drop 20%, say they go from — I mean the thing that you have to think about here is how are you buying the properties? Are you paying full retail value and paying cash versus getting a loan? Because if you’re doing that, then yes, there is a huge amount of risk. We’ll say these properties are worth $100,000, you’re paying $100,000 for them full retail value. So the cash property is $100,000 equity, the finance properties have $30,000 in equity.
If prices drop 20% then the cash property is down to $80,000 equity and the finance properties all go down to being worth $80,000 but you had three properties which each lost $20,000. You lost $60,000 of your investment instead of just losing $20,000 of your investment with the cash purchase. In that case, when you’re paying full retail, yes, it definitely is more risky if prices go down. Again you don’t have to sell your properties and prices go down. If you have enough cash flow or do things right, you should be able to ride out those storms, wait for the market to increase.
However, if you buy the properties below market value like I do, all of a sudden it doesn’t become quite as risky. The house that you pay $100,000 for, you put say $15,000 of work into it, you’ve got $115,000 cash into it and say it’s worth $150,000 now. Prices drop 20%, which is $30,000. You’re now worth $120,000 on your property, you put $115,000 into it. You’re still ahead of the game. Yeah, you lost some values, you lost some equity but you’re still $5,000 ahead of your full investment.
You own those three properties, you end up putting $30,000 down plus $15,000 repair in each property then you still have three properties worth $150,00 after repairs by buying below market value. And say all three of those properties drop in value. Yes, you lost $90,000 in equity on three properties, instead of losing just $30,000 in equity on one property. However, the money you had into those properties, you breakeven point was still $115,000. So your properties are still worth 120, you’re still ahead of the game than buying cash because you still have three properties with $5,000 in equity, instead of just one property with $5,000 in equity.
Now iff prices keep dropping, they drop 50% then you would start losing more money having more financed properties, but again you have to look at it how much below market are you buying them? Are you going to have to sell if the market decreases? If you have enough cash flow, you shouldn’t have to sell. If you have enough reserves, if you’re in a stable financial position, you should not have to sell the houses when prices go down. The people who get in trouble when prices go down are usually over leveraged. They’re financed to the tilt, maxed out, they don’t have cash flow, their rent barely covers their payments, does not cover vacancies or maintenance. So they’re not making any money anyway and they have no equity in their homes.
Those are the investors who got wiped out in the housing crisis, they weren’t investing for cash flow, they weren’t investing on fundamentals, they were investing, hoping the market would just keep going up and up and they could sell out in a couple of years and make 40, 50 grand on each property. Look at the way you invest, leverage does not have to be scary, leverage does not have to be risky, if you do it the right way and invest the right way.
Alright so — now it’s not just rental properties that have huge advantages from leverage. I do fix and flips as well, I’ve got nine fix and flips, I got a couple more coming in to the system as well. If you read one of my articles last week on InvestFourMore, I am in the process of buying a $500,000 fix and flip, that is very scary, I’ll tell you that right now! But there’s huge profit potential there and that’s the reason I’m doing it. There has to be so much profit and room to make money on those big flips because the costs are so much more. And that’s why I rarely ever do them just because you don’t see properties cheap enough in the high end to give you enough profit room percentage-wise to be safe in those high end flips.
But financing fix and flips, again is a huge advantage if you want to make a business out of it. Not just a hobby, once a year fix and flip person but if you really want to make a business of it, fix and flip properties for long term, make a lot of money from it. We’ll go to the same examples; Say you buy a fix and flip for $100,000, it’s going to be worth $170,000 when you’re done, it takes $20,000 in repairs. If you’re paying all cash for that property, you’re going to have a lot of cash needed to buy that. You will need $100,000 to buy it, you’ll need a $20,000 in repairs, you’ll need carrying cost for insurance, property taxes, utilities, all kinds of different things. If it’s an HOA, probably looking at 125 — $130,000 in cash you’ll need for this entire flip.
Now how long does it take to flip? A lot of people say, “Oh a couple of months, you can flip it.” Realistically, it takes six months to flip a house, especially if you’re a beginner, getting all the repairs done, getting the house marketed, getting it sold. That $130,000 cash is tied up that whole time. You can’t use it for other flips, it’s in that property, it’s being used. So some people say, “Yeah, but I save so much money on financing cost because I’m using cash to do this flip. I don’t have to pay hard money lender, I don’t have to pay a bank, I don’t have to pay a private money lender.” But again, you have to look at your opportunity cost; having all your money tied up into that one property, what are you missing out on?
We’ll make it easy, say you’re paying 10% interest on the money if you were to finance it. So you’ve got $125,000 cash in this one property, say you’ve got an opportunity to put 20% down instead on a couple of flips. So you’ve got $100,000, you have to put $20,000 into it for down payment. Another $20,000 into it for repairs and if I $10,000 for the other cost. Instead of having $130,000 into this property, you got $50,000 into it in cash. But you’ve got $80,000 of it, finance at 10%. Simple numbers, $8,000 a year, $4,000 in interest cost over six months. That’s what that $80,000 loan will cost you. You might have a couple of points to pay in the beginning, say even if you’re paying four points on $80,000 — $3,200.
So your financing costs will be about, we’ll say $8,000 just to max amount. And say, “Hey, it cost me $8,000 to get this loan for six months on this flip.” $8,000, a lot of people will say, “Wow, that’s a huge chunk of money. If my profit’s $32,000, now it’s $22,000. I mean I would much rather have a $30,000 profit paid in cash than $22,000 profit with that loan.” But what if you could do two flips at the same time? You’re putting $50,000 into this flip of your own money, which is a lot of money. You can find financing where you’re putting less money into it using hard money, using different options.
So all of a sudden you’ve got two flips and you’ve got $50,000 into each of them using $80,000 loan and you still have $25,000, $30,000 less cash into the both deals than you did with the one deal. Now yes, you are having to pay $8,000 in financing cost on both loans that’s $16,000, which cuts into your profit. But look, you’re still making $22,000 on each deal, which is $44,000 total compared to making $30,000 in profit on one deal. So by using financing, you’ve increased your profit by 50% almost, around there. You’ve got $25,000 less of your own cash into the deal and you’re actually in a less risky position because you have a loan against it, some leverage, less of your own money tied up. That sounds like a win/win situation to me.
And we’re talking about a pretty high interest, pretty high cost loan. When I use my bank financing, my portfolio financing, I’m getting 75% loan to value ratio at five and a quarter percent interest rate in one origination point. So my cost are about half of what we just discussed. Actually much less than that. So for me it’s a no brainer. Then I can also use private money to help me with down payments with repairs, that’s how I’m able to have nine flips at once because I have this money, because I’m using leverage, and because financing helps me make much, much more money.
If I was not using any financing, if I was using all cash, I might be able to do three flips depending on the price point. I would have the potential for — to leverage about $30,000 in profit on each flip, I’d be looking about $90,000, $80,000 in profit versus $30,000 times nine. Much, much different situation, much different business when you’re using financing. It really allows you to level up to just go after more properties and just increase your business in huge ways.
Another thing to consider, just like the rental properties, the more flips you have going at once, it does diversify your risk. Some flips we have lost money on once in a while, it’s pretty rare. But if you’ve got all your money tied up into one flip and you lose money on that flip, that really sucks. There’s a lot of work that goes into flipping, it takes a lot of time, and it really does not feel good when you lose money and you’ve only got one going, and it took you six months to do it, and you spend all that time on it.
But if you’ve got three different flips going and one loses money, if you know what you’re doing, the other two are probably going to make money, they’re probably going to make up that one that lost money, and you’re still going to be okay. You’re still going to have a profit even though one of them lost money.
Alright. So, that is all I’ve got for this episode. I hope you enjoyed it, just kind of trying to give you a real high level idea of why financing can be so valuable when you’re doing flips, when you’re investing in real estate. I hope you enjoyed it! Again, check out the site Investfourmore.com. Always welcomed to email me if you have some questions, [email protected] and thank you for listening and we’ll talk again soon.