Cash is the name of the game in the world of real estate investing. However, does using it have any limitations? What’s wrong with making cash real estate offers on investment properties?
Purchasing homes for cash has become far more popular in recent years. For some, it has been out of necessity due to lack of access to mortgage financing. Others have done it because they simply can’t find a better return on their surplus cash and investment dollars. Some just see paying cash as the ticket to better discounts on home purchases.
So what’s wrong with making a cash offer?
The Contingency Factor
The first and most noticeable issue which continues to be overlooked by so many home buyers and new real estate investors is how the lack of a contingency to withdraw from the contract and transaction can put them at a disadvantage. Having a mortgage financing contingency in your purchase contract can be invaluable when you absolutely have to pull out. Of course, this shouldn’t be done unless necessary, but it sure beats a lawsuit and losing your earnest money deposit. All too often, home buyers and new real estate investors are writing cash offers when they really plan to use financing. They think they have to in order to be able to compete, or believe it can help them get a better discount, even though they plan to get a mortgage or use hard money or transactional funding. Of course, as soon as title is needed, or other documentation is required by a lender, the ruse is quickly diminished and the transaction can be derailed. Just be honest.
Refinancing Issues
Many have gone from thinking they were on to a great deal to complete financial ruin. When it gets this bad, the long term consequences can impact all areas of life for decades. This usually comes down to real estate buyers paying cash with the intention of immediately refinancing to get their cash back. Unfortunately, few get just how complicated this can be. It can work, but it there are few promises and guarantees in this realm. Few understand the complex matrices involved in mortgage lending. Many factors can prevent even good credit property owners with good properties from refinancing. When cash can’t be tapped, schedule things can go downhill fast. Savings can be depleted and credit hit, and sometimes owners are left with an unusable and unsalable property. It’s normally safer to secure your financing upfront on acquisition if it is that important to you.
Cash Reserves and the Free and Clear Myth
It always pays to have cash reserves. Most don’t have enough. When starting out with a first home or getting into real estate investing, cash can be tight. Sometimes that is unavoidable, and the reason for buying in the first place. Here, it can be more important to maximize financial leverage. Those that have the choice should make sure they have cash reserves for living expenses, home repairs, holding costs and emergencies. Also, plan on needing more than you think you need. It can be better to finance and have more cash on hand than locking up all of your capital and getting stuck.
While there are definitely arguments for at least holding a primary residence free of mortgage debt, it can also be counterproductive and an illusion. Firstly, there are always holding costs. There are property taxes, insurance, and utilities. Remember that even the most wealthy often opt to take out mortgages to take advantage of tax breaks and the mortgage interest deduction.
Returns and Financial Gains
The other trap cash buyers often fall into is poor returns. When compared to the cash on cash returns of home buyers and real estate investors using leverage, cash buyers can find they are seriously under-performing benchmarks.
In the current environment, it can certainly be far more profitable to use leverage, and if cash must be put to work, consider buying more properties rather than putting all cash into one.
Summary
While the perception is that it is tough to get a mortgage loan out there today, many may find it far easier than expected. There are many lenders and loan programs, and far more than local and national banks advertise. This is especially true for real estate investors and those willing to make a down payment. The terms can be very attractive too. So while there may still be occasions when cash is required, seriously consider looking into mortgage financing options. Don’t make cash offers unless you are really paying cash.
