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Are Cash Investors Missing Real Estate Profits?

There are a lot of real estate investors who finance with cash but are they getting the best deals?

According to the National Association of Realtors, 32 percent of all existing home transactions in February were cash deals. On many levels such an approach to financing makes sense: There are no loan applications, no mortgage fees and no waiting for an underwriter’s decision. The use of cash gives investors leverage in the marketplace, a way to get better deals than might otherwise be the case.

But, weirdly, all-cash purchases may not be the best strategy. Here’s why:

NAR says that in February home values were 11.6 percent higher than in February 2012. The typical property nationwide sold for $173,600.

In other words, if you bought for cash in February 2012 you could — on average — see an 11.6 percent gain on your investment. (In real life the gain would be far lower after selling costs, taxes, etc.)

But what if you didn’t buy for cash? If you financed with 10 percent down you would have more than doubled your money. (And in this situation there would also be selling costs, taxes, etc. that would erode real profits.)

The typical existing home sold for $156,600 in February 2012. ┬áTen percent down is $156,600. If the value of the property increased to $173,600 in a year the equity gain would be $17,000 — more than the down payment for the investor who financed with 10 percent down.

Leverage

While the cash investor saw an 11.6 percent return the investor who financed doubled their equity and saw a better percentage return on their investment.


What we’re seeing here is leverage at work. This is great stuff when home values rise — but equally powerful when values fall.

Let’s imagine that values stall or actually decline. This could happen because the housing market remains fragile, in large measure because unemployment is high and incomes have declined since 1999.

“Median household income,” says the Census Bureau, “was $50,054 in 2011, 1.5 percent lower in real terms than the 2010 median, 8.1 percent lower than the 2007 (the year before the most recent recession) median ($54,489), and 8.9 percent lower than the median household income peak ($54,932) that occurred in 1999.” (parenthesis theirs)

Lower Prices

In the event of lower prices one can argue that cash investors have less risk.

Huh? How is that possible?

It’s possible because cash investors already have committed their funds. If home values decline their loss is limited to whatever they paid for the property. They can sell tomorrow, have a loss, but it will not threaten their financial stability. They actually will walk away from closing with a check.

Alternatively, the owner with a mortgage may not be able to sell if the value of the property drops below the size of the debt, something we saw at the start of the mortgage meltdown. In that case the owner will need to hang on to the property or face a short sale, foreclosure and maybe bankruptcy.

It turns out that one reason we now see so many cash investors is not just the avoidance of loan application hassles, it’s also because paying cash is a very conservative strategy, not a bad idea in unsettled times.

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