We’ve all heard, “Cash is king.” The phrase was coined in 1980 by author George N. McLean as a business maxim: “Avoid credit, remembering that cash is king, credit is a slave.” The phrase reemerged and grew in popularity with the 1987 stock market crash. We’ve seen plenty of professionals and investors hold to this philosophy since.

But is cash really king?

I think you’ll find in modern economics that leverage rules supreme. Let’s discuss the pros and cons of utilizing leverage versus relying on cash!

Pros of Utilizing Leverage

Increased Purchasing Power

Leverage allows investors to buy more or higher-value properties than they could with cash alone. When we’re talking about SFR investors earning rental income, that initial downpayment is the bulk of what the investor ever uses to pay for and pay off the property. Rental income pays down the mortgage. Over time, this can result in significant equity compared to that initial investment.

Diversification

Financing allows investors to acquire properties more quickly than with cash alone. After all, saving for a downpayment is easier than the entire purchase price. An investor could secure multiple SFRs with leverage for the total cost of one property. That spreads out risk and increases your streams of cash flow.

Tax Benefits

Interest payments on mortgage loans are often tax-deductible, which reduces taxable income. Nice bonus!

Higher ROI

When property values increase, the return on equity can be significantly higher for leveraged properties than those purchased with cash, as the initial investment is lower. Assuming you’re paying the mortgage down – and off – with rental income, your equity can be significant over time. Say you purchased a $200,000 property with cash. It’s now worth $300,000. That’s an equity increase of $100,000. Not bad. But consider this same investment property with leverage. You secured a $200,000 property with $40,000. The mortgage has been paid with rental income and the property is now worth $300,000.

That’s an equity increase of $160,000.

Not to mention the fact that you likely were able to buy multiple properties with leverage!

Inflation Hedge

Fixed-rate mortgage payments remain constant, while rental income and property values may increase with inflation. This improves cash flow and property value relative to the debt. The less cash you use to secure a property, the more money you can use to secure additional inflation-resistant investments.

Cons of Utilizing Leverage

Increased Risk

Leverage amplifies both gains and losses. If property values decline or rental income decreases, investors may face negative equity or struggle to meet mortgage payments. This is a risk anyone with a mortgage accepts.

Cash Flow Pressure

Regular mortgage payments require consistent cash flow from rental income or other sources. Any vacancy or maintenance issues can strain finances. This pressure eventually recedes as investors pay off their mortgages with their passive income.

Further Reading: The Best Strategies for Actually Reducing Rental Turnover

Complexity and Costs

Obtaining and managing financing involves additional paperwork, fees, and administrative costs compared to a cash purchase. There’s also the matter of maintaining a great credit score. This process is less straightforward and can take time!

Risk of Foreclosure

Inability to meet mortgage payments can result in foreclosure, leading to potential property loss and damage to credit scores. Wise stewardship of your resources and carefully selecting your investment markets reduces this risk.

Equity Dilution

Using leverage means that lenders have a claim on the property’s value, reducing the owner’s equity stake. Your equity grows as the mortgage is paid off. Early on, though, this can make selling unwise.

Balancing Leverage and Cash

Cash isn’t king. But there’s also wisdom in finding balance. Utilizing leverage while keeping cash reserves to mitigate risks. Here are some strategies to consider:

• Conservative Loan-to-Value (LTV) Ratios: Avoid over-leveraging by maintaining conservative LTV ratios to ensure your debts are manageable.
• Cash Reserves: Keep sufficient funds for emergencies, maintenance, and unexpected vacancies to maintain liquidity and financial stability.
• Fixed-Rate Mortgages: Opt for fixed-rate mortgages to protect against interest rate increases and maintain predictable payment schedules.
• Stress Testing: Conduct stress tests on your portfolio to assess its performance under different economic pressures, ensuring you can withstand downturns or market crises.

How you finance your investments largely depends on your goals and risk tolerance as an investor. Consult with a portfolio advisor to see how to get the most for your money!

Our residents stay an average of seven years in an REI Nation property.
How long might you benefit from investing in an SFR?