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