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When you buy a property "all cash," it doesn't have to be all your cash. In fact, none of it has to be.
In the most general sense, a buyer may say he is making an "all-cash offer" even when he intends to seek bank financing. In this case, he simply means he's not asking the seller to hold a note. Instead, the buyer will deliver all cash at closing, even if he has to borrow that cash.
A stricter use of the term, however, is that there will be no seller financing required and there will be no third-party financing contingency. The buyer is prepared to bring all cash to the table, without having to get approval from a bank or any third-party.
This is the kind of offer that can get the attention of motivated sellers.
So, where can you get the cash to do all-cash deals?
A hard-money lender may lend you 100 percent of the purchase price - including rehab costs, if you're buying at a big enough discount to market value. You may have a network of private lenders to finance your all-cash purchases. You may have secured and unsecured lines of credit. You may have potential equity partners who put up the initial cash for a part of the deal - and those partners may also source their cash from their own lenders, not their own pockets!
Ideally, you'd have developed access to cash through all these resources.
Now, why would you want to do all-cash deals? For a few related reasons...
Cash Creates Opportunities
The most oft-cited reason is to be able to do deals you couldn't do with third-party financing. These are deals that need to close quickly because the seller is seriously behind on payments or even facing foreclosure. These can also include deals that recently fell through after a few weeks or months at contract, when the buyer couldn't pull the financing together.
Other scenarios are those in which it would be difficult or impossible to find an institutional lender for the property. For example, it may be vacant, in need of considerable repair, or both. Or it may have code violations that the seller won't or can't clear up.
Finally, you may be working with a wholesaler or a reseller of bank-repossessed foreclosures (REOs) who is liquidating inventory only to all-cash buyers.
For all these reasons, it makes sense to constantly work on developing sources - private lenders, lines of credit, and potential equity partners - to fund all-cash purchases.
But here's the twist...
Even if you have a property under contract that banks are willing to lend on, it still may make sense to purchase it with all cash - even if the cost of that cash is higher than what you'd pay a bank (which will almost certainly be the case).
This is a good strategy to consider when you buy a property under market value to begin with, and you then increase the value by making repairs and raising the occupancy.
The idea is to use temporary bridge financing for the acquisition. Then, after the building is "performing" (rehabbed, leased out, and churning out rents like a Pez dispenser), you replace all your short-term acquisition money with long-term, low, fixed-rate financing.
The Benefits of Bridge Financing
In the right situation, bridge financing can allow you to achieve maximum leverage, free up your cash quickly, and then do it all again and again. This not only can help you earn a higher return on equity, applied repeatedly it can help you compound your wealth at a very high rate.
A caveat: This strategy - as profitable as it can be - only makes sense if you first have the fundamental real estate skills. You have to be able to buy right, rehab cost-effectively, and manage a property well (or put competent professional management in place).
If you can do that, this strategy can help you create a virtual money tree.
Here's an example of what I mean...
How to Use 100 Percent Financing and End Up With Low, Fixed-Rate Bank Financing
Let's say you have a $200,000 credit line available to you ... from your home or other investment properties. And say you find a great under-market deal on a four-unit building. After putting in $30,000 in repairs, the property will produce $3,000 a month in gross revenue and it will have a market value of $260,000. You have a motivated seller/special situation, so you're only paying $150k for the building.
Now, because the property and your credit are okay, you could get bank financing. If you did, you might borrow 90 percent of the $150k from a bank at, say, 7.5 percent. Then you'd have to come up with about $57k in cash.
That would be $15k for the down payment, another $30k for repairs, $7k for closing and carrying costs, and maybe $5k for cash reserves once the property is up and running.
But you know this property will cash flow very strongly and will appraise at a much higher value once it's performing. So you decide to do an all-cash purchase to maximize your leverage and ROI.
Now, instead of coming up with $57k and borrowing the rest, you come up with $190k. And all of it is borrowed from a credit line.
The $190k breaks out as follows: You use $150k for the purchase, $30k for the repairs, and $10k for closing and carrying costs. (The carrying costs would be higher because you'd be borrowing more at a higher rate.)
But, remember: Once the property is rehabbed and performing, it's worth $260k. So at that point you go to the bank and get a "cash-out refinance loan." In this case, the bank might agree to lend you 75 percent of the new appraised value of the property: $195,000. That repays the entire $190k you put into it, and you end up with $5,000 to leave in the property's bank account as reserves.
The $195,000 is only 75 percent of the appraised value, so the bank gives you a fixed rate of just seven percent. Your principal and interest on the loan come to about $1,300 a month. Add $300 for taxes and insurance, and another $300 as an allowance for vacancy. Add $200 as an allowance for maintenance (which should be relatively low since you just rehabbed), $75 for lawn care, and $125 for common-area utilities.
In total, your monthly mortgage, expenses, and allowances are $2,300. Subtract that from your gross monthly rental revenue of $3,000, and you have $700 in monthly cash flow. That's $8,400 annually that you created without locking up a dollar of your capital. And, at the same time, you created $65,000 in instant equity (the property's $260,000 market value less the $195,000 loan).
And here's the kicker...
That $200k from the credit line you used to make it all happen? It's freed up and ready to go again!
In fact, you may easily be able to get a 20 percent to 30 percent increase in the money available to you from the credit line you used, since you've proven that you can make payments on time and zero out the balance. Your successful track record will also help you develop your network of private lenders and potential equity partners.
Meanwhile, you now have equity in another property that you may be able to get another credit line on. And if you're buying in the right part of the market cycle, the value of that property - and your equity - will continue to grow (through appreciation, amortization, and increasing net rents).
The point is not to over-leverage. You should never do that. This strategy works because you turned a non-performing property into a star performer - a money hole into a money producer. Because you knew how to realize the cash flow potential of the property and thereby dramatically increase its market value.
Disclaimer: ActiveRain Corp. does not necessarily endorse the real estate agents, loan officers and brokers listed on this site. These real estate profiles, blogs and blog entries are provided here as a courtesy to our visitors to help them make an informed decision when buying or selling a house. ActiveRain Corp. takes no responsibility for the content in these profiles, that are written by the members of this community.