Does it make sense to buy commercial real estate outright?
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[{"id": "fcvx1g5", "text": "your return on investment will improve if you borrow money to buy the property, assuming you can borrow money at around 5%, and your cash flow will go down.  If you can put the remaining money to work and generate returns better than what you are borrowing money from the bank at, then that is what you should do.  If you are going to leave the money in the bank, getting 1-3% return on a CD, you are better off using the money to buy the property.", "replies": [{"id": "fcw6aoz", "text": "aka positive vs negative leverage.", "replies": [], "depth": 2}, {"id": "fcxf6uj", "text": "This is true but the cost of the debt is not the interest rate (unless it\u2019s an interest only loan) but the debt yield.\n\nEdit: I misspoke, I meant the debt constant but not yield. I deserve the downvotes.", "replies": [{"id": "fd8zzuk", "text": "First timer here,long time home owner, and inadequately informed re commercial R E   \nWhat is debt yield?", "replies": [{"id": "fd95ma2", "text": "See above, I meant debt constant, which is the amortizing loan payment divided by the loan amount. To have positive leverage, your property return needs to be higher than: 1) the interest rate on an interest only loan, 2) the debt yield, which takes into account amortization, on amortizing loans", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "fdmka6p", "text": "So is it realistic to think of an infinite rate of return, if you borrow 100% (or higher)?", "replies": [], "depth": 2}], "depth": 1}, {"id": "fcw0rpm", "text": "No. It almost never makes sense to buy without debt. You might as well put your money in an index fund and have it passively grow.\n\nReal Estate profit is made through leverage and tax depreciation. Leverage is your number one tool in maximizing cash flow and return. A 5% cash on cash return can be leveraged to achieve a 6-7% cash on cash return. Ok, so you're now matching historic index fund returns at that \\~7%. Your deal will take you into maybe 10% cash on cash. with a 70%ltv loan you only need 30% of the capital so you can then buy 2-3 more properties with that amount, which is great. The real kicker is this... You then amortize the debt and on refinance you can use the lump sum proceeds to buy more property. Cant do that with an all cash deal. \n\nALWAYS have cash reserves if you use this strategy!", "replies": [{"id": "fcwd7rr", "text": "Since we are in the topic, what about buying a single family home \u201cyour home\u201d all cash? Since it will not generate any cash flow, would it be wise to pay it all cash rather than getting a mortgage ? \n\nCurious to read anybody\u2019s thoughts ..", "replies": [{"id": "fcwgymt", "text": "Depends on your appetite for investing. If you can get a mortgage at 3-4% and make investments that achieve higher, then you should use that cash for investments. Finding an investment that can achieve 7% or greater isnt challenging to find. So long as you remain disciplined you use that cash flow to pay off the mortgage and have arbitrage against what an all cash ownership would be. However, there is emotional comfort in having a home paid off.", "replies": [], "depth": 3}], "depth": 2}, {"id": "fcxg9ct", "text": "Interest on the loan is tax deductible as well", "replies": [], "depth": 2}], "depth": 1}, {"id": "fcw315v", "text": "Buy the property all cash, get the hang of owning a property.  You can always get a loan based upon your equity in the real estate later to buy more property or not.  Owning it all cash puts you in a good position to weather any issues down the road.  You do not need to fully lever the property right away.", "replies": [{"id": "fcwiobm", "text": "This is terrible advice. You'll get better returns with leverage on the property, thats one of the advantages to RE over other investment types. If you want to be conservative, put a little more down then the lender requires (30-35%) to keep your DSCR high.", "replies": [{"id": "fcy4pth", "text": "&gt;This is terrible advice. You'll get better returns with leverage on the property, thats one of the advantages to RE over other investment types. If you want to be conservative, put a little more down then the lender requires (30-35%) to keep your DSCR high.\n\nNo it's not.  Debt puts risk on his equity.  While returns are important, there's downside risk if the deal goes belly up.  You don't lose 100% equity in a full equity deal.  Guy didn't mention the quality of the tenancy, etc. so you can't assume it's a low-risk asset.  You have to think of it this way-debt is money too.  Clearly, people are lending money too.  With commercial, sometimes it only takes one tenant vacating to drop your DSCR from 1.25 to 0.50.  Not saying leverage is bad, and yes it boosts returns, but big picture his advice isn't bad.  If he has the capital lying around, he can take it down full equity, and cash out some equity when he finances it.  I work for a LifeCo and we buy stuff all-cash all the time until we need to take out the equity. It's a little different with an institutional shop of course, an individual doesn't just have capital lying around waiting to be placed, but we also don't know how hands-on he can be with the investment.", "replies": [{"id": "fcye7g0", "text": "&gt;good point by Pokemeister92 - I mean it's not 'terrible' advice.  Furthermore, congrats OP for grinding what I assume is 10+ years to put yourself in position to take this down outright because there is a human element to this debate as well.  It's easy for accountants, bankers, RE agents to advise leverage here like it's the holy grail, but maybe many, or most of them have never had to manage property.  It's a pain in the ass; especially if MF management like OP, and a lot of times you're making only 1-2 grand a month (cash I mean) for years and years.  If you can get to point where you have this type of cash and want to but an asset outright go for it.  When you're in Bahamas or something for Xmas because you're making 8K a month on that investment with no loan you can consider how much you really miss that principle reduction on a 5/7 year note.", "replies": [{"id": "fda9xjk", "text": "I stand by what I said. He doesn't need to leverage up as high as a professional would, but he doesn't need to go to the extreme either. 60% LTV is conservative, 50% is extremely conservative. Leverage is a tool. It's a multiplier. Not using it, especially with interest rates where they are is silly. If he can borrow at 3.5% and earn 8-10% he should absolutely do it. There's risks in every investment, but advising someone to buy 100% cash is overstating the risk of leverage. He already said the cash flow is strong and the building isn't going to suddenly go 100% vacant, so covering the mortgage isn't a concern.\n\n There's also a number of things he can do to mitigate his risk such as just keeping a reserve account to cover unforseen expenses and vacancies. Retail can have much longer vacancy to be sure, but even keeping 12-18months of reserves to be extremely safe will be better then having no debt. \n\nAlso, if buying outright means he has limited cash on hand for an unforeseen capex then it might actually be riskier. \n\nNo doubt OP worked hard to get that $780k, now it's time for that $780k to work hard for him.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "fq88idf", "text": "&gt;You'll get better returns with leverage \n\nSorry, just wanted to say this comment didn't age well haha", "replies": [{"id": "fq8hcuc", "text": "Why\u2019s that?", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fcw8hdc", "text": "Buy with debt. What a coincidence the $780k price. Check out this video we made about a property we purchased at that price.  https://www.youtube.com/watch?v=7XnlQo0IMDo&amp;feature=share", "replies": [], "depth": 1}, {"id": "fcw8kfn", "text": "Take out conservative debt, 50% - 65% LTV with a strong DSCR, work out the ownership and management kinks. Once stabilized, refinance again, max out your equity, reinvest, wash and repeat.", "replies": [], "depth": 1}, {"id": "fcwdrel", "text": "Yes - your IRR will definitely be higher using leverage in that scenario. Here's the math: [https://blog.stacksource.com/the-loan-constant-f73954464645](https://blog.stacksource.com/the-loan-constant-f73954464645)", "replies": [], "depth": 1}, {"id": "fcwm2pn", "text": "Lender here if you need financing or have questions. I waive origination fees for fellow redditors. You only pay appraisal and title. 5/25 rate of 3.85% based on today\u2019s rates. 20% down. Pm me", "replies": [{"id": "fcx9iuq", "text": "What\u2019s max loan size and do you have interest only products?", "replies": [{"id": "fczckzg", "text": "Max loan size is up to $3MM range. No interest only though", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fcwnnt0", "text": "Lever up, baby. Increase that multiple and IRR.", "replies": [], "depth": 1}, {"id": "fcxa4a3", "text": "Not getting into capital structure here but something to consider is that small mixed use is a beast to manage - retail over multi especially. If your retailer blows out your fucked trying to find a non credit tenant and can come out of pocket beau coup bucks for base LL and TI dollars.", "replies": [], "depth": 1}, {"id": "fcxg5ia", "text": "You can of course, buy it outright. In an all cash structure, your return should be the 8.5 cap before reserves, tenant improvement and leasing commissions. Keep in mind, as tenants roll over, in either the mfr or retail portion of the project, or you need to pay the cost to re-tenant the space, and will need a source to do this. You can either pay it out of pocket or sweep some of the cash flow for a reserve.\n\nAlternatively, you can finance a portion of it. The reasons you would do this are to: 1) conserve cash for additional investments, 2) increase your return (as long as the return is higher than the debt yield). \n\nThe vast, vast majority of individual investors, use debt to conserve cash and increase returns. I would suggest you do this. I would suggest you borrow at a lower loan to value to avoid guarantor recourse, if you feel uneasy with the idea of debt. I would also suggest you put together a reserve plan for tenant rollover costs and maintenance/repair.  \n\nIf you have any questions, feel free to PM me.", "replies": [], "depth": 1}]