If you invest in residential real estate in the United States, you’re no doubt aware that we’re living through an incredibly competitive market. Most single family residential properties draw multiple offers, and demand for multifamily properties is very strong as well.
If you want to acquire properties and grow your portfolio, you’ll need to use various creative strategies to get your offers accepted. One of our favorite strategies for getting offers accepted at competitive prices is to purchase using cash. Here is why.
A Word About Cash, Private Loans, & Hard Money Loans
What does it mean to say “buy in cash?” The most obvious situation is when you have enough money in your bank account to purchase a property in cash, and that’s how you pay the seller. This is a strategy often used by wealthy individuals and investment funds.
If you’re like most of us, you probably do not have enough cash sitting in your bank account, to purchase a property in cash. Or, perhaps you do, but you don’t want to use all of that cash on a single purchase.
This begs the question: How do you access cash, which you can use to acquire properties? Enter private money loans, also known as hard money loans.
These are real estate loans, typically provided by investment firms, who are looking to earn a higher rate of return. They will offer you the funds required to close on a property, within as little as 7 days after you open escrow.
These lenders will check your credit, though they don’t usually need much detailed information about your financial profile. After all, the hard money lender’s main concern is the property you’re acquiring.
They will need to check the title on the property (to make sure no one else has an ownership claim) and obtain title insurance. They must also ensure that you’re paying a reasonable price for the property.
Hard money lenders will typically require inspections by a third-party property inspector, so that they’re aware of the condition of the property. They’re often willing to lend on properties that need major repairs, with the understanding that you’ll complete the required improvements.
Most hard money lenders don’t conduct traditional appraisals. Instead, they review information about comparable properties to make sure that you’re paying a reasonable price.
In many cases, the hard money lender will examine your prior track record of investment success. This doesn’t mean you can’t obtain a hard money loan if you’re a newer investor – but it is easier if you’ve done a few deals.
Down payments required on hard money loans vary. However, you should assume that you’ll have to put down at least 25% of the purchase price of the property. For commercial properties (such as apartment buildings with 5 or more units) you’ll probably have to put down even more.
Hard money loans close faster, offer more flexibility in terms of your finances, and are usable for properties with lots of repairs / maintenance required. So, what’s the catch?
Well, hard money loans tend to have substantially higher interest rates and loan points than traditional mortgages. It is pretty common for hard money loans to carry interest rates of 7% to 10%.
You will also pay between 1 to 4 points (i.e. 1% to 4% of the loan amount) to the lender as an upfront cost. In most cases, you’ll also have to pay loan broker fees, as well as underwriting and other costs.
Hard money loans also have a relatively short term, typically of 6 months to 2 years. This is unlike traditional mortgages, which carry a term of 30 years.
How does this work? Normally, you’ll only make interest payments during the life of the loan. You won’t be responsible for paying the principal.
At the end of the 6 to 24 months you’ll make a large payment (known as a balloon payment) of the remaining amount due. If you are unable to make this payment, the lender could foreclose on the property.
If you’re flipping a home, you’ll typically pay off the balloon amount through the sale of the home. If you’re purchasing a rental investment property, you can refinance into a traditional (lower rate, long term) loan, if the property is in reasonable condition. You use this new loan to pay off the hard money loan.
Throughout this discussion, you’ll see us discuss purchasing in cash. You should think of hard money as a (mostly) interchangeable term for cash. The two have basically the same effect, although of course hard money has higher overall costs than cash.
Cash Allows You To Acquire The Property At A Discounted Price, In Exchange For A Quick Closing
When it comes to selling a property, different sellers have different priorities. Some want to maximize the sale price, and walk away with as much money as possible.
They’re fine hiring a broker, receiving multiple offers on a property, and making a decision as to which one to accept. They don’t stress too much at the thought of a potential buyer backing out of a deal. They will simply find another buyer.
Other sellers are looking for a rapid, smooth transaction. They want certainty that a buyer will close, and don’t like dealing with too many offers. In many cases, they don’t want to work with brokers.
Sometimes, these sellers inherited the property from a relative, and are somewhat newer to the real estate business. They’re uncomfortable with the entire process. In other instances, they are facing financial distress, perhaps due to a divorce or medical issue. They don’t have time to wait around.
Very often, they are simply retiring from the real estate business, and are ready to move on. They don’t want to spend more time than they must in dealing with a real estate transaction.
For this sort of seller, they’ll often accept a somewhat lower offer on their property, in exchange for a fast closing. In these circumstances, a cash offer makes sense.
Why? Well, traditional residential mortgage loans take 30 to 45 days to close, sometimes longer. For commercial loans, you’re often looking at a closing period of around 90 days.
With a cash (or hard money) offer, it is quite possible for you to close in anywhere from 5 days to 2 weeks. The process moves at a very fast pace, which is beneficial to the seller. It reduces uncertainty. In exchange, you purchase at a discount.
We love these sorts of transactions. Some of the most profitable multifamily transactions we’ve done involved sellers who wanted to close fast in exchange for cash. This is a great way to acquire properties at notable discounts.
Cash Offers Reduce Appraisal Risk For Sellers – Which Increases The Chances Your Offer Is Accepted
When you purchase a property through the use of a mortgage, the lender will perform an appraisal. In an appraisal, the lender hires a professional (known as an appraiser) who makes an assessment of what a property is worth.
For residential rental properties (1 to 4 rental units), this usually involves looking at the value of comparable properties. Your property is rarely worth more than similar properties (i.e. similar size and condition) in the same neighborhood.
For commercial rental properties (5 or more rental units), it involves examining the cash flow generated by a property, relative to the area where it is located. That is, commercial appraisals value properties based on how much income is generated, and how much of a sales price that income should translate to in the local market.
Appraisal values are not always predictable. You might think that the single family rental property you’re purchasing should appraise for $500,000, but the appraisal comes back at $460,000.
Let’s say you were purchasing this investment property with the use of a mortgage. Let’s also assume that you were offering a 25% down payment (as is common with investment properties) of $125,000, and a mortgage of $375,000.
Now, if you still want to purchase, you’ll have to offer a down payment which is $40,000 higher. Why? Well, the bank is offering to lend $40,000 less (the difference between $500,000 and $460,000), based on the lower home value.
Of course, this is true for multifamily properties as well. An investor friend of ours signed a contract to purchase an apartment building for $3.2 million, only to learn that the property appraised for $3.1 million.
In any of these situations, as a buyer you’d have to come up with more money (i.e. a larger down payment). Otherwise, you must walk away from the deal. Obviously, this is risky for the seller of the property.
How do you eliminate this risk? Simple: Offering to pay the seller in cash. In a cash transaction, there’s no mortgage, and thus no bank appraisal.
You’ve eliminated a major problem for the seller. This increases the chances of your offer being accepted – perhaps even over higher, non-cash offers.
With hard money loans, the lender will typically want to make sure that you’re not paying more than the market value of the property. There can be a bit of appraisal risk.
However, they’re often not likely to engage in a full appraisal, especially if the price you’re paying is at or below market comparables. The chances of being denied a loan due to a low appraisal is much lower on hard money loans.
This is yet another instance where purchasing in cash / hard money makes sense. By solving a seller’s problem (appraisal risk) you can get your offer accepted.
Purchasing In Cash Allows You To Acquire Properties Which Need Repairs – And Upgrade Them
When a traditional mortgage lender appraises a property, they’ll want it to be in a certain basic state of repair. Major issues like termites, a damaged roof, or serious electrical problems, are all reasons to not fund a loan.
Why? Well, lenders are typically concerned about the safety of their investment. They worry that a property which is already in disrepair might deteriorate further. Promises from a buyer to fix the property often don’t carry much weight.
Yet, as an investor, purchasing rundown properties can be a wise move – if you’re equipped to handle them. Why?
Properties in disrepair attract fewer investors. Many investors don’t have the patience, or the human capital (i.e. skilled contractors) to deal with these sorts of issues.
If you have the skill set to turn a beaten-down property into a beauty, you’re going to have a strong advantage. To be sure, you must have a very strong rehabilitation strategy in place. Assuming this is the case, purchasing such properties can make sense.
So, how do you acquire such properties? If you have your own cash, then there are no issue. You’re the final decision maker.
Without such cash, a hard money loan is another attractive option. The hard money lender wants to make sure that you are buying at a reasonable price, and have properly estimated repair costs. However, unlike traditional mortgage lenders, they’re willing to lend on properties which need many repairs.
In some instances, you may also borrow the funds needed for rehab, directly from the hard money lender. This means that for putting up some down payment, you’re obtaining both the funds to purchase the property, as well as fix it.
Construction funds are typically dispersed in installments, also known as draws. As each part of the construction process is completed, the lender will provide you with funds, to pay your contractor and other vendors.
If you have any interest in purchasing properties which require repairs, it is crucial that you become comfortable with cash purchases, or using a hard money loan.
Cash Increases The Chances Of Your Offer Being Accepted When There Is A Lot Of Competition
When a property offers a good value at a competitive price, it is common for it to recieve multiple offers. In our market (Los Angeles) we’ve seen the best multifamily deals draw over a dozen offers.
In such a market, how do you compete? One way is by offering a higher price than other potential buyers. If you can acquire the property at such a price and still achieve strong investment returns, this is something you should seriously consider.
However, there is another tactic to get your offer accepted: Offer in cash / hard money, with a short closing period. When compared with offers from other investors, yours will look comparatively more attractive. After all, you’re offering the seller a greater degree of certainty.
Sometimes, you can even offer slightly less than the highest offer, and still have your offer accepted. Of course, this doesn’t mean you can offer a much lower price than other potential buyers. However, if your offer is competitive, and is in cash / hard money, your chances of an accepted offer increase considerably.
We have used this tactic in multiple instances. In one case, we purchased a triplex for a price that was 2% below the highest offer, by offering to close in cash in just 10 days. The property offered lots of upside once the 3 units were upgraded. Thus, this was a particularly exciting deal.
Your ability to close quickly solves a problem for the seller – and cash makes this possible. You can win highly competitive deals through a cash purchase.
The Final Word
Acquiring investment properties isn’t easy. This is especially true of multifamily properties, which have held up well through the COVID-19 pandemic, and earlier economic downturns.
If you want to win bids on the best deals, you’ll need to make your offer as competitive as possible. Offering in cash or hard money is one excellent way to do so.
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