Tuesday, February 8, 2011

Buying Real Estate All Cash

The Wall Street Journal yesterday had a great article on its front page above the fold on how all cash real estate buyers are hitting their local foreclosure markets in large numbers.

This is very true since the current mortgage underwriting process is very tight.

But what this article does not say is WHY would anyone want to buy real estate with all cash.  While you can certainly get a small discount paying all cash for a property, the notion of having an LTV ratio of ZERO on a piece of property is not just financially imprudent but sometimes dangerous.

First, the best reason to invest in real estate is leverage.  Other investments will provide you with greater cash flows, liquidity, and less active management.  Real estate leverage is the sweet spot of investing.  Have you ever heard the old expression that most millionaires have made their money in real estate?  Leverage is one of the prime reasons why.  Paying cash means no leverage.  The idea of paying cash and then refinancing later has merit but think of it this way.  If you can't get purchase money financing on good terms, what makes you think you can get it after you purchase?

Second, having so much cash tied up in a single property is dangerous.  It's a liability target in case you ever get sued.  The market risk of putting lots of your financial eggs in one basic is inherently risky.  It's hard to diversify when most of your liquid assets get put into highly illiquid real estate equity.

Third, and most importantly, I don't believe we are at a market bottom anytime soon.  Real estate prices are continuing to fall in Seattle, for example, where, incredibly, one-third of all homes are now underwater.

33%.  That's massive in a place with a thriving economy like the Pacific Northwest.

And the trend is towards future price declines.  So why buy now?  To be blunt, isn't the tight mortgage underwriting telling investors something about the perception of market risk?  I would not be writing 30-year mortgage paper at 5% when the risk of high inflation is in the air and the value of any real estate equity not so great at the moment.