Real estate investment – cash perspective

By: J. David Chapman/August 13, 2020

It’s official: Property remains the most attractive asset class for ultra-high-net-worth individuals. Did you know there was a designation for these ultra-rich people? Turns out, there is, and they really like investing in real estate. A recent survey of these affluent individuals indicates that they are committed to real estate over traditional equities and bonds due to the relative stability and higher returns. Makes sense to me – this is why many of you invest in real estate as well.

Normally, real estate is particularly attractive because you can apply leverage to the investment. Leverage simply means using other people’s money to purchase the asset and use the property as security for the loan. Lenders like real estate and will generally give a loan-to-value in excess of 70%, meaning they will supply at least 70% of the cash needed to purchase the asset. In today’s market, they are even doing so at record-low interest rates, thereby reducing the cost of borrowing the money.

Ironically, I have been seeing many investors choose to pay cash and forgo the lending process altogether. This is surprising with the cost of the money being so low; however, even with a cost of less than 5%, it is more than these investors are receiving on their cash elsewhere. This ability and preference of investors to pay cash for investment property is becoming a bit of a disruption to many investors who have built a model using leverage.

I have investors calling me and asking why property is selling for inflated pricing, claiming that the sellers just don’t understand that the investment doesn’t pencil out. By “pencil out,” they are referring to the profit/loss analysis including the debt expense. What they have failed to recognize is many are now paying cash, or applying very little leverage, and changing the analysis. By paying cash and avoiding the cost of borrowing money, these investors can actually pay more for the property and the rents received on the cash invested is still significantly higher than if the cash was in the bank, stock markets, or bonds. By paying cash, investors also are saving money on lender-required expenses that many investors don’t value such as appraisals and surveys. Like we needed another disruption.

J. David Chapman is an associate professor of finance and real estate at the University of Central Oklahoma (jchapman7@uco.edu).