I love getting questions from readers in my e-mail. They force me to think outside of my own perspective and I always end up learning a lot. Recently, one readers emailed asking me about ways to buy real estate without debt as an investment. It’s a great question and one that is likely on a bunch of people’s minds.
So let’s dive in!
First, why is most real estate investing associated with debt?
When it comes to investment real estate, debt can actually be a very helpful tool when used appropriately.
The reason is that debt gives the real estate investor leverage.
For example, let’s say you are going to buy a $200,000 property that cash flows $20,000 each year. You can:
A) Buy this property outright for $200,000 and cash flow 10% ($20,000/$200,000), or
B) Buy the property with 20% down for $40,000 and cash flow 50%! ($20,000/$40,000)
Now, please note that this is a totally arbitrary and simplified example. Your yearly cash flow will be based on all of your expenses include insurance, maintenance, turn-over, etc. And your cash down will include closing costs and renovations among other expenses. So it’s not this clean in reality.
But, the point is proven.
Using debt for leverage can dramatically increase your cash flow when investing in real estate.
Then why would someone buy real estate without debt?
I think are largely two reasons why someone would want to invest in and buy real estate without debt:
- Religious/cultural reasons
- Concern over taking on debt/the risks of debt
And these are both obviously very valid reasons to want to avoid debt when investing in real estate.
It just so happened that the reader who emailed me could not invest in real estate with debt for religious reasons. Therefore, he was looking to buy real estate without debt.
But before getting into the “how” of investing in real estate without debt, I want to address Reason #2 for wanting to avoid debt in REI…concerns over the risks of debt.
Why you shouldn’t be scared to buy real estate with debt (if you do it right)
I am debt averse.
So much so that I pay off HUGE amounts of my student loans every month even though I can invest in the market or real estate for higher gains.
What’s Better? Should You Pay Off Debt or Invest?
Paying off my debt increased my net worth in an exact 1:1 ratio and increased my cash flow as that debt evaporates.
And I apply that philosophy wholeheartedly to all of my bed debt.
But is all debt bad?
A full discussion of this question can be found here.
But I’ll summarize: There is such a thing as good debt. It is debt that pays you to have it.
How can that work? Well, my investment properties have mortgages. But the rents cover the mortgage and other expenses and also put extra money in my pocket. That is debt that pays me.
But one has to use this debt wisely:
- Carefully screen and analyze properties to evaluate them before investing in them
- Use conservative numbers in your estimates
- Choose good tenants
- Automate your processes including rent collection
- Be a good landlord
Do this, and I argue that debt for real estate investments can be good debt.
So, if you are in the “avoid debt” camp for investing in real estate for Reason #2, I would reconsider your stance. Maybe debt can actually help you.
But still there will be those who want to avoid debt completely. And that’s OK. And there will be those like my reader who may appreciate the leverage that debt offers but just be unable to use it for other, very valid reasons.
This is for you…
Top 3 ways to buy real estate without debt
Keep in mind that I am talking about investing in real estate without taking on any debt yourself. Some of these vehicles may use debt in their inner machinations. Buy you personally will not have to take on or use debt to invest. So these meet the criteria laid out above…
1. Buy real estate “straight cash homie”
This is the Randy Moss method of buying…well, anything.
The most sure fire way to buy real estate without debt is to buy with cash. Just purchase the property outright.
While you will not be utilizing leverage, you will be maximizing your cash flow and minimizing your risk.
My advice is to carefully screen and analyze properties and still maintain the criteria that a property must reach 10% expected cash-on-cash to be invested in. It may be tougher to find properties meeting this criteria, but I wouldn’t get more lenient or you could find yourself in trouble.
The biggest downside of this method is obviously that you need to have the cash on hand to make the purchase. That means saving up for longer or potentially using money earmarked for something else.
So evaluate your financial plan and see where this fits in. It can certainly be very worthwhile!
2. Invest in syndications/real estate funds
Now we are moving on from more active to more passive forms of real estate investing.
Syndications and funds are a great way to invest in real estate. Basically, a general sponsor raises money (from investors like you) to buy one or many large properties. Your money goes into the pool of investors. Then, as the invested properties make money, so do you. Of course, on the flip side, if the properties lose money, so do you.
The biggest advice I can give you when investing this way is to spend a LOT of time on due diligence. You are basically handing someone your money to invest. So you better really trust them and also believe in the investment that they are making and the strategy they are using.
But these are good ways to buy real estate (that’s what you are doing) without debt.
You also buy real estate without any active involvement in the day to day operations. And this is a big advantage for many would-be investors.
See my full guide to real estate syndications here.
3. Real Estate Investment Trusts (REITs)
This is the easiest way to buy and invest in real estate. It also happens to be a way to do so without debt.
REITs actually were my first foray into real estate investing.
Real Estate Investment Trusts or REITs are basically investing in a mutual fund of real estate investments. These are available in nearly every brokerage.
As you know, real estate doesn’t correlate with stocks/bonds so this is a good, passive way to diversify. However, unlike the other options on this list, there are no traditional tax benefits with this type of real estate investing.
But, if you are looking to inch yourself in and want to invest, say, 5% of your portfolio in real estate, a great way to do it is to buy a REIT fund through your brokerage!
And there you have it!
Those are my top 3 ways to invest in real estate without debt. If you are looking for more information about using real estate to accelerate your path to financial freedom, this guide will tell you all the downsides and how to overcome them while this step by step guide will walk you through the process.
What do you think? Have you bought real estate without debt? What do you think using debt as leverage in investing? Let me know in the comments below!