Investors seeking safe assets and high returns are rushing into the real estate market, predominately via cash purchases of existing housing stock. In 2013, nearly 60% of real estate purchases were made in cash. By purchasing in cash, investors miss out on higher returns, risk diversification and a valuable inflation hedge.
An investor with one million dollars to invest can purchase three $300,000 properties with cash. With mortgages, however, that same investor could comfortably purchase a dozen $300,000 properties by putting down $60,000 per property and borrowing the rest. Keep in mind that the tax-deductibility of mortgage interest will lower the cost of borrowing below the stated interest rate on the loan. Using leverage, the same investment amount can yield much higher returns.
Using loans to purchase a greater number of properties allows a prudent investor to minimize risk by diversifying her real estate portfolio geographically. Also, increasing the number of number of assets reduces the effect that an underperforming property can have on a portfolio. A larger portfolio of assets allows an investor to cull non-performers from her portfolio without drastically altering her exposure.
Today's interest rates remain near historic lows. Investors can lock in low rates for the next 30 years. If we see double digit inflation as we did in the 1980s, then today's 4% loan will be squarely in-the-money. An investor in this position will see a substantial portion of her debt inflate away. Alternatively, in the unlikely event that mortgage interest rates drop, the loan can simply be pre-paid without penalty.
Investors have had a major role in stabilizing the housing market. As real estate prices are driven higher, the real estate market will lose its appeal as a safe refuge, and investors will have to find alternative investments for their surplus cash. Investors who purchase their properties with loans, however, have essentially purchased an option for further investment at a later date, but at today's prices. Several years from now, if an investor has more money to invest but feels that property prices are inflated, that investor has the option to pay down some mortgage debt. This will increase the investor's real estate exposure and potentially increase the cash flow of income properties.
Cash-only real estate investors miss out on higher returns, lower risk, and an effective inflation hedge. The advantages of leveraged real estate investing vastly outweigh the minor cost and hassle of securing mortgage loans.