Staff Writer, with Ten-X Research Quantitative Analyst Matthew Schreck
Let’s say you’ve found a new home in a competitive market. You’re first in line at the open house, you connect with the sellers and even write them a handwritten letter afterward to express your enthusiasm. Rather than negotiate, you submit your best offer first… only to be beat out by an all-cash buyer from halfway across the country, who bought the property sight unseen.
It’s fast becoming a familiar tale. According to RealtyTrac, more than one in three homes in the U.S. are now purchased by all-cash offers. In some markets—such as luxury homes in New York City—the number climbs to two out of three.
“So far it’s distressed homes and foreclosures that tend to make up the bulk of all-cash sales,” said Matt Schreck, a quantitative research analyst with Ten-X Research. “It makes sense since institutions and high net-worth individuals are generally the ones buying all-cash, and banks are extremely motivated to get real estate-owned properties off their books. That creates the perfect marriage of buyer and seller. Condos and co-ops in major gateway markets like Miami and New York have been another big source of all-cash sales, since they’re a good way for foreign investors to park their cash.”
But while it may make sense for a wealthy or institutional investor to pay all-cash for a new home, does it make sense for a typical homeowner? Let’s weigh the pros and cons.
The Case for Cash
1) No mortgage. With the median mortgage payment averaging north of $900/month, mortgages tend to be the biggest bill—and the biggest liability should you lose a job or face a financial crisis. Paying all cash eliminates the sizable debt that comes with a mortgage as well as closing costs, origination fees and other expenses.
2) Green discount. If you’re willing to pay cash up-front, you might be able to beat out the competition even with a lowball offer, as a seller won’t have to worry about you backing out if financing is denied. Sellers also know that an all-cash payment will become available immediately for their future investments, and therefore might be willing to shave a few dollars off the purchase price.
3) Speedy deal. With no financing to wrangle through and less paperwork to process, an all-cash offer can reduce a real estate transaction time from two months to as little as two weeks.
“All-cash offers usually come at a discount, so there’s a big advantage there for buyers,” said Schreck. “And if you’re looking to make a profit in the residential space, you can get pretty good returns on flipping them or investing in them en masse. The housing market is the biggest piece of the US economy that has lot of slack left and room to grow, so it makes sense from that perspective.”
The Case Against It
1) Future uncertainty. If you place all your financial bets on a piece of property and lose the lion’s share of your liquidity, you could tie up your finances for years. Since you don’t know what your credit score will be or what your home will be valued at down the road, it could prove more difficult to obtain a home equity mortgage at a later date.
2) Low reserves. If you spread yourself thin in order to buy a home, and then for whatever reason it doesn’t work out and you want to sell, you may no longer have the cash to put down as a deposit on a new property. Ditto for other potential investments.
3) Stock opps. If you catch the stock market on an upswing, you could make more by investing your money there rather than in a home. By putting all your money into a property and therefore into one asset class, your portfolio could suffer from a lack of diversification. And if you find yourself in need of quick cash, stocks and bonds can be cashed out quickly while a home can take months to sell.
“For the average American, a mortgage can be a good way to build credit history, if you need to have outstanding debt in order to improve your credit score,” Schreck said. “Interest on first and second home mortgages is tax deductible up to $1,000,000 and can contribute to a bigger deduction at the year’s end. And with a low mortgage rate, you could take the money you saved on the down payment and put that into an index fund, and get a higher return than what you’re paying on the mortgage. In theory you’d be making more money, but it depends on market conditions that can fluctuate.”
Today’s Takeaways
If there is one thing experts agree on, it’s that you have to evaluate your individual financial situation before deciding on an all-cash offer. While it can be easy to pick a path for those at the financial ends of the pendulum swing, the decision is trickier for those in the middle who could make an all-cash offer but grapple with whether they should.
“I think for a homeowner with a stable income who has enough for a down payment but not a ton of liquidity and cash, taking on a traditional mortgage is generally a better option. But every situation is different,” Shreck said. “In the run-up to the last housing bubble, people had the sense that a home was an investment you could bank on increasing in value every single year in perpetuity to the moon. But if you’re planning to make an all-cash offer on a home with the expectation that it will be a cash cow, that can’t be the only reason.”
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This article is originally published on Ten-X Homes.
