Cash-rich? Why It’s Still A Good Idea to Finance Your Real Estate Purchase.
By Maya A. Johnston on 13 Apr, 2012
Having decided to buy a Barbados property, the question that is frequently posed by our Private Clients is how they should pay for it- should they finance or use cash? Over the economic recession, many High Net Worth clients have built up significant cash (or near-cash) reserves due to the fact that there have been few other attractive investment options and also because most people have simply become more risk-averse. As a result, cash is increasingly a viable option for purchasing that second home.
In answering this question, I find myself torn between two mindsets. My family upbringing wants to blurt out that cash is king and that you should never borrow if you don’t need to, but the banker in me is almost legally bound to say “Why finance, of course. How much do you need?” Here’s why my banker alter-ego is actually right this time around.
Strategically it’s a great time to borrow, and all the more so if you don’t need to. The fact is, strategic debt differs from traditional lending in that it’s about using debt opportunistically as a tool to achieve your financial goals. Debt is often thought of in a negative light, but when used intelligently, it can provide enormous benefits. Not only are borrowing costs today much lower than we’ve seen in some time, but this is especially true for affluent clients who can often borrow at a lower cost than the average person.
Using debt to finance your real estate purchase puts you in a position to magnify your personal returns (and losses) through leverage. If property bought in 2012 increases in value by 3% in 2013, then the cash buyer makes a 3% return, whereas the buyer who financed 70% of the purchase, makes a 10% return on their 30% equity stake.
Debt can also reduce your overall cost of ownership. In many instances, the use of near-cash instruments (e.g. marketable securities) means liquidating a portfolio and possibly generating capital gains that may be taxable. Avoiding this through financing can be a cost-effective strategy. In addition, the interest costs of borrowing are often tax-deductible in themselves.
In addition, debt is useful for lessening risk. Instead of using that cash on one large purchase, financing a portion of the purchase frees up the remainder of your cash to invest in other geographies or types of investments. By diversifying how your cash is deployed, you naturally reduce the risk and impact of any one investment. The other way borrowing can reduce your risk is that by leaving a significant portion of your cash reserves untouched, you can achieve peace of mind that if you need cash urgently for a rainy day or a new investment opportunity, it will be there.
In the end, if you are still not sure which way to go in the long-term, bear in mind that borrowing is easier to reverse than not borrowing. Simply put, reversing debt is like floating downstream in that you can always ask your banker to structure the loan so that you can prepay in advance without penalty. On the flip side, reversing a cash purchase through an equity take-out loan can be a little like swimming against the tide. It’s a harder loan to get approved, especially for offshore investors, so it’s best to be sure you won’t need that cash back once you put it in.
In the end, each buyer will make the right individual decision for his or her own circumstances but hopefully this provides some food for thought. In addition to gloating about being right, the my inner Banker wants me to remind you that Scotia Private Client Group is always happy to help if the need arises. Happy hunting!
Let Terra Caribbean help you in your hunt for Barbados real estate. To view properties for sale or rent in Barbados, visit www.terracaribbean.com/barbados
Maya is Centre Director, Caribbean East for Scotia Private Client Group. She manages the full suite of client services offered under the Scotia Private Client Group umbrella. Maya is a Barbados National Scholar, holds dual Bachelor of Science degrees summa cum laude in Economics and Engineering from the University of Pennsylvania, and an MBA degree from Harvard Business School.
This article is extracted from The Red Book 2012 - The Pink Pages.