How Much Do You Need To Save for Your First Investment Property?
You have discovered the power of real estate. Capital preservation, cash flow, appreciation, tax benefits—all words that are music to your ears. And you are ready to dive in! Then you check your bank account and realize you aren't really sure how much you need for your first investment.
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Not knowing the answer, you turn to the BiggerPockets Forums and post your questions, only to get a series of responses ranging from $0 to $100,000 and everything in between. What’s worse, most statements begin with the words, “It depends…”
Where do you start? Who is right?
Well, it depends.
Why Padding Your Savings Is Critical
While it’s true that you can get started in real estate for no money down, I often advise people to have at least $50,000 saved up. Not that you need $50,000 to buy that first property (you may need far less), but more importantly, so you can have a shored-up financial foundation and invest from a position of strength.
I call this having a financial moat. This financial moat generally consists of saving up a minimum of three months of personal expenses (I prefer having six to 12 months of expenses myself) and any deductibles in cash. This cash pile can help you navigate a job interruption, broken-down car, or health crisis, or buy you time to figure out your next steps financially should life throw you a curveball (like a pandemic!).
How To Prepare Financially To Buy an Investment Property
Now that you have your financial moat in place, it’s time to figure out how much money you need to invest. In most cases, to buy a property you need to have the following.
- Down Payment
This can vary widely depending on your investment strategy, market, and lending strategy. If you are using an FHA loan, this may be 3-5% of the purchase price. If you are using conventional or commercial financing, this may be 20-25% or more of the purchase price.
- Closing Costs
This too can vary widely depending on your investment and lending strategy.
This can vary from lender to lender, with most lenders post-COVID-19 wanting to see six to 12 months of expenses in cash or in escrow. I’ve even seen lenders requesting the insurance deductible set aside, as well.
- Rehab vs. Rent-Ready
The make-ready expenses on a property can vary widely, from simply changing the locks to a full gut rehab. In either case, make sure to have your full rehab/rent-ready scope estimate locked in prior to closing on a deal, and add a contingency to this budget to account for surprises.
- Lease-up Expenses
- Vacancy Expenses
Be certain to factor in, at a minimum, one month of vacancy costs in your underwriting (which is 8%)—if not more—for the next year or two. Your property will be vacant at some point, it’s just a matter of when.
- CapEx/Maintenance Reserves
It’s not uncommon for a new investor to “fudge the numbers” on their first property and not set aside adequate CapEx and maintenance reserves in the beginning. I’ve heard many stories like this: Investor closes on a property, and the water heater that’s supposed to have five years of life left goes out all of a sudden. You, as the new owner, will have to replace and repair items. A water heater costs the same whether it’s a $60,000 home or a $200,000 home.
As you can see, the costs to close a property and get it to profitability can add up quickly.
How To Get Started Investing in Real Estate
So, how can you start navigating this process, building your “financial moat,” and building capital for your first investment? Here are a few steps to take.
- Pay down any consumer debt that will negatively impact your debt-to-income ratio and prevent you from getting decent lending. Look to reduce these payments first:
- Credit cards
- Personal loans
- Car loans
- Set aside at least three months of personal expenses plus any deductibles for your health, car, and home insurance. Bonus points if you can get to six to 12 months. If you have some of your debt paid down, you can now snowball your previous payments to build up your personal reserves.
- I like thinking of my Roth account as a double-duty retirement account since I can liquidate it penalty-free for most emergency needs. Moreover, you can leverage your employer payroll deductions and potential match to build this account quickly.
- When you are close to having a minimum of three months of reserves set aside, begin to determine your investment goals, investment strategy, and market. This will help inform what you will need for your other expenses.
- Talk to various lenders to determine your lending needs for down payment and reserves.
- Talk to local property management to understand what fees you can expect for your property expenses.
As you can see, it’s not a cut and dry answer for how much you will need to get started in investing. It very much depends.
By taking stock of your financial foundation and taking care to build your “financial moat” properly, you can invest from a position of strength. That way, you will be well-poised to navigate the wonderful world of real estate.
If you’re starting out, what amount are you aiming to save? If you’ve already been investing for a while, how much did you save up before jumping in?
Share your numbers in the comments.