Larger Down Payment for "Cash Flow"

31 Replies

Hi

I am new in real estate investing and was looking to one day buy a SFD in my area.  However, the "2% rule" seems totally shot in my local market. Looking at several online tools and doing some comps on Craigslist, it seems that the only way to generate a positive cash flow is to have significant down payment on your property so you can get a cheaper mortgage (30% plus).

My question is would you ever be willing to put 30-40%+ down on a home just to generate a larger positive cash flow on a house. Or sometimes are you happy just to "break even" at first, knowing that in a few years you can refi, or that rents will likely rise, or that within several years you can probably sell the home for a profit?

I would like to hear your thoughts. Thanks,

@Jimmy Humphrey I think their is no absolute correct answer to the question you pose.  For me personally, I do not like to bet on appreciation or rents rising.  

I like to evaluate deals based on what I can control, which to me is

  • buying the property at a price point where I am comfortable with the cash flow all things considered
  • how much value can I add by improving the property to raise rents or just simply raising rents that may be well below market

This way long term I know at minimum I will have a house that works for me cash flow wise and at best I get the appreciation and incremental raises in rent that make it that much more appealing as an investment.

Good point Michael.

I was looking at my home as a typical example as the basis of my research. My home is worth about 250k at the present moment, and I have about 60-70k in equity. My monthly mortgage payment fully escrowed is about $1400 per month.  According to my research I could probably rent my home for about $1600-1700 a month.  I figure after you add it all up, that's pretty much break even after expenses and vacancy.  I might be ble to squeeze a few extra bucks out of the deal because of some upgrades.  But at that point, I feel like I'd be better risking my money on a stock with a 2-3% dividend.

I guess that it'd take some real digging to find a home worth renting. 

You're rationalizing that a larger down payment is getting you a higher cash flow.  Yes, and so what.  The bottom line is it's just costing you more of your money...as in cash.  This is simple math...cash in, cash out...cash flow is only a part of it.

This is a typical deal in my market, so I'm not just making up numbers to prove a point.  Let's say you are buying a house for 80,000:

Option 1:  putting 20% down = 16,000.
*  Cash out of pocket                 16,000
*  Cash flow per month/yr          350,4200
*  Time to recover cash in          46 months/3.8 years

Option 2:  Putting 30% down = 24,000
*  Cash OofP                              24,000
*  Cash Flow per month/yr         400,4800
*  Time to recover cash in          60 months/5 years

Then you have to ask yourself, what else could I have been doing with the extra 8,000 I put down on the house?  If I put it towards another property...?

keep in mind you will have vacancy and maintenace.  Are you ok with a 60 day vacancy and a $1,500 bill to make your home ready for the next tenant. What about an eviction? Are you ok with no cash flow for 3 to 5 months? When people live in your house, things happen. They loses jobs, get divorced, die, job transfers, etc. I think you need cash flow to sustain your property. 

Originally posted by @Jimmy Humphrey :

Good point Michael.

I was looking at my home as a typical example as the basis of my research. My home is worth about 250k at the present moment, and I have about 60-70k in equity. My monthly mortgage payment fully escrowed is about $1400 per month.  According to my research I could probably rent my home for about $1600-1700 a month.  I figure after you add it all up, that's pretty much break even after expenses and vacancy.  I might be ble to squeeze a few extra bucks out of the deal because of some upgrades.  But at that point, I feel like I'd be better risking my money on a stock with a 2-3% dividend.

I guess that it'd take some real digging to find a home worth renting. 

 Never, EVER, look at your own home as an example comparison to an investment house.  Investors that think like homeowners when applied to investing will lose.  Homeowners operate on a "spender/saver" mindset.  Investors operate on an "investor/entrepreneur" mindset.

If you put two of the exact same houses side by side.  Same value, cost, expenses (utilities, etc...), mortgage, repairs, erc...and, one was a rental with a tenant, and the other a homeowner's house, the only things in common is they are houses...and someone lives in them.  Other than that, there are similar things (stated above), but they are NOT the same thing to the two different owners.

Too many REI think like homeowners when they invest, and they either lose or miss out on great opportunities...that are hidden in plain sight.

Originally posted by :

 Never, EVER, look at your own home as an example comparison to an investment house.  Investors that think like homeowners when applied to investing will lose.  Homeowners operate on a "spender/saver" mindset.  Investors operate on an "investor/entrepreneur" mindset.

If you put two of the exact same houses side by side.  Same value, cost, expenses (utilities, etc...), mortgage, repairs, erc...and, one was a rental with a tenant, and the other a homeowner's house, the only things in common is they are houses...and someone lives in them.  Other than that, there are similar things (stated above), but they are NOT the same thing to the two different owners.

Too many REI think like homeowners when they invest, and they either lose or miss out on great opportunities...that are hidden in plain sight.

Could you elaborate on how the mentality is different? I would be curious about this. I'm not sure I quite get it? 

Originally posted by @Jimmy Humphrey :
Originally posted by :

 Never, EVER, look at your own home as an example comparison to an investment house.  Investors that think like homeowners when applied to investing will lose.  Homeowners operate on a "spender/saver" mindset.  Investors operate on an "investor/entrepreneur" mindset.

If you put two of the exact same houses side by side.  Same value, cost, expenses (utilities, etc...), mortgage, repairs, erc...and, one was a rental with a tenant, and the other a homeowner's house, the only things in common is they are houses...and someone lives in them.  Other than that, there are similar things (stated above), but they are NOT the same thing to the two different owners.

Too many REI think like homeowners when they invest, and they either lose or miss out on great opportunities...that are hidden in plain sight.

Could you elaborate on how the mentality is different? I would be curious about this. I'm not sure I quite get it? 

 The full explanation can get long, but the quick one is this.  Just look at all the bills to be paid:  Home purchase, interest on loan, utilities, repairs, maintenance costs, insurance, taxes, etc...  Now, if you had those two side by side houses I mentioned above, who pays these bills? These bills are "costs" to a homeowner because they go in one direction...out and gone.  These bills are "expenses" to an investor since they come back in the form of rent payments (with bonus money attached).

In the end, this also shows the lie of your home being your greatest investment...it's not.  It's your greatest cost (aside from taxes).  If you add up all the bills, they will always be greater than the "profit" you make when you sell the house.  I'm not saying don't buy your own home...I'm saying it isn't and investment...in the profit sense.

An investor with a rental, on the other hand, makes a sizeable profit.  As long as you have positive cash flow, you are making a profit, since your tenant is paying all you bills.  When you sell, you are making a profit on the difference between what you bought and sold the property for...plus, you get the cash flow every month(year) on top of that.

All those bills (costs) that the homeowner pays comes out of the supposed profit, since the homeowner is the actually paying for them.  Those bills (expenses) that the tenant pays for the landlord comes out of the rental income.  The investor keeps that profit...and the cash flow.

Most people's primary homes are a good example of what not to buy for investments.  It's good to run real numbers on it, but that's about it.  $250k PP with a $1600 rent rate won't pencil, even in the 3% mortgage rate environment we are in.  Moving out of your house and 'breaking even' may be a good  idea if you don't have tax-free equity to realize if you sell or if you're under water, but in general, pretty houses in great areas are not good CF investments.  Appreciation plays, maybe.  But that's just gambling.

If a property needs 30-40% down to cash-flow, it's not a good opportunity.  How  many times have we heard that from agents and homeowners? "Just put more down if you want a return." I run my cash-flow projections based on a 10% DP and I need it back within 60 months. Some areas do much better and I could too (on paper) but I stay out of 'hoods.

 As @Joe Villeneuve illustrates,  it takes longer to get your money back the more you put into it. How many times can you do that? Very finite.  Any property will cash flow with 100% down.  

Buy low, rent high, sell high and leverage as much as possible (minimize your down payment). The more cash you preserve buying investment properties = more investment properties. The difference in cash flow buying one investment property with 40% down will never match the income generated with two properties putting 20% down on each. If you buy low on two properties you have twice as much equity and more monthly cash flow minus extra holding costs such as insurance and taxes.

One thing to consider is a good rental is not the same as a nice retail house. In my area the 2+% rent deals are lower/ low mid range houses that you can buy cheap, put a little money in them and rent. If you are looking at nicer retail priced houses you will probably never get close to 2%. I would not put more down to cashflow I would look for a better property.

you can always find a good investment property in any market if you work hard at it. For example I know a guy that knocks on doors offering to buy houses in cash in million dollar neighborhoods and snags one a month this way with lots of equity built in. home owners can be lazy and sell for less thinking they can buy for less on the next house. Now that's hard work but he is rewarded for his efforts. A good local broker with pocket listings can be just as profitable. 

We do both ... Buy to lease and sell to investors turnkey and also fix and flip to home owners. Finding houses is not hard the trick is to buy with real equity and still get nice cash flow. 

Originally posted by @Jimmy Humphrey :

Thanks everybody for your great insights. 

How much are you willing to come off the 2% rule?

 I don't use the 2% rule.  All that tells you is how the property works for the person that came up with that rule...it's based on their criteria, not yours.  Come up with your own "rule of thumb" based on your criteria and your market(s).

1%, 2%, 50%, rules don't, and shouldn't apply to REI...they should apply to milk...as in,

1% = Milk only a mother would love.

2% = Milk that is growing in popularity

50% = the increase per year in the number of people drinking 2% milk (I'm told this)

@Jimmy Humphrey

Milk joke aside, @Joe Villeneuve is correct. The 'rule' is also greatly affected by the class of property you're purchasing.  This is a very local number and a 'good' number will vary from market to market.

Currently, I'm purchasing properties in Las Vegas in Class A or Class B Communities with a '1.2% Rule'. Once I have all the property information, I calculate my DSCR to ensure it is over 1.35 and then I'm good to go. Once you are familiar with your market, you'll be able to setup your own guidelines to know if you're interested in the property.

Additionally, I don't think it is ever OK to break even (or have negative cash flow). If anything unexpected goes wrong, you can end up in deep financial trouble, especially as a new investor. 

-Christopher

Originally posted by @Jimmy Humphrey :

Hi

I am new in real estate investing and was looking to one day buy a SFD in my area.  However, the "2% rule" seems totally shot in my local market. Looking at several online tools and doing some comps on Craigslist, it seems that the only way to generate a positive cash flow is to have significant down payment on your property so you can get a cheaper mortgage (30% plus).

My question is would you ever be willing to put 30-40%+ down on a home just to generate a larger positive cash flow on a house. Or sometimes are you happy just to "break even" at first, knowing that in a few years you can refi, or that rents will likely rise, or that within several years you can probably sell the home for a profit?

I would like to hear your thoughts. Thanks,

 I think that the purchase price point is very important. From there you can play with the figures. But the initial cost of the house is what's going to make it.

I, personally, like to buy mortgage free but other people would rather more properties with a mortgage on each one. 

One day I'm going to have to do the math to see what's better. I'm sure that there are a lot of articles about this on Bigger Pockets.

But, irrelevant of how much you want to put down you're going to need to see what the cost of the house is, along with closing costs, agent commissions (paid by seller but you're still paying it), taxes, renovations, etc. and then you have to see whether you think that you can sell it for a profit a few years later.

But cost is the largest determining factor over whether you're going to achieve positive cash flow or not.

Remember one thing. The less you borrow now the more you'll have available to borrow in the future when you need it (banking ratios).

Right...use the 2% rule as an "off handed" double check to see if you're in the ballpark. Use a spreadsheet to determine the profitability of your property.  Instead of thiniking in terms of increasing your down payment, or other ways to increase the cash flow, simply determine the profitability of the property if you paid all cash. If it doesn't work, put your money somewhere else. I personally find RE fun, but hard work. I want to be compensated. I want to be cynical with my numbers and if they don't work, don't buy. 

making a larger down payment gets you a return of whatever your interest rate is. 

eg if your loan is a 5% interest rate, you will get a 5% cash on cash return from your extra down payment. Personally, I would rather invest that cash in the next deal and make greater than 5% return. 

@Jimmy Humphrey - a few thoughts for you:

First, @Michael Noto talks about not liking to "bet" on appreciation of equity or rents. On the surface I agree, however, upon deeper examination both types of appreciation are indicative of something - what?  Answer - economic and demographic vibrancy!

Now, another question - would you rather invest in an economically depressed market without growth, or would you rather place your bets in places that exhibit a multitude of economic / demographic / geographic trends which over time lead to growth?

I am in Lima Ohio, and I've done well enough. But, I guarantee I would have done better in your hood :)

However, you are right - underwriting property strictly on CF becomes very misleading in a market such as yours. Winning is possible both in your town and mine, but it looks differently. Most of the country lives in places like Lima, Oh. You are fortunate...

If you don't see how and why, time to study, as more perspective is needed :)

We bought one duplex that we expected to put 25% down and were jockied into putting 30% down.  It is cash flowing but  We are unhappy about putting the 30% down but we got involved with it and did it.   It's a newer house/duplex and turn key with tenants paying $!,100 rent each (total $2,200)  and it cost $199,000.  No cappex on the horizon and very low maintanence expected and we also self manage.

How bad a deal is this??  We are OK with it?

Originally posted by @Frank B. :

making a larger down payment gets you a return of whatever your interest rate is. 

eg if your loan is a 5% interest rate, you will get a 5% cash on cash return from your extra down payment. Personally, I would rather invest that cash in the next deal and make greater than 5% return. 

 ...and your non-return, as in cash going in the wrong direction, is increasing by the principle you are adding to (down payment).  Simple math tells us the dollars going the wrong way are greater than the dollars coming back to us.

Example:  $100k property, 10% down ($10,000) or 20% down($20,000)
(assumptions:  5.1% amortized over 30 years; rent = 1000, Expenses = 300; CF = 700)

10% Down                                     20% Down
$10,000           Down Payment         $20,000
$90,000               Loan                     $80,000
$488.65          Payment/Month        $434.36
    0                Savings/Month          $  54.29 
$211.35/m      Net Cash Flow          $265.64/m
$2536.20/y     NCF/Year                  $3187.68/y
    3.94            Yrs to Recover DP         6.27

More important, that extra $10k that is resting in this property (the right column), could be out repeating the investment (left column x 2).
 

Example: $100k property, 10% down ($10,000) or 20% down($20,000)
(assumptions: 5.1% amortized over 30 years; rent = 1000, Expenses = 300; CF = 700)

20% Down                                         10% Down x 2
$20,000           Down Payment           $20,000 (= 2 - $10,000)
$80,000            Loan                           $180,000
$434.36           Payment/Month          $977.30
$265.64/m       Net Cash Flow            $422.70/m
$3187.68/y      NCF/Year                    $5027.40/y
   6.27              Yrs to Recover DP          3.94