Starting REI with low income, high capital

17 Replies

Hi folks, I've been researching how to get started with REI (house-hacking/duplex, or SFR with roommates), and am wondering what sort of strategies people use when starting off with lower income but high starting capital (inheritance). I see TONS of advice for the reverse situation. It seems conventional Freddie/Fannie loans are capped based on income severely limiting my financing and in Los Angeles I'm finding I would need to put over 50% down (which I can, just uncomfortable being so un-diversified). The FHA loans can get me much more financing but have such higher costs and really add up making that an unattractive option.

Thoughts? Strategies? Is it worth the FHA costs to be able to secure more financing, or just load up personal capital on my first property?

Updated 9 months ago

Edit: To clarify, my goal as a freelancer in LA is to be in an owner occupied unit that pays for itself.

I believe you said you were a newbie.  If it were me in your shoes, I would:

I would stay active here on BP, go to some local meetups and watch who is doing deals, listen, and ask questions.

After you have found a few folks that you think you would be comfortable working with, see if they would be interested in a JV. (Caution do not jump into a partnership just because they talk a good game, check them out, see their projects etc.) They would provide the credit score and experience, you would be providing up front cash.

The key here is having a good exit strategy, going into the deal.  A house hack on a good duplex, triplex, fourplex.  As units are vacated you can refurbish.  You would be in one unit.  After a while, you could either buyout the partner, let them buy you out or sell it.  

I like to make sure that the money is "Honored".  Example you put up $100K, for downpayment and materials.  When settlement is finalized, of course the all note payoffs and selling expenses would be deducted then, your investment + an agreed upon interest rate, then profits would be split as prearranged.  

Just a thought, but it gets your foot in the door, and you have someone you can learn from and make money too.  

Again, Vet who you will be doing business with, line up responsibilities and HAVE AN EXIT STRATEGY.  

@Rory Kinnear Not into lending or its industry. But I have read about CA/LA has more higher limits. But to your question:

Your income = 3,000/mo
Buy 1M house, 500k down/equity 500k loan
Refi to 750k loan, 250k equity
Rent other units at 2000/mo/unit (say 4-plex, rent 3) = 6,000/mo
New modified income = 3,000+6,000 less expenses
Buy 2nd unit at 1M, 250k from 1st house refi add 250k more (750k capital exposed) ... 500k loan, 500k equity/down
Refi to 750k
Rent 4 units at 2,000/unit/mo
New modified income = 9k + 8k (2nd prop) less expenses
........ repeat steps until capital runs out.

There’s no other exit in CA, ask the Patels. They hold it forever. For the rest, it’s buy low sell high, or buy below market rents, upgrade, then raise rent.

Originally posted by @Manolo D. :

Rory Kinnear Not into lending or its industry. But I have read about CA/LA has more higher limits. But to your question:

...

 Tremendously appreciative of your post, that is very much a coherent strategy.

As for LA I'm running into the issue that at 3k/month income the only way to get a 500k loan is FHA which is considerably more expensive per month (but I'm still meeting with lenders to determine options). In addition the math typically leaves me with more than 50% of my net worthy exposed in a single real estate venture, which may be less than advisable in the current market.

Honestly I think you're looking in the wrong state @Rory Kinnear . When I was in California I decided real estate prices were too expensive (impossible to cashflow with a high LTV) and bought in CO (which only a few years ago was far cheaper!)

Now that I'm in Denver it's hard to find cashflowing properties with low % down so I'm planning to put most of my capital (aside from house hacks) towards out of state investments. In my case I grew in upstate NY so I'm familiar with Albany, Binghamton, Rochester, etc. but there are deals to be had in many cities right now (KC, Buffalo, Houston, Cleveland, etc.)

For out-of-state investing there are basically two paths:

1) Lower return/easier - invest using an established turnkey company such as the ones listed on Jay Hinrich's site. They'll handle renovations, property management, etc. You just sign the check and you'll have a cashflowing property. The downside is that if they do most of the work your returns will reflect that. You will, however, probably still get better returns than the stock market.

2) If you want higher returns then find a real estate agent familiar with investment properties and start shopping in an OOS market (find a good one by looking through Zillow Research data). Make sure to start hunting for a property manager at the same time so that as you start to acquire properties you'll have somebody to professionally manage it. This is the route I'm taking at the moment - but it's not a "passive" investment, I'm actively managing my managers & various projects remotely. You'll need to be the orchestrator if you go this route.

Given that you don't have much disposable monthly income you should be looking for ways to increase that your income as your top priority. That will come from high cashflowing areas like the midwest, not appreciation markets like LA, SF, NYC, etc.

Thanks @Jim S. , I am very grateful for your input. Since my goal is to give myself greater financial freedom here by owner-occupying, and my career is 100% LA dependent (for the next 10 years or so) I am just going to have to deal with what are the very real challenges in Southern California. Becoming an absentee RE investor would not satisfy those goals, but in fact add so much additional pressure that it would distract from the work that is my top priority. Given that I am able to put up ~50% down, I think the LTV should not be as difficult for me as others.

Originally posted by @Rory Kinnear :

Hi folks, I've been researching how to get started with REI (house-hacking/duplex, or SFR with roommates), and am wondering what sort of strategies people use when starting off with lower income but high starting capital (inheritance). I see TONS of advice for the reverse situation. It seems conventional Freddie/Fannie loans are capped based on income severely limiting my financing and in Los Angeles I'm finding I would need to put over 50% down (which I can, just uncomfortable being so un-diversified). The FHA loans can get me much more financing but have such higher costs and really add up making that an unattractive option.

Thoughts? Strategies? Is it worth the FHA costs to be able to secure more financing, or just load up personal capital on my first property?

 It really just depends on what you are trying to do. Investing in a buy and hold can help you save over time and you can also use that toward another property. Flipping is a full time game and costs a lot. There are many different kinds of investments out there. 

@Rory Kinnear

The BRRRR strategy would seem to be a good fit. Lot's of good resources on BP describing that strategy.

In Pittsburgh you can get some good deals if you are a cash buyer and willing to fix up a property and then refi after the seasoning period. Other midwest markets and rustbelt areas seem to be the same based on everything I see on BP. It would build a solid cash flow portfolio and keep your money moving if you're willing to do out of state. 

 You could do the same in LA, but I don't know that market as well. It has always seemed like it's better for flipping than buy and hold/cash flow. 

If you want to house hack as you stated you could do FHA. Not a bad deal if the numbers still work. If you are a first time home buyer there might also be programs for you in your area. I would look around.

Also, I just saw your conversation with Jim. If you had a few properties in a different area than your home that still made enough money to offset your housing costs that would still impact your personal balance sheet well. Just like house hacking except you solve your barrier to entry issue. 

If your goal is multifamily in LA FHA loans would be my suggestion. I have personally closed 4 unit buildings at over 1 million dollar price points with less than $50k out of my buyers pockets (including closing cost). The up front mortgage inuance and monthly mortgage insurance are a slight pain but in no way compare to you putting over 50% down on a property and the market potentially shifts. Low downpayment would allow you to make a Ca investment and possibly get another or even diversify on other areas. I strongly advise against 50% down in the Ca market. At the rate of appreciation most of my FHA client srefi in 2-3 years dropping their mortgage insurance. In short, FHA is worth it, I use it for individuals with limited capital as well as buyers with high net worth.

Hey @Jim S. , Im a semi newbie in REI located in Denver and interested to do the same thing you are, invest out of state. I am sure this is a very newbie question but what does OOS mean? Also, do you attend any of the meetups in Denver?

Hey @Jennifer Ward

No worries on the question. I'm assuming he means Out Of State. I think a lot of people are looking out of state for buy-and-hold properties. The investors I'm working with here in Denver are getting more creative. Some are looking for small spaces to furnish and put a traveling nurse in. Others are buying a place with a basement apartment that they can Airbnb. (That's more for people looking for a place to live as well.) And there's all sorts of house-hacking varities (a la BP's and Denver's very own Craig Curelop in this blog post).

Either way, congrats on getting out here and looking for investments -- whether in Denver metro or OOS. It's exciting. 

Originally posted by @Manolo D. :

There’s no other exit in CA, ask the Patels. They hold it forever. For the rest, it’s buy low sell high, or buy below market rents, upgrade, then raise rent.

 So true. It's a market where you need to hold it forever. 

Thank you @Clarence Johnson , grateful for you chiming in on behalf of FHA, 50% would also put me nearly 1/3 of my net-worth in a single asset which has its problems too.

Thanks @James Carlson , I knew it would be something obvious, especially considering the context.  I am just overloaded with abbreviations reading through the forums and trying to sort them out. That is exactly what we did, we purchased a tri-level home in Arvada and AirBnB our lower two floors. We had a traveling nurse stay with us for 6 months.  It has worked out great for us. Now thinking about putting a camper next to our house and airbnb that too.  The neighbors are going to love us!

I think that for me, personally, I have the goal of attaining early financial freedom aggressively, but also like to maintain a conservative financial position with lots of liquidity and a hefty positive margin between my income and expenses.

If I had a huge lump sum of money that I came into all at once (and was otherwise unlikely to be capable of rebuilding said sum in less than 5 years), I'd be looking to invest it consistently, according to a system that I could sustain. I would likely not, for example, invest more than 50% of the large lump sum into one real estate investment starting from a position as a complete newbie. Instead, I'd invest a third, a quarter, or less, in a cash flowing property in or out of state, after at least a few months of planning, research, self-education, and networking. 

Then, between the savings from my personal life, and the cash flow generated from the real estate investment, I'd consider making another investment a year or so after the first. After a few years, and after my career continued to gain steam, after my properties produced more and more stable cash flow, and my reserves grew, I'd be able to gradually invest the entire lump sum, in between 3-7 periodic investments, hopefully preventing me from buying all at once at the wrong time in the market (almost no one can successfully time the market). 

During this time, I would probably make sure that I took advantage of the cash infusion, and shore up my reserves, and diversify the investment in CDs, bonds, and other investments that are relatively safe in the short-medium term.

This is one perspective, so I'm sure that there are others that have different thoughts. I'm not trying to say that this is the best way to do anything, just that this is a way that strikes me as something I'd be tempted to consider as an effective, yet reasonably conservative way to invest in the asset class that I believe will help me build the most wealth over time, without putting myself all at once in a position that I might be unable to sustain. 

You ask about financing. One potential advantage to this strategy is that you might have the ability to qualify on a property that you purchase with just 1/3 - 1/5 of this total amount. After a year or two of experience, this rental income will may help you qualify for additional financing, and may be counted as part of your income. This is what has happened for me, and my real estate investments actually significantly increase my purchasing power because 75% of the gross rents is counted toward my income, and this is still significantly higher than the debt service on my properties. However, there is no substitute when it comes to financing to simply talking to a couple of lenders. Find a few local lenders through referrals from trusted friends or family, or your own research elsewhere, and ask about your options. You may have more than you think!

Originally posted by @Jennifer Ward :

Hey @Jim S., Im a semi newbie in REI located in Denver and interested to do the same thing you are, invest out of state. I am sure this is a very newbie question but what does OOS mean? Also, do you attend any of the meetups in Denver?

Hey Jennifer - I was going to go to the "Bad *** REI" meetup on Monday but ended up skipping it. In general I plan to start going to some of these local meetups.

Yep, I meant "out of state" - let me know if you have any questions on the process or want some data on potential areas to buy in (I have a spreadsheet w/ Zillow data I use). I've been through OOS twice now and am about to close on a property here in Denver as a SFR house hack as well.

If buying a multi-unit primary residence is your entryway into REI.... its a great way to start. FHA is a great product. It allows you to get into a primary residence with little money out of pocket, 3.5% down payment. This allows you to invest your other liquid assets in other areas, or hold them as reserves.

There's obvious/many reasons why putting less money down can be beneficial.  BP has tons of articles on the benefits of using other peoples money & leverage.  Here's the only downsides: you'll have a higher payment, because your mortgage amount will be higher; your overall costs will be more because interest is paid on a larger loan amount, and fees are higher; you're starting off with little equity so depreciation could put you at risk of having negative equity. 

In the end, the right decision depends on your short and long term goals..... and what you're going to do with the money if you don't invest it in the down payment. If you're diligent with your money/investments and are deciding between 3.5% vs 50% down, you're probably best going with little money out of pocket so that you can keep your cash liquid for other investment opportunities!  

My first property purchase was a 2unit home that I bought via an FHA loan w/ 3.5% down. It worked out to be a great investment for me because it taught me about being a landlord, my home appreciated since I bought it, I had great tax write-offs from the PMI, depreciation, and rental expenses, and was able to invest capital in other places since I was able to get into the house with little money out of pocket.

Lastly, below is a breakdown of the FHA costs that you would take into account when analyzing "is it worth the FHA costs to secure more financing":

Monthly Mortgage Insurance Premium: FHA calculates your monthly PMI by using an annualized rate. Right now, the monthly MIP varies between .8% to 1.05% depending on how much you put down. This MIP can simply be added to your interest rate in order to get an idea of your gross rate. i.e. if you have a monthly MIP rate of .80% and an interest rate of 4.0%, your effective interest rate is 4.8%. Many times, the FHA rates are lower than conventional rates, so this can help to offset the monthly PMI

Upfront PMI Fee: FHA charges a 1.75% upfront fee on your total base loan amount.

Best of luck!

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