Down on Investment Property

25 Replies

What is a good guideline % wise on a down payment?  If purchasing an investment property would you put more money in to get cash flow positive?  Does that even make sense?  

That is a real broad question that is hard to answer without more specifics.
Are you using a bank or private money or seller financing or what?

Where you get the money is as if not more important than the deal itself.

@Caleb Heimsoth If you don’t have much money saved to put into a property, would a lower percent of 10% or less still be wise? This was my initial thought because starting out with a first property as soon as possible would allow you to leverage your money, even if there is less cash flow. Or is it worth saving up those few months more in order to put a larger %down?
@Henry Davis I don’t know think you can put 10% down if you go with traditional financing. I have to put at least 25% down for my OOS properties and 20% for in/state properties.
@Ed Martinez - The lowest you can go on SFR rent is 15% (with PMI) or 20% down without PMI. Depending on thr deal and the cashflow it generatea paying PMI may not be a bad idea. All my rentals are out of state and I have done them all with 20% down On 2-4 units you will need min 25% down. period For 5+ - Depending on the bank and the type of asset it would be anything from 20-30%

That depends on your income and tax situation.  These days suggest at least operate on break even for calculation at say 5% interest 30 year mortgage.  Most investors in San Jose pay cash or put heavy down as the rent is way < a 80-20 mortgage. Want less negative or positive go the States where the appreciation is no more than inflation. South or Midwest. Some States home prices stay put for decades.

If you are buying in San Jose, you will need to put more down in order to cash flow. 20% might not make sense in that market. But in other markets where the cash flow is much better, put the minimum down.

@Henry Davis

Comment about putting little down. 

Last 13 years as a FT realtor I put in many high offers in the midst of Great Recession, those 10%, FHA do not even get considered. Unless you are the lone bidder chances of being considered is not high. For conventional mortgage in anything less than 20% down you need to get PMI insurance that goes from $200 to $500 ish per month. Same with FHA loan. Starting in 2018 insurance is no longer tax deductible for primary residence.

Paying down a property does not increase the cash flow generated by the property. What you are actually doing is buying cash flow with your own cash. Paying more money than it actually generates is not investing. Ideally you want to keep your DP to a minimum to maximise the cash flow generated by the property.  Buying cash flow  generates a over all financial loss due to the lost opportunity value of your cash.

When a property can not produce it's own positive cash flow with a hypothetical 100% financing the property itself is a poor investment.

For the most part, I agree with @Thomas S. If the property is not cash-flowing at 25% down, you may have an issue. However, your situation will dictate what works best for you. For example, if this property has high taxes, an HOA fee, or you had to pay significant points/origination fees for the property, it MAY make sense to put more cash into this property before you buy another (esp. if your goal is only to buy a handful of properties). You have to run the numbers to see (see below).

Many people look at the percntage return (ROI, etc). However, you can't spend or invest percentages (a relative figure of merit). You can spend and invest actual dollars (an absolute figure of merit). So if you have another $$25K (or however much) to invest, you want to know if it will return more total money to you buy investing in the current property or investing in another property

Try running the numbers with 25, 50, 75, and 100% down.  Then consider how much return you would get by using the same amount of money to buy another property.  Wherever the numbers turn out better is your best investment.

Best to you.

Leverage is a double edge sword. It can help you grow your portfolio and it can leave you exposed. It is the classic greed vs fear question.

I personally will take as much leverage as I can find. This not to say that I will borrow irresponsibly or use the leverage to make frivols purchases. I keep cash on hand to cover any unexpected expenses. I do not budget a reserve per unit, as many people are fond of doing. In reality, does it really matter if I have an unexpected auto repair or hot water heater expense. Clearly, they are accounted for in different ways, but it comes from the same pool of money.

If you buy the property correctly, you are going to be fine regardless of the leverage. In a doomsday scenario could you rent out a place and be cash flow neutral. There is an intrinsic minimum value in retail rental property. If you offered to rent a 4 bedroom condo in downtown San Francisco for $800. The line would be around the block. Retail and commercial does not have the same built in market. While not something many people look at, could you maintain the property if you had to rent it for your cost? 

Keep in mind the maximum real return you make by paying down a mortgage is the savings on the prevailing mortgage interest rate. When a mortgage is at 4% and you pay it down your money is only earning 4%. This is why investors take 30 year mortgages and have a tenant pay it down so they can invest their cash for a 10%+ return. 

Dead equity is cash hoarding for your senior years. Make no mistake your children will appreciate living the life style of the rich and famous when they sell.

I think it's best to put 25% down, especially on your first property. I realize that slows you down and I know there are ways to do 'low money down' deals, but the peace of mind with a higher downpayment is helpful on the first property.

A huge part of being successful in any kind of investing is self-discipline and drive. Saving up the downpayment develops both of those skills. It's painful, sure. But worth it!

There are folks that will do the Nomad investing strategy and buy a home to live in with 0%, 3%, 3.5% or 5% down (or more), live there for a year (or more) and then convert it to a rental when they buy their next property to live in. This does get you slightly lower interest rates which can help with cash flow. In most cases you will have PMI (save VA loan if you qualify for that loan program).

If you're not willing to living in the property first as an owner occupant for year before converting it to a rental, as others have mentioned, you can do 15% with PMI for non-owner occupant. At 20% you won't have PMI. At 25% you are both borrowing less (which improves raw cash flow dollars) and typically getting an improvement to your interest rate (which also helps with cash flow).

I am not sure if you get an interest rate improvement at additional down payment levels... perhaps a lender knows the answer to that.

As for which loan program is better, it really depends on what happens in the market.

If it were me, I'd model whatever I decided to do with both optimistic market conditions and pessimistic market conditions and make sure you're comfortable with both. Property select is extremely important as well as mentioned above.

Originally posted by @AJ Singh :
@Ed Martinez You should aim for twenty to twenty five percent down plus reserves for vacancy and capex With ten percent down, you have a tough road ahead

@Ed Martinez 

Maybe conventional financing isn't the way to go: It's too limiting

I was asked by a couple of people to compare doing a Buy & Hold Rental using conventional financing and buying Subject To with selling to a Tenant Buyer and what that would look like.

This is an actual deal I recently did. I bought a 4 Bed 2 Bath 2000' property in a decent neighborhood in Mesa AZ that was built about 1985.

In this Spreadsheet I am comparing:

OPTION: 1 Conventional Financing for "Buy & Hold" for a Rental vs

OPTION: 2 using "Subject To" and Reselling to a Tenant Buyer

OPTION: 1 As a Rental, the Kitchen and Bathrooms needed updating requiring about $5,000 of work in order to be ready to be a Rental. From the Renter I would get first month’s, last month’s and deposit. I would have to have a loan from a bank with 20% down or about $45,000 to qualify.

OPTION: 2 However, Selling it to a Tenant Buyer requires no rehabbing on my part. The Tenant Buyer will do (or not) the rehab to their liking. From the Tenant Buyer I get an Option Payment of $25,000 and a rent payment when they take possession. There is no deposit. Here I simply take over the existing loan and payment & need about $15,000 “Cash on Hand” to cover expenses & reserves etc. I can sell the property for more because he doesn’t have to qualify at a bank and will pay a slight premium.

I used to do these as Joint Ventures with people and split the project, now I just sell them as Turnkey. People can do these on their own, if they take the time to learn how. And No, I don't mentor ;-)

Let’s see how the numbers work.

@Ed Martinez I have used up to 40% down for a checkbook 401k purchase and as little as 10% down for personal purchase. Both are cash flowing about the same ($500-600 per month) since the 40% down is financed for 20 yrs and 10% down is financed for 30 yrs. same neighborhood same price point. (Higher-end, new home rentals)
@Ed Martinez I love this question. The answer is, as little as possible. If you are willing to move into the property you can put 3.5 percent down. I did this with my first 4 properties. Don’t let having no money hold you back. GET CREATIVE! You may have to make some short term sacrifices but you can real some truly long term rewards. Do NOT put 25 percent down on a property unless your sitting on a pile of cash. If this is your first property, then get your hands dirty and learn some skills. I bought my first property with 5% down, because I refused to pay pmi. (it’s not tax deductible) talk to a loan broker and find out your options. No matter the deal, the less you put in on this one, the more you can spend on the next!
Originally posted by @Henry Davis :
@Alpesh Parmar

I you are to hlusehack a property, would gettIng a residential mortgage of 10%or less be okay? I live in the UK and this is what I plan to do once I leave school, because I will not have enough saved to put 20-25% down.

If you are ok with paying PMI, it would be fine. You may need to put more money down to get your offer accepted though.

Check local banks, they are more investor friendly if you have a working relationship with them. I have financed multiple properties with 10% down and no PMI. The rates are a little higher than a "traditional" lender but without PMI it was worth it for me.

Originally posted by @Sierra Crisp :
@Ed Martinez I love this question. The answer is, as little as possible. If you are willing to move into the property you can put 3.5 percent down. I did this with my first 4 properties. Don’t let having no money hold you back. GET CREATIVE! You may have to make some short term sacrifices but you can real some truly long term rewards. Do NOT put 25 percent down on a property unless your sitting on a pile of cash. If this is your first property, then get your hands dirty and learn some skills. I bought my first property with 5% down, because I refused to pay pmi. (it’s not tax deductible) talk to a loan broker and find out your options. No matter the deal, the less you put in on this one, the more you can spend on the next!

How did you go from one to the next? I just purchased a duplex as owner occupied in December but in order to do it again i would need to refinance it out of the FHA program and into a conventional loan since I can only have 1 FHA loan out at a time. I would love to do this and get out of the PMI too but that is a bit wishful thinking unless i want to put down $30k to get below PMI threshholds.