Drawbacks of making a large down payment?

Buying & Selling Real Estate
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Drawbacks of making a large down payment?

Samir S.
Rental Property Investor · Livermore, CA · Member since 2015 · 29 posts · 9 votes
We are hoping to buy our first buy-and-hold property by the end of this summer. We feel like we've been analyzing properties ad infinitum and just need to take action! We live in the East Bay Area (Livermore) and would like to buy locally but what we could afford here would mainly be condos/townhomes; not sure we like not having full control over the property. We both like the Folsom/Roseville area (near Sacramento where we are from) and find ourselves in those areas several times a month visiting family. We've read the advice on not to buy any property with negative cash flow. It seems, though, that if we put a larger down payment, we can create positive cash flow. We know that reduces some leverage, but we are somewhat conservative and don't necessarily want to leverage to the hilt. The question is (and maybe there is no right answer): is it advisable to put more than 20-25% down for the sole purpose of generating positive cash flow? What are the negatives of that if we plan to only hold one or two properties for the long term? We already have a significant (to us) chunk of money in stocks and would be investing in real estate solely to diversify our holdings. Would that change the answer? Looking forward to hearing your thoughts and advice. Thanks!
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Jordan Thibodeau
Rental Property Investor · San Jose, CA · Member since 2013 · 486 posts · 170 votes
11y

@Samir S.

 Welcome to BP. I'm from San Jose and I invest in Sacramento. Also, please add line spacing to your original post, it makes it easier on the eyes. Remember 5 sentences = one paragraph (god i hated English class).

Two things: When analyzing a property, don't mix the value/earning power of the property with your own personal financing. Because if you go to sell this property other investors will consider the former not the latter. 

Analyze the property based upon it's current asking price, and how much income you can bring in (after expenses, not including mortgage). If it turns out the property is barely earning a return, then it's time to look for another property.

Currently the market in Sacramento is starting to heat up again, so price to income values on properties I'm seeing is high which means the return on investment is low. Now doesn't mean you can't find a great deal, but it means you will have to look harder for it.

Think, if you took the same money and threw it into a 401k, you would earn a tax and effort free return in stock somewhere around 6%~ a year (Based on historical returns from 1800s to today). Now if you took that money and invested it in a over priced piece of property, you would now earn a lower return and you would have to spend a lot of time maintaining it.

Regarding a larger down payment, I'm all for that because it means your mortgage payment is lower and you have a higher margin of safety, HOWEVER, if the underlying asset is not returning much, I wouldn't advise increase in the down payment to make it look as if the investment is doing better than it really is.

I say to thee KEEP LOOKING and BE PATIENT. You'll eventually find a good deal.

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  • Samir S.
    OP
    Rental Property Investor · Livermore, CA · Member since 2015 · 29 posts · 9 votes
    11y

    @Liz Brumer-Smith

    I appreciate the response.  After some more thinking, we've decided that we are willing to make a larger down payment in order to cash flow (minimally) in an area we feel will appreciate over the long term.  It's a risk, but one that we are willing to take.

    The one goal we have made is to have our passive income exceed our expenses.  We are a ways off from that, still!  But since we are young, we think that we can weather a "calculated risk gone wrong" and still come out OK in the end, especially since real estate is not the only investment vehicle we will have.

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  • Liz Brumer-Smith
    Specialist · St. Petersburg, FL · Member since 2013 · 114 posts · 49 votes
    11y

    @Samir S. glad you were able to find the best solution for you! That's what it all comes down to after all, what helps meet your goals. 

    Note Investing is a specific area of investing in which you buy, sell, and/or create mortgage notes. This can be bank created or owner financed (meaning the owner of the property creates(ed) the note). From an investment standpoint you can buy notes that are paying on time and always have been (performing), notes that aren't paying (non-performing), or notes that the borrower defaulted but has since started repaying again (re-performing). They all come at a different discount, but typically you can see yields from the 12% - 22% range, sometimes higher if it's a non-performing note (but those are a lot more work). The best part is that you never physically own the home, just the promise of repayment of debt from the borrower. So if they need a new roof, or taxes, or anything else with property maintenance you're not responsible! It's a really cool way to gain passive income over time.  I suggest reading about it more. 

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