Does a bigger downpayment make a deal better

Question

Hi everyone,

Recently I got into a discussion, which turned into a disagreement with a family member about downpayments. In short I said if a deal doesn't cashflow with a regular downpayment % such as 20-25, throwing more money into it won't make it a killer deal. In this conversation the fictional property wasn't going to be refinanced to pull any cash out and was going to be put on a regular 30 year note. In my opinion that would be a lot of capital tied up in a not so great deal.

So my question is, was I completely wrong in saying that/thinking it or does putting down 30%+ make a bad deal a killer deal.

thanks

Andrew Johnson · Answer

@Daniel Gonzalez I think you've gotten some good advice so far in that throwing more money at the deal doesn't make it a better deal.  I don't know that it makes it a "worse" deal but it doesn't make it a better deal.  I do think there are some cases where you can get a small benefit by paying in a down payment.  Sometimes a 60/40 LTV loan will have a slightly better interest rate than a 75/25.  In the past there have been limits on this likes "Super Conforming" loans and staying under that amount (or under a "Jumbo" classification) can get you a lower interest rate.  So I can't see while someone (with little other use for the cash) might put more down to secure better interest rates.  However, that rambling aside, I'd only advise doing that if you think it makes a good deal even better.  I would never do it as a way to make a bad deal seem palatable.

But I'll also point out that I'm not one the legion of BPers that wants to have maximum leverage on every property.  My thought of increasing a down payment to get a lower interest rate will seem vile to them :-)  So just take this as one of many perspectives.

Thomas S. · Answer

People that believe increasing their cash down increases cash flow or makes a deal better have absolutely no idea of the value of cash and should be avoided at all cost.

In the truest scenes of income property investing a property that does not have positive cash flow with a hypothetical 100% leverage will never have true positive cash flow.

The reason for this, and the reality that many investors "choose" to ignore, is that every property actually has two income streams. One is the property the second is the equity in the property. There is no point in investing in a building in which only your own cash is generating the cash flow. That would make the building itself a liability not worth owning.

If we, as investors, value cash at a 10% return then for every 100K in equity you must deduct $833 off of the rental income as a first expense to account for the income generated by the opportunity value of your equity.

You then deduct all other expenses, including debt repayment, from the remaining rental income to determine the true positive (or negative) cash flow generated by the property itself. The resulting number is a measurement of the true value of owning the property. (keep in mind your cash has the ability to earn a return anywhere other than being buried in the property in question)

I would venture to guess that the majority of investors buying properties valued above 100K with cash (no mortgage) are not making a single dime generated by the property itself. They in fact hold a high risk liability. Their only positive benefit is the speculation on appreciation. That of course is never known till the day they sell.

They could generate higher returns without the inherent risk of owning brick and mortar by investing in REITs or mutual funds.

All to say that the more down, rather than improving a deal through higher cash flow, actually decreases cash flow generated by a property.

Greg Moss · Answer

@Daniel Gonzalez

The biggest indicator in a buy and hold traditional rental property(being financed) hands down is Cash on Cash return. Overall cash flow numbers are irrelevant if you don't turn them into a % basis. If you are putting 60k down and want 10% cash on cash you need 500/m cashflow. if you put 120k down you need 1000/m cashflow. Although your cashflow doubled in the second one your returns are exactly the same. Now this doesn't include other factors such as building equity, appreciation, etc, but this should be able to clear up the disagreement.

JD Martin · Answer

No, you weren't wrong. The source of funds has nothing to do with whether something is a good deal or not. Just because something will have more cash flow with a smaller note doesn't mean that it was a good buy in the first place. For me, for example, I expect everything I have that I own outright will provide at least a 10% return. If it doesn't/didn't, I could just as easy park that money in a Vanguard index fund and make 6-8% solid, year after year. If I'm going to do some work - and real estate is some work - then there needs to be more money to be made.

Daniel Gonzalez · Answer

@Andrew Johnson thanks for your input. That is a good point, I'll be honest I didn't think about a lower interest rate going along with a bit higher down payment. I know that is usually a factor in getting better rates, but in the conversation I was referencing it wasn't even a thought.

Appreciate the new perspective, a different way of looking at it definitely doesn't hurt.

Mitch Provost · Answer

Does this also mean that less down does improve the deal? What if I used a heloc to pay all out of pocket cost where all cost is financed and the rent payments cover all those costs plus a positive cash flow?

Daniel Gonzalez · Answer

@jdmartin thanks for the response, glad to know I was not off base there. Realestate is work and I would rather have my capital parked in a property making a better return then the market can.

@Greg Moss thanks for answering. I went with the cash on cash approach to try and explain my point but it didn't work. At the end of the day I go back to that metric as one of my main criteria when I analyze my numbers. Your example is a perfect explanation, just because cashflow doubles doesn't mean the cash on cash doubles.

@Thomas S. thanks for the input and breakdown. I would love to avoid this person but it's my uncle, I took it with a grain of salt and didn't make a big deal out of it. He sees that I am educating myself and learning more about real estate and wants to go in on an investment together, but with his mentality I told him I wouldn't. The "deals" he finds aren't even deals. They are break even at best situations.

Overall as mentioned I'm just glad I wasn't blowing smoke and wrong about in what I said. I guess the school of BiggerPockets is paying off after all.

thanks for the help

Does a bigger downpayment make a deal better

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