I heard on BP Podcasts multiple times- especially from Co-host @Brandon Turner that he bought a house as soon as his daughter was born, he bought a multi-family property for a 15 year note so that when his daughter wants to goto college (or use that money to invest in real estate) that she can just re-finance and take that cash out to pay for it.
I heard something to the affect of: you can re-finance that and take the built equity and use that cash for college?
How does this concept work? How can you-refinance on a home that you already have most paid-off? Please provide examples as they are the best way for me to grasp concepts.
You need to stop thinking like a homeowner, and start thinking like an investor.]
First, yes, you are incurring debt...good debt. The net result of each property is this...cash flow. The rents you are charging is higher than all the expenses (inc. the mortgage payments), so in reality, your tenants are paying off your debt on each property.
Second, follow the bouncing cash. You started with $10k on the first property, and after you got the $50k loan, fixed it up so it was now worth $100k & refinanced it at $70k, you are walking away with $20k in cash...your original $10 + $10k more.
Do it again, and again, and again. Each time you repeat the steps, you are $10k ahead after you refi.
Now, here's the best part. You haven't spent a dime, no matter how hard you try. Every time you put in $10k...they give you back $20k...plus, you get the positive cash flow from each property that accumulates as you add each property to the mix.
You need to understand the difference between debt and leverage...which is the difference between thinking like a homeowner, and thinking like an investor.
@Patrick R. yes your tenant not you is paying all costs including mortgage and interest expenses. That means he's the one paying the interest not you. In regards to wich down payment is better that depends on you and your goals. If your retired and worried about an income than the higher the down payment the more cash you get every month. The less money you are earning tho. Also you are safer with a higher down payment if rents or values fall. The tenant is paying you your own money back at a very slow rate. Your down payment dollars are losing buying power every year. You are making less of a percentage on your dollars but getting more cash flow. Wierd huh. If you are young and want to make more money and build more wealth than you want to find properties you can buy with a lower down payment and still make cash flow. You used lower down payment so you can buy more of these higher interest paying properties. It all depends on your goals. Many properties won't pay any cash flow until you get 20-25% down payments. Banks like you to have some skin in the game if the house is a rental. The higher down payment provides the bank some cushion if rents or values fall. That's why you must find a very good deal to be successful doing this. The majority of properties in today's market are high priced and it gets difficult to find something that works. Remember we are only talking about cash flow here and not accounting for appreciation or value add. (Value add being raising rents, rehabbing, appreciation or flipping things like that). We are also not allowing for the money you would make if you found a good deal and paid $100k for a house worth $200k. That why they say you make your money when you buy. We are only talking cash flow here. Nothing else. RR
@Patrick R., you wrote: "I lost understanding when comparing what is better to do - put 5% down or 20-25%?"
Using Ralph's example: Paying all cash might net you 6% per year in that scenario, whereas borrowing 95% of its value would net you 17% per year in that same scenario! It only becomes problematic if it WON'T cash flow positively once you owe 95% of what it cost you (which is a separate issue to what its value is).
The changed percentage between 6% and 17% return (100% cash vs 5% deposit) is linear (and inverse), so it should be relatively easy to find out what the percentage would be at 25% deposit. [Hmmm. Did I explain it well?]
I hope you did understand Ralph's (theoretical) comment: "If you had your original $100,000 you could buy 20 of these houses at $5,000 down and make 17% per year on your $100,000." The MAIN point I got out of out of that is: Not only would your yearly return be nearly THREE times greater than if you paid all cash, at the end of the loan period - you'd be TWENTY times wealthier - even if you spent all the cash flow in the meantime!
The reason it's "theoretical" is: Lenders are not in the habit of lending out 95% of the purchase price to buy INVESTMENT properties. But, where theory can become reality is: when you only buy BARGAINS, you can get all (or most) of your outlay BACK again when you RE-finance (6 months to a year later)! Cheers...
@Brent Coombs @Patrick R. @Ben Leybovich it's hard to explain the principle of how leverage works to create wealth but I can tell you this. My grandparents had multiple rentals and got them paid for. All bought before during and shortly after the depression. My father then inherited them. By then many were pushing 100 years old. My father died and my sisters and I in turn inherited these properties. There was nothing we could do but sell them. They were very old needed updating and while they had increased a huge amount from their original price they did not show as much profit in 3 generations of being paid for as they would have if they would have been properly leveraged. If every time they got about 1/2 paid for somebody would have refinanced them and reinvested that money there would have been many many more units and probably newer ones as well. In the end my father and then my sisters and I were forced to sell them to get any income from them. I almost went down the same path. I learned right here on BP. the value of leverage. My sister and I both bought our first investment about the same time 8 years ago. She paid cash for a single family house. I paid off all my debt and leveraged my first unit intending to pay it off. Enter Ben leybovich and many others on this site. They set me streight. Today 8 years later my sister still has only one paid for unit. I have 8 leveraged ones and have refinanced my down payments back out of 3 of them. I have room to do it on 4 more. I'm holding my equity in them in case we get a market correction. Who do you think feels a vacancy more me or her?? I just took my recoverd down payment money from one unit and made an offer on a 37 unit self storage facility. My first commercial endeavor. In the past 20 months I will have purchased 3 rentals and if something doesn't fall apart a 37 unit self storage facility. I love leverage. RR