I Don’t Make Down Payments … Here’s Why

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Those of you who know me well know that I don’t like to bring money to closing; I’ve alluded to this fact in multiple articles here on BiggerPockets including here.  Indeed, I specialize in Creative Finance and aim to achieve 100%, or as close to it as I can get on every deal that I do.  There are very good reasons for this, which is the topic for today.

First, let’s establish that there are basically 3 reasons why people commonly feel that making a large down-payment is either necessary or desirable, and they are:

  1. Down-payment is required by the lending entity.
  2. Down-payment facilitates greater cash flow.
  3. Down-payment facilitates stronger equity position and safety.

Let me address all three…

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1. Down-Payment is a Requirement of the Lending Institution

This is going to be quick – I don’t play by those rules.  If a lender requires a stiff down-payment and there is no way to work around it using a blanket or some other type of cross-collateral then I move on – period.  We live in a 14 trillion dollar economy plus, and if you can’t find some type of financing which is easier to accomplish than 25% down – open your eyes…

2. I Don’t Buy Cash Flow – I Create It

I hear this all the time – if the property doesn’t cash flow enough, just put more money down. What kind of backwards logic is that?  As investors, we should never buy cash flow – we should create it!

First of all, in my book an acquisition needs to cash flow a bare bones minimum of $100/door under 100% financing to start with.  But, even this should not be enough for you to pull the trigger.  The reason real estate is so much better than stocks and other paper investments is because it comes with possibilities of expandability – things that we can do as investors to increase returns; this goes back to inefficiency of the real estate market which I discussed here.  As such, you should only be buying the building if you see ways to improve that $100/door minimum cash flow to $120 – $150/door.

Now – in some markets SFR is going to represent better investment opportunities in this respect, while in other markets you are better off with multi-family.  Regardless, paying for more cash flow is the absolute opposite of what you should be doing…

3. I Don’t Buy Safety – I Create It

Conventional wisdom tells us that it is not safe to finance 100% of the purchase price.  After all, should the market dip this could force you to be upside down on your financing.  A large down-payment is often viewed as a way to alleviate this concern, since it frees-up equity in the deal.

The counter-argument to this, however, is the notion that equity has to be bought.  As a sophisticated investor, you should not be in the business of buying equity any more than buying cash flow – that’s for amateurs.  You should create equity!  Personally, if I ever pull the trigger on any opportunity, it is specifically because I believe that one way or the other I can force appreciation of equity, thereby creating safety quickly. Furthermore, I believe that doing things my way creates much more than just safety – it creates value.

As investors we should always be looking for ways to create value; this is why we invest after all.  In the absence of opportunities to create value by forcing appreciation all that we are doing is hoping for the market to go up; that’s not investing – that’s gambling; I don’t gamble and you shouldn’t either…

Allow me to remind you that equity in the income-producing space, which is where I play, is tied to income.  We buy property because it represents income streams and the more the income the more we’ll be willing to shell out for this property – basic math.  With this in mind, it should be noted that if we can improve the income of the asset, more specifically the NOI, then we can create value not only on the Income & Loss Statement (Cash Flow) but also on the Balance Sheet (Equity).

For Example

Let’s say you bought an 8-plex whereby each unit rents for $500/month thus bringing in gross income of $4,000/month.  Typical net operating income (NOI) in a building such as this might be $2,000/month.  This means that at a CAP Rate of 10% this building would valuate at about $240,000:

VALUE = ANNUAL NOI / CAP = $24,000 / 10% = $240,000

This is what you paid – $240,000.  Now – let’s say that you manage to lower the monthly costs of operating this building by $100/month, and also raise rents by $50 per unit per month.  In this case you will have managed to increase the NOI by a total of $500/month ($3,600/year).  In this case, the capitalized value of the revenue stream represented by this building is $60,000 more than what you started with at $300,000:

VALUE = ANNUAL NOI / CAP = $30,000 / 10% = $300,000

Thus, having paid for the building $240,000 you are now sitting on $60,000 of equity (25%) due to the increased value of your asset.  And the best part of all this is that the extra $500 of NOI you’ve created flows directly into your cash flow because there are no monthly expenses associated with creating the additional revenue.

But, improving the NOI often times requires investment of capital into upgrades to physical structure and other aspects of the operations of the asset, which brings me to a question:

QUESTION:  If you only have finite resources, would you rather spend your money on a down-payment, or to improve the cash-flow and grow the equity?

Conclusion

Most people would run out and make a $25% down-payment for this building – $60,000.  If you do this, you will own $60,000 worth of equity in an un-improved building.

On the other hand, you can create the same $60,000 of equity by likely investing a fraction of $60,000 into the improvements to the building’s operations and in the process improve the NOI and Cash Flow of the asset – this ain’t rocket science guys… This is why I do not make cash down-payments; I’d rather invest my money in ways that actually create value in lieu of just buying what’s there!

Are you with me on this?

Cayusa

About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.

72 Comments

  1. I am with you!
    I have never put a down payment on any property that I bought, except if it was forwarded by a private lender, or I could immediately cash out at settlement.

    I buy low income properties, I have no intention of locking up my money when the tenants are perfectly capable of paying all costs of ownership, and providing me with a profit.
    Recently I have taken to being so lazy I don’t even manage the multi unit properties anymore. So for the newbies add in 10% to the expenses for management or you will be a management slave to your tenants.

  2. Hi Ben:

    We try to never tie up any money in a property we hold. If I have my own money in it, I certainly don’t consider that equity or profit – it’s simply moving money from one bank account to another.

    You made your point so well in this article. It will be a real eye opener for some who’ve never looked at down payment this way.

    Thanks for another great post.

  3. Awesome article Ben. So many young investors or Newbie investors like myself wouldnt think outside the box like this. Another reason that BP and the amazing people that contribute here are what I would consider my teachers. Thanks again.

  4. Hi Ben,
    Great article, and we are with you! My wife and our business partner and I try to duplicate your method as well. We practice the teachings of Ken McElroy via his book on real estate investing, “The ABCs of Real Estate Investing”, and your instruction from one of your BP podcasts. In one of your BP podcasts, you mentioned a great miltifamily deal where you utilized the prorated rental income and security deposits to cover most of your down payment and closing costs, allowing you to only have to come to the table with about $15,000 on a $300,000 property. If i recall correctly (and please forgive me if I don’t), I believe you might have utilized a vanilla bank loan for 70% of purchase price, and some seller financing or private money to cover about 20% of the remaining 30% on that deal as well. Thus, instead of needing around $45,000 to cover the remaing 10% and closing costs, you only needed around $15,000. I think you mentioned closing around the 7th of the month to maximize the rents already received for that month.
    In addition to the above, I believe you had found a great deal where you could purchase the property at a discount because you had developed a good reporte with the seller and it had been on the market for a while, add value by increasing rental income, and decrease expenses as well.
    All of that being said, we personally look for ways to maximize our cash on cash return with little or none of our own money, improve cash flow/NOI, create value and refinance tax free to keep our money moving, while still maintaining good cash flow for passive income.

    • Hey Greg,

      The podcast in question is here:
      https://www.biggerpockets.com/renewsblog/2013/04/18/cash-flow-creative-finance-life-ben-leybovich/

      My required DP was 5% which was a bit over 18k, but ended up needing a bit over 5k of cash. That building has been stable for 3 months now. The NOI is up from $3,400 to $3,900 justifying a value of about $465,000. I paid $373,500 and I spent about $25,000 to get it here thus creating value of $65,000. My outstanding debt on this is sitting at about $354,000, which considering a value of $465,000 means that I am looking at about 100k of equity plus or minus. Finally, the all important Cash Flow is up from $1,000/month to $1,500/month. This was a rough process – fast moving. But – I’m still standing 🙂

    • Ben, am I understanding correctly that you’re “utilizing the pro-rated rents and security deposits….”? In the states where I invest, it’s illegal to co-mingle tenant security deposits with personal accounts, i.e., landlord/investor accounts. Can you provide more information on this? Thanks.

      • Yes – some states require security deposits to be treated separately on the closing docs. I’ve never known this to be the case here – everything just goes in the same pot to my knowledge. Now – I do not own that money; it’s not mine and I will pay it out as necessary. But, on the closing statement everything seems to go in the same pot. I let the attorneys handle that; I’m not smart enough. I show up with as much money as they tell me 🙂

  5. Great article Ben! I have a different strategy then you, but that is mostly due to the type of property I buy and my situation. Right now I am having problems finding properties more than I am funding them. I believe if you buy right with cash flow you run a very low risk web with 100% financing.

    I like SFRs that need work and those are usually REO or short sale and there is no chance for seller financing. I could do private financing, but it tends to be too expensive for my tastes. That’s just me though, I think yor strategy is great for many people.

  6. Good stuff. Disagree about real estate being unquestionably better than the capital markets.

    Each provide advantages and disadvantages. They are complimentary in many ways. Everyone should own both IMO!

    Merry Christmas and Happy Holidays!

  7. Nice write up Ben. Investors comes in all flavors. What works for one may not work for others. For instance I buy REOs-SFR for all cash, add amenities/value, get it rented out and then refinance getting all my money back with a pretty good cash flow. In a word like you just in a different way, no money out of pocket at the end of the day.

    • Nice – in Mark’s marketplace SFR works better as well. Here’s the thing, though, Mark puts down a sizable DP and you pay all cash – see a pattern? A lot of readers out there simply do not have that kind of capacity, and financing REOs and such the way I do multis simply doesn’t work because SFR is not viewed by most money as a stable asset. Therefore, in my estimation, for anyone looking for 100% financing MFR is a much better bet…Thoughts?

  8. Ben,

    I’m always in a foul mood when we have to bring money to close … the more money we bring, the grumpy it makes me. After all, if I’m bringing my chequebook, I missed something in the run-up to Close. As soon as we are closed, the plan is to force appreciation and pull those funds back out for the next something.

    We just refinanced two properties we renovated over the summer (at 0.5% lower rate) – the new appraisals came in almost 70K over the old. The properties now sit with an LTV of 75%, but all our original funds are back in the bank.

    My preference is to control cash flow rather than build mountains of equity.

  9. Great Article Ben. I will be up front and say that I have not invested in units probably because of fear. Having grown up in the Southern CA area the price of units is expensive in LA county and the positive cash flow is not super attractive in some areas. Now living in North Carolina I would be more open to trying and being open to some of these creative financing techniques. I will definately be reading more of your articles. Love the “outside the box” thinking

    • Man – I would do anything to live in the Carolinas. Probably South but pretty high up and close to the border. Nice out there. It’s about a 10 hour drive for me and i’ve got good friends there. I even though about finding like a 50-unit there and having a second place and slowly removing myself from OHIO. If you know of anything let me know Gerald 🙂

      You call it out of the box – my wife calls it out of my mind lol And she Is always right! I am glad I can help. Good luck!

  10. It’s not so easy finding other r.e.investors that advocate for creative financing in lieu of putting up cash payments for SFRs nor MFRs. Actually its how I first learned about REI many years ago and I love and live by that philosophy to date. Other peoples money / creative financing is what true real estate investments are about. Thanks a million for sharing this, Ben.

    • Yes Mary I agree/ In the old days real estate investing was synonymous with creative. But, the advent of the 5% 30-year mortgage put an end to that. Creativity will come back because these ridiculous low rates can’t stay forever.

      Thanks so much!

  11. Michael Lemieux on

    Love the article. Thank you Ben. I love “outside the box” in many different aspects, it makes life more interesting. Appreciate the knowledge, & enjoyed your podcast as well.

  12. Opened my eyes a little bit…thanks for the article, Ben. Do you partner with other investors who bring deals to you? If so, what areas of the country do you work in? Outside the U.S.?

    Thanks,
    Gary

    • Hey Gary –

      Depends on what you mean by partnership/ Partnership is like a marriage and I wouldn’t consider it unless I feel very comfortable with the person. I invest in Ohio but I’ve been thinking about the Carolinas lately just because I think it would be nice to live there 🙂

      Thanks for reading!

  13. Ryan Chamberlain on

    Ben,

    First off, I love reading your articles. I feel like I always learn something of value and something I can implement in my own investing strategies. Just starting to expand into MF rentals now with a 4-unit after a few years of fix and flip “investing”.

    That said, I want to clear something up with this article. Just on a number basis, I completely agree with the investing principles in the article and am in the process of implementing some of them now. In the example above, you raised the NOI by $500/month ($3600/year), and said this raised the value from 240k to 300k. Wouldn’t this be 276k? Just checking to make sure I understand correctly. The total NOI of $27,600/.1 = $276000.

    Thanks,
    Ryan

    • Haha Ryan – professor Ben made a mistake. Indeed, $500/month increase to NOI is annually $6,000 – not $3,600. Not sure where $3,600 came from, but $6,000/year of additional NOI would in fact justify a value of $60,000 at 10 CAP.

      Are we good? And thank you for the kind words. I figure REI is complex but not complicated – it’s just a matter of perspective, and I try to convey perspective. I am glad you and others are finding my thoughts useful!

      Thanks!

      • Ryan Chamberlain on

        Yes, makes sense now. Can’t believe I missed that.
        I agree that it is not complicated. There is so much to learn on the subject though, that is why I love reading bigger pockets. Because I can always learn a new way to solve a problem and that is one thing I love about REI – creative problem solving.

        • Ryan – I can tell you haven’t been around RE for too long the way you romanticize it. Personally, I don’t like RE – what’s to love? Old bricks and mortar that need fixed all the time – Contractors – Tenants – Insurance costs going up all the time – Harsh punishment for mistakes…

          No my friend – it is a means to an end; that’s all. A way to secure a family’s tomorrow, so to speak. That’s how I see it anyway…

  14. Ben,

    Great article, I agree with your logic and I bet that was a Rich Dad-esque paradigm shift in thinking for many people.

    Where can I find resources/articles/books on creative financing methods for multi-families. I’ve got a couple of properties but the real dream is to do precisely what you are doing but I need help obtaining my education in creative financing.

    • Wow – if I’m reading this correctly, you just suggested that my article has an impact comparable to Rich Dad. Thank you indeed. Although, because I am bashful, I’ll say that Rich Dad has nothing on me – my hands are actually dirty from being in the trenches doing exactly what I preach…:)

      If you are interested in learning more in-depth about my specific perspective, techniques, and approach to investing, I invite you to come browse my website – you’ll find the link at the bottom of my forum signature as well as in my BP profile. CFFU might be something interesting to you…

      If you have trouble finding it, just PM me here. Thanks a lot Brett!

  15. Ryan Chamberlain on

    Yes, it is a means to an end. And I guess when I say love it may be too strong of a word, but that’s relative to other possible occupations. If I am going to work, and it’s not like I can afford not to yet, I’d rather it be challenging and rewarding – kinda the opposite of the desk job that would drive me up a wall. I like to be in control – as much as possible – of my earning potential and future financial freedom. I believe, and I think you might agree, that REI is the best way to achieve this IMHO.

  16. Thanks for the article. I guess this would best be suited in a situation where the seller has 1 of 2 issues going on:

    1. Financial distress
    2. Physical distress of the property

    I walk in and say in a nice way 🙂 — “This is a disaster. A bank would have a hard time saying yes to a loan for this. Let’s work out some owner finance terms and I buy it as is.”

    Of course part of those terms are to buy with little or nothing down and instead of the down payment being invested you are investing money into repairs and operations of the building in order to make the building more valuable.

    What would you say are the top 3 ways to find such deals for most people looking to get them?

    • Well Julie – not the MLS, I’ll tell you that. I think that the better perspective to adopt is to focus on attracting deals in lieu of looking for deals. I don’t do very many deals myself – one per year; specifically because repositioning projects take time and energy, so I am not the best person to ask about marketing. I just have put myself out into the world as someone who gets it done and so people approach me with deals. Bottom line – people must know that you exist and what you do; otherwise you are left with the MLS…

      Hope this helps Julie. Thanks for reading!

  17. How much does your method depend on building credibility with lenders? In other words, can a Joe schmoe (aka me) acquire the right knowledge and come out of nowhere to close on an mfr with little of my own capital?

    Great post as always, thank you.

    Russell

    • You ask a poignant question indeed Russell. I think you just gave me the topic for the next article :). Do I have your permission to quote you?

      Very briefly, the answer is YES and NO, mostly because of the way you asked the question. In my estimation, you simply can not put “acquire the right knowledge” and “come out of nowhere” in the same sentence. Knowledge does not simply presume books, courses, and blogs. Knowledge is also action. With this in mind, if you knew what I know – YES. However, if you did know what I know, you wouldn’t be someone coming out of nowhere. Understand – people will listen to you, and then they will watch you. Their impetus to work with you resides in what you do and not what you say… Relationships drive this business

      • Thanks for your response, Ben, of course you can quote me. Your answer makes perfect sense and I look forward to doing some back reading to find out a little about the path you took along the way.

  18. Ben –

    Your articles are always very thought provoking. I don’t like putting money down either. Those investors that get really good at creative financing and increasing the value of the property they buy can expect much success in their business. Happy holidays Ben.

    Sharon

  19. Ben

    I know I’ve already commented by I’ve read this about 10 times! This maybe my favorite quote of 2013:

    We live in a 14 trillion dollar economy plus, and if you can’t find some type of financing which is easier to accomplish than 25% down – open your eyes

    • Wow – 10 times…! Wow

      And the thing is – you know about as much as can be known relative to conventional financing. It’s what you do and teach others for crying out loud. I take it as very much a compliment that you found this article interesting…

      Thanks much indeed Jimmy!

  20. Good read Ben, i love your information on Multis and 100% financing. Im hoping to use the same principals to get into my first very soon.

    This might be a newb question, but when it comes to 100% financed deals do you typically get a lawyer to draw up the language separately for each property or do you use a interchangeable contract ?

  21. Hello Ben,

    Right before coming across your article, I got an email from a private lender who is asking me to come up 10% down and closing cost and they can finance the SFR I would like to purchase. How should I get back to them on their request?

    Nalo

  22. Ben,
    I own a handful of single family properties in Colorado. I enjoy reading your articles on here, but I’m having a hard time getting past reason #1 on this piece. I have never dealt or have found a lender that does not require 25% down for an investment property. Can you please help me understand how to get around utilizing your own funds for a down payment? What are other options?
    Thanks!

    • Yes Nick – all traditional lenders require a down-payment. The things I do and write about are not traditional – that’s one thing. Secondly, don’t think of 100% financing as going to 1 lender and financing the entirety of the deal. Think of it instead as having the tools in your bag and the relationships to synergize 100% financing where there otherwise would not be.

      The most basic answer is finance the down-payment, but how. Private lender; Your 401k; Home Equity Line against your primary; Blanket Note against your portfolio; Owner; and everything in between…

      This is a very long conversation which I’ve addressed in CFFU. Hope this helps somewhat Nick!

  23. Ben, you write “in my book an acquisition needs to cash flow a bare bones minimum of $100/door under 100% financing to start with.”

    Is this an ironclad rule in your book? The rule works in less-competitive/”hot” markets such as Lima, OH. But, if it were followed completely, would rule out vast majority (all?) of deals in markets that have significant *appreciation*.

    Should we consider a tradeoff between the two? For instance, consider a 4plex in Austin, TX. It cashflows $100/door but only with 20% down. On the flipside, that market has experienced significant appreciation for many years.

    As BPers always say (and I agree): “Investing purely for appreciation is speculation”. But these are not mutually exclusive. Can’t we pursue a hybrid strategy of both CF & appreciation.

    Penny for your thoughts?

    • Andrew,

      The reason for this rule is not because it makes some great investment sense. The reason is that from the stand point of Cash Flow the deal is either good enough, or not; safe enough, or not…

      The thing is this – in order to hold on to property long enough to benefit from appreciation and tax write-offs we must take care of CF. The IRR formula includes in itself the back-end profit, otherwise known as appreciation. But, if you are not around to see it because you choked from insufficient CF, then appreciation never even enters into the equation…

      I believe that unless a small multi generated $100/door under 100% financing, then the deal is not good enough, nor is it safe enough. This is a gamble, and I don’t gamble.

      I hope this makes sense 🙂

      Thanks so much for reading!

  24. Jim Stallings

    Great Article Ben! I agree with you 99.99%, I don’t put any down payment either, but I do give the seller a $10 EMD. I simply write them a $10 check have them sign the back of it and give it back to me and then I give them a $10 bill. Most all of my purchases are from motivated sellers. With the exception of 2 or 3 I only gave them a $10 EMD and all of them financed the deals at 0% interest for 180 – 360 months. In the past 12 months I’ve structured 20 $0 down, 0% interest deals. It makes it so easy to figure out what the monthly payments are! Such an easy formula!!! Purchase Price / Number of Payments = Monthly Payment Who needs a financial calculator! lol

  25. Sam Watson

    Buying safety in the form of a down payment is not the point of investing! I’d rather put that cash into more properties and get more leverage, force appreciation and watch my equity build over time as I create value with each investment.

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