Is it Really Necessary to Make a Down Payment?

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Wow — that’s a loaded question, especially coming from a guy known to the readers of this blog as the creative finance, no-money-down finance aficionado…

It is true that everything I’ve ever bought had been 100% financed with OPM. My experience leads me to believe, therefore, that down-payments are not necessary, and I’ve been rather vocal with this in the past. I’ve also on occasion asserted that making down payments is rather not smart, aside for being unnecessary.

All of this might lead you to believe that I am against down payments at all times and in all transactions. This is not entirely true, and today I’d like to add some color to this conversation.

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

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3 Reasons People Make Down Payments

There are basically 3 driving pieces of rationale which necessitate down payments in most people’s minds:

1. Lender Requires It

Sure, any conventional — and even not so conventional — lender requires a down payment. 

So…? If they required you to jump off a roof, would you do that, too?

Listen — they require a down payment, but does it have to be your money necessarily? Can this be your partner’s money? Can this be a loan of some sort? 

While this argument is fraught with caveats, such as banks DSCR requirements and appetite for your proposed type of asset purchase — and you may need to have an established relationship with the bank — a down payment requirement can potentially be fulfilled in a multitude of ways which alleviate the need for you personally to put up collateral.

I am not saying I don’t provide down payments — only that it’s never my money. 🙂

2. Insufficient Cash Flow

If I experience some semblance of understanding toward the latter, I feel that this reason to make a down payment is completely nuts. And yet, I see this all the time — even on BiggerPockets

Someone in the forums would present us with a breakdown of the numbers for a deal, and people comment how it’s not a deal at all because there’s insufficient cash flow. Often, unfortunately, some fool very seriously suggests that buyer could put more money down to free up some additional cash flow…

Wow — is this the dumbest thing you ever heard? Real estate investors worth anything NEVER BUY CASH FLOW — amateurs do that. We create cash flow!

3. Equity Position

Yep, the market can shift on a dime and you could sustain a loss of equity, and therefore it’s a good idea to buy-down your spread…

Or you could just be smarter and buy below intrinsic valuation, with further opportunity to push the valuation via value add. And if you are not sure what I just said, then the best thing for you to do is not to buy property, but educate yourself.

Enough said.

Related: Real Estate Down Payment: Gone in 60 Seconds?

Conclusion

What follows is the simple reality that if the deal is good enough without a down payment, but you still want to or need to make one, then by all means do it. 

But analyze the deal as though it were 100% financed, and please make sure that it stands up to the minimum threshold requirement relative to both equity and cash flow.

What’s your stance on down payments? If you own property, did you put your own money down to purchase it?

Join in the conversation below!

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.

27 Comments

  1. Ben, you never fail to provide solid content!

    Have I every made a downpayment? Out of the 4 properties I own, I’ve made two down payments. The first because I was a newbie (young and dumb), and the second because I didn’t have the gumption to pursue OPM. Being a military member, I was able to take advantage of two VA loans which required no down-payment; but I still never really considered I was “seasoned” enough to ask for money. I will say that I’ve really taken to the idea of analyzing every deal as if I were going to do 100% financing, but this article was the final “push” I needed to getting out and communicating that I can indeed provide value to others. Thank you!

  2. True that you don’t have to put money down, but once you move past the 20% down to 10% or 0 down usually the money gets much more expensive. That last 20% down might be twice as expensive as 80% loan.

    I think one needs to look at the return of 80% down with one low rate versus no money down with a much higher rate, shorter term etc. Does saving that money make up for the higher costs?

    • Hey Mark!

      The reality of higher-priced money simply requires us to take action on extraordinary deals only – nothing average. Mark – same is true in the world of syndicated offerings. If I have to provide an 8% pref CCR to LPs plus 50% split, unless the deal is steaming hot, there won’t be anything left for me.

      Cost of doing big deal is real, but big deals are out of reach unless we are willing to pay that price.

      Thanks, Mark!

  3. Great post! I’m a bit of a newbie and did 20% down on our house (half of that borrowed at low interest loan) and we avoid PMI. I’d be interested to see an example of “doing the math” and what variables are considered in that. Would you be able to post?

  4. Solid content, Ben!
    Especially the advice is highly applicable to all investors (novice or experienced) that the deal analysis should be done such that 100% is going to be financed. Whether to actually put any money in the deal or not can depend on few other things.

    I also agree with Mark that the cost of the final 20% should be considered in making this decision. For example – if the cost of 80% loan is 5%, and the cost of last 20% loan is 10% – why would one not put own money for the 20% (esp if one has it in the bank)?

    • Thanks, Sandeep!

      As to your question of why someone shouldn’t put the money down:

      a. Most don’t have it
      b. I bet, if you really think on it, you can come up with 20 ways to achieve a higher ROI than the 8% financing. It’s all about arbitrage…

      Thanks so much for reading!

  5. Ben, here’s a reason … RISK.

    I, like you, have done lots of creative deals with none of my own money. It’s worked fine. But at some point I think we reduce our risk and and taper back some of the growth.

    All of the formulas, all of the good deals you talk about, don’t compensate for the fact that the uncertain future, the bad things you can’t predict, the 2nd lender who wants their money back, etc … make an argument for having more equity to allow you wiggle room and better sleep at night.

    But rather than make a bunch of down payments on all properties, I think it would be better to have 2 properties hocked to the hilt, and have 100% equity in the 3rd property. You have no risk in the 3rd, and in the first 2 are so leveraged the lenders will want to work with you in a storm. The riskiest situation for the borrower is about 50-60% LTV on all your properties. Lender controls the show.

    Good topic.

    • I don’t disagree, Chad! Everything in life is cyclical, and growth of portfolio is as well. Personally, I am in the mode of paying things off at the moment. Paid of one balloon last year, and going to cash out another this month. Not so much because of anything to do with risk, but the cycle in the marketplace is less conducive to buying the type of assets I want to own. I get better returns paying stuff off at the moment. Also, I’ve reached a critical mass in my portfolio whereby simply paying stuff off frees up enough CF that I can be done playing- at least for this leg of the competition.

      The risk doesn’t bother me. Contracts are in place, and as long as the thing was bought right and everyone plays by the rules, there is no more risk than traditional financing, in my opinion.

      But, I don’t disagree with the premise that there is time to be aggressive and creative, and there is time to be boring – I am there until the market decides to flip…

      Thanks so much for reading and commenting, Chad!

      • Ben,
        I agree that paying debt off to increase cash flow and when returns aren’t found other places is a good idea. And most of all I agree that sometimes it’s just nicer and simpler at certain points of life to make all your cash flow on fewer properties – which means fewer tenants, fewer maintenance issues, etc.

        Risk is still a concern for me in my long-term portfolio, and not making payments for whatever reason seems to me the biggest reason I have seen people go bust in our business. Paying off debt in chunks to free up cash flow is a quantifiable way to reduce that risk.

        • Ben Leybovich

          Chad – debt is not why people go bust, ever. Slim CF margins, balloons, prohibitively short ARMs, expectation of appreciation – these are the things that put people under. Wisely applied leverage comes with very manageable risk in my opinion.

          And yes – there are phases in one’s career to be sitting tight and amortizing notes. While I am there at the moment, I won’t be there forever. Too much equity is a liability bulls-eye on our back, which is not wise in today’s society…:)

    • Hey, Tim!

      Thanks indeed for reading and commenting. Isn’t it funny how much more intelligent I come off on paper than in person…?!

      Is it appropriate to tell the good people reading this that I work for you; only because I think you are the sharpest broker in Lima, and the only one worthy of my company 🙂

      Yes, infinity return is great. But, this audience is sophisticated enough to know that the other metrics have to do with risk, therefore we don’t talk much about the CCR, and more about IRR or discounted cash flows. See – this site is where the best and the brightest live, Tim. Which mean 2 things: One – you are in the right place, and two – cash on cash is the very surface-level metric of return for a lot my audience..

      Welcome to BP Nation, Tim!.

  6. I suppose that a rationale to justify any strategy can be made, and examples provided that demonstrate how it can work. By reading this post, it becomes clearer to me that in order to make certain strategies work, you need to have a certain level of knowledge and experience that is not available to everyone. Further, each strategy has its own advantages and disadvantages, which are nearly always quite significant. For the “zero out of my pocket” strategy to work, you must only participate in the relatively small number of deals where you can divy up the pot among several outstretched hands. There is nothing inherently incorrect about this, at least, not in theory.

    I came to this web site because I am not a “very sophisticated” investor. I have done deals, but I don’t have nearly enough experience to follow some of the proposed strategies that I often see here.

    In fact, I have followed the opposite path. I happen to be a lazy investor. Perhaps even a terribly, lazy investor. I’d prefer to just buy whatever I want, (subject to the limitations inherent in my strategy), whenever I want, with no concern for the market or interest rates. That way, I can engage in my investment plan whenever I am ready to do so. I also do not spend enough time evaluating the cost of repairs. I have no idea how much it costs to fix things up reliably beforehand, because, again, I do not have the knowledge or experience to make those accurate repair estimates, or hire others to do it. It is only after it is fixed, that I know accurately how much it will cost to fix.

    However, I’ll bet you a dime to a dollar, that my best deal performed far better than your best deal…by any metric that really matters! Yes, I suppose that I’ll lose at least a few of those bets, but I’ll get the rest of you suckers who didn’t notice the fine print in time…

    I pay 100% down. I get one, easy, monthly payment. I have never been foreclosed upon. Once I started using this strategy, I have never worried for even one second about “where am I going to get the money for the payment next month”. When I run in to a road block on my project, or a repair I just haven’t the slightest desire to handle, I just abandon it until I decide to get my act together. Nobody calls me to tell me that I better get on the stick or else… I don’t worry about cash flow or rental vacancies. I never have to get up and answer the phone from irate tenants, who found my number on Google, in spite of my hiring a property manager to “shield me” from such unsavory experiences.

    Further, my money (we’re talking about after deal profits here) is tax free. So, I don’t have to hire a bunch of accountants or other financial experts to tell me what I “must do” in order to minimize my “fair share” of the nation’s tax burden. I don’t have to waste my time analysing purposely obscure tax code in order to determine whether the tax advice I am being given is, in fact, useful, or whether the so called “expert” information provider is blowing smoke up where it doesn’t belong. (Definition of an “expert” that I discovered one day. Expert: An ex- is a “has been”, and a spurt is a “drip under pressure”. I hope you enjoy!)

    In short, my system is not for everyone either. It is probably not even for most investors, as it is still incomplete and in a somewhat formative stage at present. However, it DOES have at least one significant advantage, in that almost everybody could follow it, including totally ignorant non-investors, and further, they would do far better with it, at least financially speaking, than renting an apartment forever. Which some people on this site would prefer that they do.

    So, the real answer, seems to be to “Know thyself.” Not always an easy task to perform. Pick the strategy that best matches your temperament, and willingness to work/unwillingness to work. By the way, I always get a real chuckle out of people who claim that they are getting an “infinite” return on their money.

    There is no such thing, and they reveal their own lack of awareness of reality on a level that they are apparently unfamiliar with yet. The most significant measure of ROI, is: “What is your return on YOUR TIME?” I’ll bet that my system beats your’s in THIS area too!

    Thanks for a great post, and for helping me to see myself more clearly than before I read it!

  7. LOL – tou-che, Barry.

    What professional investors do requires much knowledge which is uncommon. This is the reason for this site being in existence.

    You likely don’t invest – more like store capital made elsewhere. This is wise, as RE is inherently safer than most other vehicles. However, I’ll bet dime to dollar that for most people reading this blog, probability of achieving a level of sophistication required to play the game my way is a margin higher than probability of coming into sufficient funds in the bank to be able to write checks as you do.

    Both strategies work. However, while you store capital, a lot of us actually build wealth ad income via the vehicle of RE. We approach this from opposite sides, and while leverage is an enemy to you, it is a friend to us, with which I circle back to your original accretion – to do what we do (to play with other people’s money), we must be extremely well educated 🙂

    Thanks so much for a thoughtful comment!

  8. Im currently looking to get financed or at least preapproved for a loan in order to purchase a multifamily property that I do not plan on living in. From what Ive read and been told is, that if this is the case I may need 20% down at least. After reading this post, it makes me wonder, if I would somehow be able to put down much less than 20% or even 0% out of pocket. Any pointers as to get more info on this?

  9. I’ve found lenders who don’t require a down payment if the deal is good enough. However, they still require you to have a certain amount of funds in reserves. So no down payment is possible as I have seen it however I have not been able to prove the point that you don’t need money to invest in real estate. From my limited experience POV, that’s simply not true.

  10. Leybovich as always good stuff and thought provoking to all levels.

    I’ve said it before but if you want to minimize risk you need to be close to 100% financed or close to 0% financed. I fail to see how putting down 20% on a place minimizes your risk. If the market goes down fast you could lose most of that. If you need to firesale it you will lose a big chunk of that, with the rest going to your transaction costs. Maybe you aren’t getting foreclosed on (maybe) or bring a ton of money to the table (maybe) but what you did risk and lose was… 20% of the price you paid for the place. With 100% financing, even at retail, as long as it cash flows you have little risk since even if things go to hell you have no money in it.

    On the other end if you bought all cash there is little risk at all. Pretty much as long as you can pay your taxes on it you can’t lose it. If the market tanks but it cash flows who cares? Minimal holding costs so you can ride it out. And of course with NO mortgage on it you have very low holding costs.

    A sizable down payment is the worst of both worlds. You have a good amount of money at risk and you have a big debt element that you have meet the obligations of or you can lose it.
    Now of course if you are buying way under value you can have less risk. If I was buying a property worth $160K as is and was getting it for $100K and was getting a vanilla bank loan for $80K, yeah that is probably pretty safe. However that is a killer deal so you can probably find better terms (such as no money down…) if you want to work a little for it.

  11. Timothy Trewin

    Ben,

    This was a good article and although I am late responding to it, it gave me something to think about. I am about to purchase my first true investment property (not the one that I am keeping in case I move back to where it is at) and I was looking to most likely put 20% down on it. From what you are saying there is no reason to. I guess I need to learn a lot more about how to do creative financing to avoid the 20% down. Thank you for that.

  12. benjamin cowles

    “Or you could just be smarter and buy below intrinsic valuation, with further opportunity to push the valuation via value add”. I looked “instrinsic valuation” up at investopedia and it took me down a whole other rabbit hole of it’s own and I’ve been reading and podcasting REI for a good time now well into the “analysis paralysis” phase and honestly there isn’t a subject less clear in the world of REI than that of when to pull the trigger. The more you learn the more you learn you need to learn all the while the common message pops up constantly to ‘get in there and do it and learn along the way’. I think I’ll lean a bit cloer to the safer side of continuing my education.

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