How Much Money Does it Take To Invest in Rental Properties?

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How much money does it take to invest in rental properties?

Probably not as much as you think.

In the history of the world, perhaps nothing has killed more real estate ambitions than the belief that one does not have enough money to get started.

In fact, I speak with people all the time who don’t know it’s even possible to invest in real estate without having the full 100% purchase price of a property. They look at a $200,000 property and try to do the math in their head, thinking, “Well, if I saved $200 per month from my job, I could start investing 83 years from now. But that’s never going to happen, so I guess investing in real estate is only for the privileged rich.

Related: 12 “Hidden” Real Estate Expenses That Blindside Investors

Not so!

Enter: Leverage

(P.S. This is unrelated, but FYI – last Thursday night I did a webinar here on BiggerPockets about Analyzing Rentals that had over 2,000 LIVE attendees. If you missed it, don’t worry: I’ve put the replay up until Monday night, so if you want to check it out, do so this weekend before it’s gone. Click here to check out the replay! Or to sign up for THIS week’s LIVE webinar, visit BiggerPockets.com/webinar)

How I Bought, Rehabbed, Rented, Refinanced, and Repeated for 14 Rental Properties

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Using Leverage to Reduce the Amount of Money You Need to Invest in Real Estate

While yes, it is true that some investors pay for properties in all cash, the majority of investors utilize leverage when buying rental properties.

Leverage is a term that simply means applying a small amount of force to achieve far greater results.

With real estate, leverage usually comes in the form of loans. A small down payment is supplied by the borrower, a lender provides the remaining balance of the purchase price, and you pay that lender a small amount each month until the loan is paid off.

For example, I might look at that same $200,000 property but get a bank to lend me 80% of it. They would supply a $160,000 loan, and I would need to only come up with the $40,000 down payment (plus closing costs, which we’ll cover in a moment.)

Now, I only need to save up $40,000 instead of $200,000.

Yes, I need to pay the bank each month for many years, but hopefully I’ve done my math right and I’m making far more income than I’m spending on that loan payment.

nomoneybookOf course, saving $200 a month (as I mentioned earlier) would still take many years to save up that $40,000. However, there are other strategies for using even more leverage or finding lower priced properties. (Like you’d hear about if you picked up a copy of The Book on Investing in Real Estate with No (and Low) Money Down.)

Yes, this is pretty basic stuff but you might be surprised at how many newbies fail to realize that this is how the game is played.

The Dark Side of Leverage

Leverage, of course, can be both a blessing and a curse.

The more leverage you use, the greater risk you may be placing yourself in.

For example, if you paid 100% cash for a property, you wouldn’t have a loan payment due each month, so a three month vacancy on your property wouldn’t hurt as bad. Or if you bought a house with just 5% down, and the value of that property dropped 20%, you are now “underwater” and owe more money on the house than it’s worth.

This limits your future options and can make it difficult to sell, refinance, or do much of anything with the property.

This leveraging is what caused much of the housing collapse and glut of foreclosures in the market in 2007 and 2008. Homeowner Hank purchased a home for $100,000 and used 100% financing, putting down $0 on the property. When the value of that property dropped to $80,000 and Homeowner Hank lost his job, he couldn’t sell the property because he owed far more than what he could get. The bank needed $100,000 to be satisfied, and the most he could get is $80,000. As a result, Homeowner Hank and millions of others simply allowed the bank to foreclose and take back the house.

So, was leverage to blame?

Should we NOT pay 100% for rental properties?

What is the magic number?

I’d like to reframe the question and force you to think about it in a little bit different light. Rather than discussing how much to put down, I like to think “How secure can I be?

Two Important Truths About Risk

There are ways to increase your security when using leverage, so let me cover the two main points.

First, the down payment is not as important as the deal you get. If you purchase a house for $100,000 and put 30% down (thus obtaining a $70,000 loan) and I buy an identical house for $70,000 with 0% down (thus obtaining a $70,000 loan), who is at more risk?

I’d argue that YOU are at the greater risk because you have more cash invested, but our loan amounts are identical. I just did the upfront work required to pay $70,000 and you didn’t. I leveraged my creativity in place of a down payment.

Secondly, when investing in rental properties, knowledge can help decrease the risk of leverage. The better you understand the market, your investment and how to manage that investment, the lower risk you have of something going wrong.

For example, if you do the math correctly before buying an investment property and you know that you need to account for the property sitting empty a certain percent of the year, then that vacancy, when it occurs, won’t sting. It’s just part of the business. Your knowledge helped secure the investment against the things that WILL go wrong.

For this reason, we built the BiggerPockets Property Analysis Tools to help you run the numbers on any potential deal, to help you avoid buying bad deals and focus on the good ones.

How Much Money Should You Put Down?

So, perhaps you can see now why I can’t simply give you a clear answer to the question, “How much money does it take to invest in rental properties?

However, I don’t want you leaving this post without having a good number in your head, so let me offer two of the most common scenarios:

House Hacking

If you plan to purchase and live in a small multifamily property between two and four units, you could obtain a bank loan for as low as 3.5% down through the FHA loan program. This concept, known as “House Hacking,” is a great strategy for those just starting out with real estate and have limited cash and experience.

However, again, you are required to live in the property (for at least one year). Also, when using a low-down loan like the FHA, know that there is an additional fee charged to the borrower each month known as PMI that can increase your loan payment by around $100 per $100,000 financed, so just be sure to include that in your math.

(For more on House Hacking, see “How to Hack Your Housing and Get Paid to Live For Free.”)

Conventional Loan

Most banks want a 20% down payment, at minimum, for rental properties. There are a number of banks which will allow less, such as 10%, and some banks will require more, such as 25% or even 30%.  Each bank will have their own requirements, but as of the date of this writing, it should be possible to obtain financing for around 20%, as long as you qualify.

(For more info on qualifying for loans, see “Confessions of an Ex-Banker: How to Get Your Next Loan Approved, Guaranteed.”)

Much of the discussion in the real estate community revolves around 20% down payments, as the norm for planning and strategizing for the future. This is definitely the most common, but please understand that the dollar amount or down payment percentage is not as important as the concepts that lie below the surface.

If you want to read everything I know about investing with creativity, don’t miss my first book, The Book on Investing in Real Estate with No (and Low) Money Down available on Amazon or at BiggerPockets.com/nomoney.

I have no problem with people who want to use 100% financing on their real estate. I am a big fan of the personal finance advice given by Dave Ramsey, who is a staunch advocate for paying only 100% cash for all investment properties.

However, I also recognize that for many, myself included, waiting to invest until I have all the cash needed would require decades of sitting on the sidelines.

If you decide to invest with all cash, I would caution you to pretend that you were not when shopping for deals.

Having excess money when shopping is dangerous, whether you are in Nordstroms, the supermarket, or looking for rental properties.

Being able to pay all cash allows people to be “soft” on the math and pay too much for the property because it’s easier to just write the check than it is to find a great deal. Know your numbers, scrutinize the property carefully, and be sure it provides a solid return on investment.

What About Reserves? 

This post has focused primarily on the down payment needed to invest in rental properties. However, there is another purpose for your cash… and that is for reserves.

Related: An Easy, Slow, Low-Risk, & High-Reward Way to Buy Your First Investment Property

The fact is, when investing in rental properties, things will go wrong. You’ll have good months, bad months, and average months — and you never know what you are going to get. This is why it’s imperative that you have cash reserves to cover any problems you might face.

It would be terrible to buy a rental property and, in the first month, be forced to evict a tenant and make thousands of dollars in repairs, but this kind of thing could happen.

The amount of cash you should have in reserves depends on a number of factors, most notably the number of properties you own, the condition/age of those properties, how much it would cost to fix the property up (will you be doing the work yourself?) and your management abilities.

I would encourage you to start with six months of expenses per unit you have. For example, if you have a single family home that costs you $800 per month in expenses, I would recommend having $4,800 in savings for that property. As you get more and more properties, you may be able to decrease this amount, but it’s a good starting point.

So how much money should you have to get started investing in rentals?

You tell me. 

Leave your comments below.

I’d love to know how much YOU think you should have to get started!

About Author

Brandon Turner

Brandon Turner (G+ | Twitter) spends a lot of time on BiggerPockets.com. Like... seriously... a lot. Oh, and he is also an active real estate investor, entrepreneur, traveler, third-person speaker, husband, and author of "The Book on Investing in Real Estate with No (and Low) Money Down", and "The Book on Rental Property Investing" which you should probably read if you want to do more deals.

18 Comments

  1. Don Nelson

    So true! Reserves are the way to go. I got over-leveraged and in 2007 had 3 out of 5 properties go vacant and also had some repairs to do. Went belly up and lost them all. If I had weathered the storm, I could have held them, and sold them now for 50% more than purchase price. Hind-sight hurts…

    But now I have $60K to use for a purchase (or two). Problem is I’m a full time investor/flipper and need that money to live on until I get more. Would love to hear about creativity in more detail…

  2. Tyler Bain

    Brandon,
    You make an excellent point about having money saved up for reserves in this article that isn’t brought up much in others. I keep finding myself analyzing how much cash I need in the bank before finally taking the leap for that first rental property and focus primarily on how much the down payment and closing costs will be but forget to keep that “cushion” in mind.

    I plan to “house hack” for the sole reason to gain land lording experience as close to the action as possible while still maintaining enough funds to jump at another property if i find the right deal.

    After reading this I’m seeing I’ll have to wait until those reserves are back again until pursuing so thanks for the post and excellent advice as always.

    Tyler

  3. Great points Brandon. All my properties required 20-30% down. Some of the later ones also required enough capital to pay all the mortgages, including the new one, for 6 months. Plus at least two years of rental income as verified by the tax forms for any rental income that I wanted to use as income. And a 740+ credit score.

    If you do not have enough income to pay your own mortgage, plus the rental mortgage, with your exiting income it is tough to get a mortgage.

    But they can be very rewarding. The deal is what makes it, not the mortgage. Not all properties are deals, but all properties are deals at the right price.

  4. Jerry W.

    Thank you for the article Brandon. Your statement about the down payment is not as important as the concepts that lie below the surface. I sometimes stray from that logic and have bought properties for more than I would normally pay because I got them with no money down. Good deals make you money, bad deals cost you money, that simple.

    • Brandon Turner

      Ah, that’s true! But I figured I’d generalize all the low-down loan insurance in one (or at least, that’s what I’ll say here to avoid saying I slipped up on that… 😉 ) That said, I didn’t know about the reduced MIP – I’ll have to read up on that! Thanks 🙂

  5. Adam Spencer

    Great read Brandon! Love reading and growing my brain. I plan on doing the FHA as well this year but have to get a new job to qualify. Long story but being a trucker makes is hard to get a loan! Good to hear about the MIP on the FHA is gone down 🙂

  6. Nathan W.

    This may not be the best idea and I’m sure it will be controversial, but I am not convinced that having a load of cash reserves is all that necessary. I have two rental properties right now, and have not found reserves to be necessary. Why? Well it isn’t because I don’t incur unplanned expenses! It is because I have a $40,000 line of credit that I keep clear in case of emergencies. And if that gets frozen for some reason (say financial meltdown), I have several high limit credit cards.

    Sure it sucks to pay interest (only 8% on my PLOC) for those months where I have an unplanned expense, but it makes way more sense to me to go and invest my cash at 8-10% and take an 8% or so hit in certain months when I have to draw, than leaving my cash in a savings account earning 0.05% in case of a rainy day.

    That said, I AM starting to build up a small cash reserve just because I feel like I am supposed to. But for someone starting out with sufficient lines of credit, I would absolutely not wait around till I had some indiscriminate amount of reserves built up before wading into the game.

  7. I don’t think it’s always a misconception or lack of trust in one’s own self that he has got sufficient money to buy a house. Literally, I can’t even spare $100 for my savings. I don’t think I can enjoy the concept of leverage with such financial situation. For me it’s a dilemma to decide what is more important – the down payment or the deal. Moreover, how I am supposed to be assured about involved risk if I invest a large amount of cash as down payment?

  8. Allen Sproul

    My wife and I ‘house hacked’ our first home, purchasing an REO at an amazing price. We have lived there for 4 years now, and are ready to acquire our second property. Problem is we purchased the first at such an amazing price that it is hard to find a similar deal.

    We are also trying to determine how much our reserve should be, and I am currently calculating it as “normal” plus 10%. In other words, I am looking at what our normal expenses are on the year for a unit, and figure 10% as a reserve. So far, we have not had any major issue that has cost us more than that 10%. I probably should look at adjusting it to what historical figures would dictate as my max, but 10% helps me sleep at night, so 10% is where I sit.

    I am sure if and when the right deal comes along, we can dip into that reserve to our comfort level.

  9. This is another great post, Brandon! Some first time investors drain their bank accounts thinking that their rental investments will give them return right away. These tips are very helpful in ensuring that the journey to building wealth through property investments will be smooth and successful.

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