why is a large downpayment a bad thing?

General Real Estate Investing
1

Ive read through any thread i thought looked interesting on the past 14 pages here in the begginers forum. And i noticed many times the idea that a large downpayment is a bad thing, or that to think that a larger downpayment to sweeten the monthly cash flow on a rental is bad.

i dont understand this theory? If my plan is to OWN, out right quite a few rentals over the course of my life, why is financing as little as possible not a good thing?

i see 1 reason is because now that money is tied up and cannot be used toward acquiring another property… but if my plans are to only have a couple mortgages at a time, wouldnt i want to finance as little as possible initially?

sure, i might not be able to get as many properties in the same amount of time, but im also not risking not being able to make a payment if i lost my income and couldnt find renters. no?

2

Because your tieing up that money in just one property, when you could use it elsewhere and get more cash flow.

Example…

Lets just say, for example sakes, theres 2 houses for 40,000 each. You have 20,000 cash.

Whats better?

  1. Buying one house (putting 20,000 on it) and getting 600 cash flow. or…

  2. Buying two houses (putting 10,000 on each one) and getting 450 cash flow EACH. Thats 900 total.

First example gives you 600, second example gives you 900, but you had the same amount of money. See how that works?

Its all about getting the biggest return on your investment.

3

Hoosier’s got it.
The rate at which you can grow increases when you find deals where you put a minimal amount down. Your concern about the risk of having multiple mortages is somewhat valid, but you can manage that risk if you do things right.
If you buy right and have good cash flow from your rentals, your other rentals will help carry you thru when you have vacancies or repairs on one of your houses. Pretty much all of our houses rent for at least double our mortgage payments on the houses. Once you have several SFHs, a vacancy here or there won’t kill you as long as your cash flowing well on the rest of the houses.
Leverage is very powerful and helps build wealth faster if used wisely. Over-leveraging can ruin you.

4

It’s ALL about leverage and using other people’s money (OPM).

The more money you put down, the less liquidity you have…you can’t spend a deed!

Keith

5

ok. that all makes perfect sense. and thats pretty much what i thought the reasons would be. I guess i am gossly afraid of over leveraging, sunds like maybe too much so.

so i guess that leads to the question of where to draw the line. would it be at the exact amount you could still afford if something drastic happened and you had no tenants in any of them. in other words, squeak by on all your mortgages and your own living expenses given your current employment/income

6

That answer depends on your comfort level as well as probability.
Just like when you select mutual funds for investing…do you go with something aggressive (more risk, more chance of reward) or do you go with something stable?
An entirely safe route would be to only have the amount of mortgages so you could pay them all if everything was completely vacant (as well as having sufficient funds set aside for major repairs in case an HVAC system completely breaks, etc).
Or you could ask yourself what is the likelihood that ALL your properties will be vacant at the same time? Not very likely unless you didn’t do things right at all. Maybe your house is way overpriced for rent amount. Maybe it’s disgusting.
As you grow, you’ll get a feel for the money flowing in and out and you’ll know when you’re able to expand or when to just sit tight and wait for awhile.

7

A large downpayment is not NECESSARILY a bad thing. It depends on your goals. My RE investment goal is INCOME, not rate of return. So if I leverage my purchase 100% and get $100/month cash flow I can put the balance in the bank at .5% and pay over 9% on a NOO mortgage but get a infinite rate of return on my money. Or I can put down 100% and get about $1100 per month income at about a 10% return on my money. At the moment, I want the income and am having a tough time getting a decent rate of return on my money in anything I consider reasonably safe. I’ll take the 10%.

jmd_forest

8

^ ok, you brought up my other point i forgot. forget the word downpayment… i plan to, Lord willing, pay CASH for my purchases a few years from now. I guess i am ultra conservative on this front. I still cling to the borrower is slave to the lender mantra.

9

Your cutting youself way short then…

The amount of time itll take for the cashflow to give you back your big downpayments wont be worth your time.

Paying all cash is something for retired people to have. As somebody just starting out, you dont need paid off assetts like that.

10

also remember that right now is probable the best combination of low house prices and low interest rates, that we will ever see.

This is the perfect time to leverage heavily.

As far as 'what if" all of your properties were vacant at the same time,if that happens it would probable mean you were a terrible landlord, or you made extremely bad choices when you purchased property,that just doesn’t happen,its not if a property will lease, its at what price it will lease

andy

11

A large down payment is not necessarily a good OR bad thing.

“What is your rate of return” or “what is your annual percentage yield” is the only real question you need to ask yourself.

I started paying cash for income producing assets years ago, encapsulated in a corporation/LLC that has nothing to do with real estate, and I have gotten yields ranging from 80-125% on those assets over the last 7-10 years or so. And I have a whole new company too that is very profitable and giving me bigger yields than that.

But anyway - I am paying cash for real estate - and I am getting yields of up to 25-33% or more on my properties every year. I am “under leveraged” you might say, by paying CASH for real estate, but on the flip side I have virtually no risk to my assets (I am speaking about real estate here specifically) since I have “no debt” on them, all of them are encapsulated in LLCs, I have double-layer insurance polices and rock solid attorney created legal documents for everything I do. NOTE And I also have massive equity in my properties, and I can extract that if needed … I can easily sell them for double what I have paid for them - in this down market. I will be able to sell them for triple what I paid for them when the market picks up in a few years!! So personally I like little to no leverage!!! LOL. I am using compound interest to get myself richer, and my business system is so rock solid it is an almost guaranteed system to win. If I sell a property for 3x what I paid for it, my year over year yield actually might be something along the lines of 50% or greater - it really depends on how long I hold a particular property, or group of properties.

On the polar opposite side of what I do, you have guys who borrow money to get 20 homes w/ little or nothing down, and they have $18,000 or more in monthly operating expenses and $20,000 in monthly gross income…yet they have little savings/reserves and work a regular job making $3000 to $5000 or so per month in take home income. THAT IS NUTS TO ME. Why? The risk of bankruptcy - if you make some big mistakes or have something unexpected happen to you. Sure, your combined annual percentage yield from your 20 assets is off the charts, but you pay for that with excessive financial risk.

I personally don’t what my future defined by anyone else other than God or myself. I don’t want to go bankrupt because of a lawsuit, layoff from an employer, or a factory closing in my town which causes a lot of rentals to be on the market. Sh*t happens unfortunately. And I am well prepared for it, yet I am getting rich too. And almost nothing will stop me from becoming worth $50mm or more when I am old and gray at this point.

HOWEVER - there is nothing wrong with borrowing money, as long as for -certain- that you do not get over leveraged and you have the ability to pay back that debt. EXAMPLES - There are guys out there who do stuff like borrow $1,000,000 to fixup and improve a run down multifamily complex, and turn around and sell it for $1,500,000 and get a $500,000 capital gain within a matter of a year or two. And there are people who put large payments down, 20% on all their long term buy & hold properties, and do very well. And there are people who put small payments down, 0% (hard to do now) to 5%, and do very well too.

Borrowing money IS ok. So please don’t think you shouldn’t do it.

Just be smart about it.

You need to do what works best for you, and your business/investment plans

12

Motivatedceo. . .

     What do you mean when you say that you have "double-layer insurance policies"?  Also, specifically, what kind of "attorney created legal documents" do you have that are benefiting you?  I am just curious because I am looking at paying cash for a condo as an investment property and am curious to know if I should create an LLC for the property.  I live in California and my understanding is that it costs $800/year for a LLC, this is only a $41500 condo.  Would it still be advisable?  OR would just having an Umbrella Policy Liability insurance satisfy my protection needs OR is there another recommendation for protecting myself?
13

I agree with TK7 that when one’s intentions is towards buying something, then why don’t we pay larger amount. But on other hand, I would really like to quote that when the seller have got enough amount from you, he would be busy in finding some new clients and wont really accommodate you as a former undone client. So pay as less amount as you can for avoiding any inconveniences.

14

What do you mean when you say that you have “double-layer insurance policies”?

I have limited amount of assets in one LLC, then a full coverage insurance policy for each property and an umbrella policy to back up that. That creates multiple layers of protection.

What “attorney created legal documents” do you have that are benefiting you?

Primarily a very well written lease between my LLC and the tenant, which limits my liability to virtually nothing and makes them responsible for everything - including some/most maintenance - which actually is legal in Texas but it must be written correctly. But I have a few other documents too.

Yeah, $800 a year -minimum- is what I think California charges for an LLC. Personally since this (sounds like it) is your first property, I would only get a single full coverage policy only that has a $1,000,000 minimum liability coverage amount. You need to even see if you like real estate before you buy more properties, venture into getting LLCs, or an umbrellla policy to backup other existing insurance policies.

THAT IS NOT LEGAL ADVICE…just what I would do myself if I were in your boots. =)

Good luck w/ your new purchase!

15

Hi
I think you are new to the business.So In really simple words,
The more you borrow the more you have to pay in interest. The more interest you pay the bigger tax write off you get.

16

motivatedceo;

I can only dream about returns like that. I generally buy at 40% to 60% ARV, rehab the properties into top condition, and then rent. 12% COC return is my best return yet. This does not include the additional equity in the property (generally 35% - 45%) generated by the rehab or the additional return due to tax benefits.

This is a tough area for REI … low rent to price ratio.

jmd_forest

17

NEVER, EVER base your investment decisions on the tax consequence…that will set you up for failure. Your investment decisions should be cashflow driven and tax treatment seen as ‘icing on hte cake’!

This is my opinion but I’ll bet I have a lot of backing in this area!

Keith

18

I don’t think we will see interest rates this low for a long time, which is one reason I believe in leverage, that and the price of housing.

If you have a house that your monthly PITI is $750, which you have just rehabbed and replaced nearly everything in,and the market rent right now is $1150,its hard not to go after it,

Also if your buying at market, then put a large down payment, but if your buying at 60% of market and putting 10% more into rehab (or some combination like that),then you can get away with less cash down

19

not to call you out, cause until about 2 weeks ago, i believed this also… but that is actually completely false.

yes… you do get all of it as a tax deduction… but you are paying the bank WAYYYYY more than the deduction is worth. Look it up in the tax tables to confirm for yourself, i did … its true.

example.

you have a $200,000 loan at 5%. thats about $10,000 in interest paid to the bank, in 1 year.

ok, lets say you make $70,000 a year. look at the tax able. the filing single tax owed for $70,000 is $13,675.

now take off your $10,000 paid to the bank. youre now paying taxes on $60,000. the tax filing single for $60,000 is $11,188.

you just paid THE BANK 10 GRAND, for a savings of $2,487!!!

you actually LOST $7,513!

So, dont ever buy or leverage based on the tax right off alone!

20

The real numbers are good, but I sure hope this wasn’t news to anybody.
Yes, you paid money in interest, but you also have a pile of cash(assuming you had the option to buy w/ cash) That pile of cash should make you more than you “Lost” to the bank.
If it does, borrow for the purchase, if it won’t, then buy w/ cash.