^ hmmm, good advice. i hadnt thought of it exactly like that.
Large down payments are not good or bad. But the basics of real estate is that it is a different category of investment than anything else in existence if used as real estate. You see real estate is no better than any other investment except for leverage. You don’t get more than about 7% to 12% return on the cash you put into real estate. You can get that without all the headaches buying stocks.
If you employ leverage your returns go up. This is a simple example of what I mean. Compare the return you get if you have $100,000 and pay cash for a house as opposed to using leverage. If you have $100,000 cash and you buy a house worth $100,000 and rent it out for $1,000/month you have made $12,000/year or 12% on your money. But if you took that same $100,000 and put 10% down on 10 houses you then have $1million worth of houses. If your PITI is $600/month you are now making $400/month per house or $4,000/month which translates to $48,000/year. That $48,000 versus the $100,000 initial investment is a return of 48% versus the 12% if you paid cash. You also can’t really live on $12,000/year but probably can live on $48,000/year. Using leverage you have made your $100,000 investment a retirement sum but using cash it just becomes a rent house.
In short the more you put down the worst the investment becomes.
My thoughts on this …
To me, it’s a risk vs. reward spectrum.
On one end of the spectrum is using all cash to purchase properties. This is very low risk and saves a ton of money in the long term because you’re not paying interest on a loan. However, very few people have the financial resources to do this and continue to scale up. At some point your cash runs out and you need to either wait to accumulate more or sell some properties to finance future purchases.
Somewhere in the middle of the spectrum is using loans and such to purchase properties. This has the advantage of scaling up your operation quickly and getting more net cash in your pocket in a shorter timeframe but the downside is increased risk. You’ve got to make that payment to your lender whether or not your property is profitable. Also, your long term expenses are higher because you’re paying interest on the loan compared to paying all cash. However, this approach is more accessible to most people because it requires less personal financial reserve.
If I had an unlimited wallet then I’d go with all cash due to lower risk. However, if I had an unlimited wallet then I wouldn’t be here in the first place. :cool I think what you choose depends on your level of risk tolerance and financial situation.
My $0.02.
Keith,
I agree. Tax laws are changing all the time. There is a group lobbying to give the tax deduction that landlords currently get to renters.
The renters could deduct the total amount of rent paid from their income for taxing purposes. And, the property owner would loose their tax deduction for mortgage interest!!
I don’t think this will happen in the near term, but the idea has been floated.
JP
Most of our renters don’t need another tax write off. They’re making big bucks from the gov’t already for doing nothing…
hello,i want to comment here…i think downpayment is not bad thing because you can pay less in coming your debts for the next month
TK7,
The answer to your question is “Do whatever best supports your investment objectives”.
If you just want to own a couple of free and clear properties so you have cash flow to fall back on if you are out of work, then paying cash for each property you acquire will do this.
If you want to be able to retire and live off the cash flow your properties generate, then you need to determine how much money you will need for retirement, how many properties it will take to generate that income, and then develop an investment plan to acquire that many properties before your retirement. If the number of properties turns out to be more than you can acquire with all cash, then you may have to resort to some financing to meet your goals.
PM me if you would like to talk about this offline in more detail.
As others have noted in this thread, a large down payment is not necessarily a bad thing. It does indeed depend on your investment goals.
In my experience, most that are building their investments early in life use financial leverage to boost yields. This must be done very carefully however as leverage is a two edged sword and it carries with it risks. As was seen recently during the economic downturn, many investors that were over leveraged with insufficient equity, cash flow, and financial reserves lost lots of property. This in many cases not only caused substantial financial loss, but in the case of loans with personal guarantees or endorsements caused significant personal credit damage.
IMO, it is VERY important that you buy investment property in areas not likely to suffer strong downturns (this is impossible to know for certainty but careful market analysis can help limit the risk), and to buy property with EQUITY if you are using the property to secure borrowed funds. Additionally you should ensure you have sufficient debt coverage. That is, your company should have sufficient cash flow to cover all your operating expenses and to cover the debt payments, with a margin of safety.
I have suggested to investors I’ve coached to create a long term investment strategy and as a they reach latter stages of their investment career, begin de-leveraging the portfolio. This lowers yields but also lowers risk. As the time available for recovery from unplanned issues that may occur shortens it is important to start shifting to lower risk investments. Also, as the portfolio leverage decreases, assuming the portfolio is sound and well diversified, the cash flow from the portfolio should increase thus providing residual income.
It is very important, as noted in earlier posts in this thread, to use appropriate protection of your portfolio, ever more so if you leverage your portfolio. As earlier mentioned I too use corporate entities and insurance protection to lower risks of large losses.
I’ll share a real world example. Unfortunately, a young investor I have coached some in the past years enrolled in a popular training class offered by one of the industry “guru” instructors. This particular instructor stressed to the students that the financing was what mattered most, and that it did not matter if the property had equity, as long as the terms were great. The “guru” encouraged a reckless and high risk investment strategy. I strongly cautioned against this and my advice was ignored. This particular investor has just finished losing all of his property, which he had borrowed against and which he spent lots of money fixing up. His credit is toast, his reputation is toast, and he has lots of deficiency judgments that will follow him for many years. The original sellers in several cases took the properties back as they had seller financed, and they indeed got the best end of the deal as the properties are worth more now than when they sold them. The terms were great, but the properties had no equity and the investor did not ensure he had sufficient cash flow. PAINFUL LESSON.
So, my recommendation is, consider your goals, consider where you’re at in your life timeline, and consider your risk tolerance. Then make a decision based thereon. If you use leverage, you can realize higher yields, and if you’re careful this can help you accelerate your wealth building, but if you do so, you must be careful!
Best of luck with your investing endeavors!
This is the best advice so far. When people come to me ad say they want to buy this house or that house I always ask them why they want to buy it. You don’t buy real estate just top buy real estate you need to have a goal in mind. That will determine what my advice to them is going to be. (I am not saying one doesn’t exist but I have never found a good answer to pay cash or large downpayment for real estate. I am all ears if someone has a situation that makes sense)
By using leverage you can significantly increase your cash on cash return. If your goal is to maximize positive cash flow then you are better off earning 10K per month by leveraging 30 units then making 3K owning 5 units outright. And you get the tax benefits.
Having more cash means being able to do more deals and also having reserves to deal with any problems such as repairs and maintenance or vacancies. As many others have said it is all about leverage. That is why real estate is a great investment vehicle. There are other ways to invest but none offer the same leverage that you will get with real estate. That said, every one has their own goals and risk tolerance so you have to make your own decision. Good luck!
The borrower is the slave to the lender in things like your own home, cars, credit cards and personal debt. Using leverage for a property that earns you monthly income is not being a slave it is significantly improving your cash on cash return. Your tenants are paying your mortgage. On top of that you get tax benefits and appreciation over time.
Leverage is OK if done right.
Just never forget, cash talks, especially in this market.
You can pickup $150k houses for $50k cash in Dallas! Most people don’t have $50k cash laying around, but if you DO, you can make purchases most folks can not even dream of doing with leveraged deals. Why? Desperate sellers are always around, even in good times, but they are more prevalent now than ever…and they want to close fast and prefer to deal with experienced buyers who have cash…especially after they realize that they don’t have 90 days for an old fashioned realtor to sell their house. Someone else’s problem can become your opportunity, with cash.
And if you want leverage … you can take out a mortgage on your property once the deal is closed, or later on if you need access to the money. =)
Any newbies goals should be to minimize risk and maximize annual return. By far and away most unsuccessful deals are at the beginning of investors careers when they make the most rookie mistakes. Using your own cash is risky, using OPM or Other People’s Money limits your risk. At the same time you can maximize your cash on cash return. Leverage is one of the biggest advantages of real estate and best ways to minimize your risk. In addition, banks, hard or private money lenders will have to double check your due diligence so you get another set of eyes to make sure your deal is legit. Make sense? My recommendation is always go with leverage.