Bigger Down Payment = Bigger Profit On Rental Properties
What percent down do the pros use (10%, 20%, etc.) when calculating if the monthly profit on a rental property is high enough to do the deal? Of course if you put 10% down, the profit may not look great, but if you put 20% down it looks better, and even better at 30%, etc. What is the rule of thumb regarding the percent down when figuring out if a rental property is worth buying?
0%
It should be able to cash flow without investing any of your own money. Then your down payment is a bonus and adds a little extra insurance.
-Chris
Crunch, why dont you put down 100%. Then tell us how it works out for ya... I perfer 0% down but thats just me i guess..
No offense crunch, but you are looking at the numbers backwards. The LESS you put down, the more the profit. Sure, the more you put down, the less your mortgage will be so the more "monthly profit" your cash flow will be. But look at the big picture, you have to make your 30% back before you start to profit. You will profit much quicker if you only put down 5% or less. The formula (rule of thumb) is to put as little down as possible and make it back as quickly as possible. It will be tough to obtain true wealth if you plan to put down 30% of your own money for every deal. Do one deal that you can get for very little or nothing out of pocket and make a good profit on. Use the profit money to move on from there. From that point on, you're using OTHER PEOPLE'S MONEY!!! Then when you are rich, famous, and doing late night infomercials, you will be able to track your total out of pocket investment all the way back to the very first deal! Good Luck
crunch,
I understand exactly what you're saying. And at first glance, the idea of making a bigger down payment in order to generate a higher cash flow seems logical. But as you look closer at this issue, the logic fades away.
Purely for example, let's say you have $150k. With this money you can buy a small multi-unit property that cash flows $2.2k per month. Sounds pretty good.
But let's say you could purchase these types of properties with only 10% down. That would mean that for the same amount of money, you could probably buy 7 such properties. Assuming a 7% 30-year fixed rate mortgage and annual taxes of about $6k, your cash flow becomes about $800 per month per property, or $5600 p/m total for all your holdings. Now there are quite a few expenses I haven't taken into consideration in this explanation, but you get the general idea. Even with these additional expenses added in, your monthly cash flow would most definitely exceed the 2.2k you would have received from purchasing just one property. And don't forget that you're now also building equity in 7 properties, not just 1. So paying as little as possible in a down payment and using your money to purchase as many quality properties as possible, is definitely the way to go.
Still, I understand your desire. I've got a little bit of money right now, and I know that I should buy more properties with it. But it's oh so tempting to just pay off one of my existing properties.
Others have covered the benefits of leverage.
Once you understand leverage then things like 'cash on cash return' become a good measure. Effectively, what is your return on the cash you actually put into the property (not the funds you borrow).
As most lenders want to see a down payment and many want to see 20% then the game become finding legal ways to use less. Sometimes this means getting a second mortgage. Other times it means buying really low with cash and then refinancing after improvements.
My perspective. I like to leave little to no none of my own money in the deal. I want to recycle the funds into my next investment. That said I want the deal to work re: the cash flow. I am a buy and hold investor and I want the property to support itself. Once i get my cash out and the property supports itself then I focus less on the exact return. I focus on the next deal.
John
[addsig]