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How Much Money Is Needed To Invest In Rental Property?
Nothing has extinguished the dreams of a real estate investor wannabe more than the perception that one does not have enough money in the bank to start with.
And at the end of this article, I promise you an answer to how much money you need to start with.
While the investor in me secretly pump my fist in celebration as the more people there is with this limiting belief, the lesser competitors there are to spar with me in the market. The sharing nature in me weeps silently at this misconception that is probably the biggest barrier newbies face.
I have conversations with people all the time who still think that they need 100% of the purchase price in order to buy a house.
And the look of shock in their faces can be priceless when you explain the basic concept of 20% down payment and even 100% funding via creative financing.
If 100% of a property’s purchase price is required in order to buy it, only less than 1% of the population in the world will be able to afford buying a house.
If you need to save up to buy your own home, it might take decades or even centuries before you can afford your dream home.
Now… we know for a fact that this is not so in real life practice.
People buy their dream homes all the time. In fact, someone is probably signing the purchase agreement for his dream family home right now.
The magic pill
So what is the magic investing potion that is allowing regular people to buy houses everyday?
Surely you’ve heard about leverage?
Leverage more of a financial jargon more accustomed to the hustle of Wall Street. But it is EVERYTHING of what real estating is all about.
Without it, few people will be able to build their property empires no matter how shrewd or resourceful they run their businesses.
In real estate investing, leverage usually comes in the form of a source of financing. And for most people, this source is a loan from a lender.
But even if the form of financing that you eventually settle for has nothing to do with a bank or financial institution, the concept will be the same.
The investor pays a down payment equivalent to a specified percentage of a property’s value or purchase price. The balance amount is then supplied by a lender/financier. Then the investor makes a small payment to the lender monthly for the term agreed upon in the agreement, or until the loan is paid-off or redeemed.
If we take for example a house priced at $100,000 and you managed to convince a lender to lend you 80% of the purchase price. You will then have to come up with just $20,000 as down payment in order to buy the place. This is without mentioning the closing costs involved.
If we take for example that this loan is structured with a simple interest rate of 4% annually over a 20 year term, you will eventually pay [4% x $80,000 x 20] $64,000 of total interest over the 20 years. This works out to a monthly mortgage payment of [($80,000 + $64,000) / 240] $600.
This would mean that you are in the black as long as you get a rental above $600 a month from a willing tenant. This is without taking into account the $20,000 hole in your bank account for the initial down payment. Note that this is just an oversimplified example to drive home the point.
Although this can look like a simple basic example that can be easily understood. You could be surprised at the number of working adults who don’t fully grasp it.
2 main extremes of leverage
There has always been 2 opposing camps with very different views of how leverage should be viewed.
On one camp (camp A) belongs to those who feel that the more leverage and gearing you take up, the higher the risks involved in your investments. On the other camp (camp B), investors believe that the higher quantum of financing they are able to obtain, the lesser their risks as the lesser their own money is involved.
There is no right or wrong answer here. Which side to lean towards really depends on your own personal preference and how you perceive risks.
If we take for example an investor from camp A buys an apartment for $100,000 with 20% down and 80% loan. And a maverick from camp B buys an apartment for $80,000 with no money down 100% financing.
Your preference to which camp carries more risk would probably determine your perception of risks.
In camp A, the borrower probably got a better deal on the loan that translates to lower interest rates and better terms. He might also sleep better should the real estate market tank suddenly causing value to drop by 10%.
In camp B, the borrower has zero amount of his own cash involved in the deal. Granted that he probably got a lesser apartment translating to a lower potential rental. But that’s nothing a little home staging cannot solve. Anyway, he could be a flipper after all and ready to sell within a month or two after remodeling it.
Most people will feel that the investor in camp B is taking on bigger risks. But is he really?
If you really think about this without any bias, and center your thoughts on your OWN financial well-being. The camp B investor can look very attractive after all.
But make no mistake about it. Creative financing deals for quick flips or rental is risky. However, that is nothing a little education with how these things are conducted couldn’t fix.
The answer to the riddle of “how much” is here
Learning the ins and outs of investing in rental real estate can alleviate a lot of the associated risks involved.
The surprising thing is that even when experienced investors get so good at identifying deals and opportunities, a lot of them stick to deals involving 20% or more down payment like a habit.
This is even when they are 99% sure that the deals are winners. Either they are perfectly happy to grow slowly or they haven’t realized that they could supercharge their portfolios by using other people’s money.
The answer to how much money you need to start investing in real estate? Zero.
This is assuming that you know what you are doing or have experts in your corner to guide you along. yet a lot of times, you simply learn how to swim when you jump into the deep end of the pool.
You can choose to either invest with zero capital or dump 10 years of savings into your first rental property. Just make sure you have a good grasp of the consequences and implications of both routes of investing.