One of the biggest roadblocks to investing in rental properties is the money required to buy rental property. I believe buying rental properties is one of the best investments for increasing wealth and creating passive income. I am relying on my rental properties to give me enough income for retirement as well as offer a luxurious life. It is not easy saving the money to buy rentals, but there are ways to buy with less money down.
I have purchased 16 rental properties since December 2010 and I am seeing at least 15% cash-on-cash returns on them. I detail my strategy on purchasing, financing, and finding rental properties in My Complete Guide to Purchasing Long-term Rental Properties. Rental properties are a great investment, but they require a lot of money in most cases. It is simple to figure the cost on a rental property if you are paying cash, but things get more complicated when dealing with financing. Most banks require 20% down when buying a rental property and you have to consider carrying costs and repairs as well.
How much money do you need for a down payment on a rental property?
The biggest hurdle for most people when purchasing a real estate investment is the money it takes to buy rental property. It is very expensive to buy rental property since most banks require at least 20% down, but there are ways to invest in real estate for less. If you are looking to buy many rental properties as I do, it is tough to avoid putting 20% down. Many banks start requiring 25% down once you have four mortgages in your name. Most banks will stop lending to you all together once you reach ten financed properties. There are ways to finance more than four and more than ten properties with a portfolio lender. Down payments are not the only factor when determining how much money is needed to buy rental property.
How much money is required for loan and purchase costs on a rental property?
Depending on house values in your area, a 20% down payment is a lot of money. The houses I buy are usually right around $100,000, which is about $20,000 needed for the down payment. You will also have closing costs when purchasing an investment property, which consist of interest, insurance, recording fees, origination fees, tax certificates, appraisals, and more. It is usually safe to assume closing costs will be at least three percent of the purchase price, but you can ask the seller to pay all or part of your closing costs. I usually ask the seller to pay part of my closing costs to reduce the amount of cash I have into a property. You also may have to pay for an inspection, which can cost $250 to $500 and some sellers such as HUD do not pay for title insurance, which can add another $500 to $1,000.
How much money do you need for repairs and carrying costs on a rental property?
Repairs can add a huge chunk to how much money is required to buy rental property and you have to wait for the repairs to be completed before it can be rented. While you are waiting for repairs, you are paying carrying costs on that property, which also increases the amount needed. You will have to pay interest, utilities, taxes, and insurance until the home is rented. In a perfect world, it should only take a week or two to have a professional contractor complete most repairs, but it always takes longer. Here is a great article on how to determine what to repair on a rental property.
As for repairs, they usually cost more than you think they will. On a house that needs minimal repairs, I still assume that I will need at least $5,000 in work done before it can be rented. On a house that requires more repairs and updates, I can easily spend $20,000 or more. It is always the little things that take time and add up to big repair costs. As a general rule of thumb, I always add $5,000 for unknown costs on any rental or fix and flip that I buy.
Make sure you get bids if you are not an expert at estimating repairs. Estimating repairs can be a very difficult thing to do, even for experienced investors. Repairs always seem to cost more than the investor thinks they should and contractors always seem to find more things that need repaired.
Turnkey rental properties are one way to save money on repairs and put less money into rental properties.
How much total money will you need to buy a rental property?
Here is a breakdown of the costs that I would normally have on a $100,000 rental property.
Down payment: $20,000
Closing costs: $3,000
Repair costs: $10,000
Carrying costs: $1,000
Total investment: $34,000
These figures would be on a home that needs moderate work. I am a real estate agent, which means that if I had purchased this house from the MLS, I would get back about $3,000 in real estate commissions. I could also ask the seller to pay $3,000 of my closing costs if I thought it would not jeopardize my chances of getting the deal.
Having to put 25% down on a property would greatly increase the amount of money needed. Repairs costs will affect how much money you would need as well.
Another factor to consider is that the bank will want you to have money in reserves when you get an investment property loan.
For more information on investing in rentals the right way, check out, Build a Rental Property Empire: The No Nonsense Book on Finding Deals, Financing the Right Way, and Managing Wisely. The book is 346 pages long, comes in paperback or as an eBook, and is an Amazon best seller.
How to save money when buying a rental property
There are ways to decrease how much money is required to buy rental property. You may find a gem that needs no repairs at all, but it is rare to find a home that is a great deal and in good shape. Rental property number ten and rental property number nine were both in decent shape and purchased below market value. You can ask the seller to pay part of your closing costs when making an offer. It is very common for a buyer to ask for two or three percent of closing costs to be paid by the seller. If the seller does not want to budge on price, raise the price of the property to make up for the closing costs. The cash you save up front will make up for the slightly higher loan and purchase amount.
If you are a real estate agent, you can also save a lot of cash on each property you buy. I am a Realtor and I save thousands on each property I buy because I am paid a commission for my side of the transaction. This decreases how much money is required to buy rental property tremendously. Here is a much more detailed article on how becoming a real estate agent will save you money when investing. Here is another article on how much money real estate agents can make.
Here is a more detailed article on how to save money for a rental property.
Cash reserves needed when purchasing rental property
If you find yourself looking to invest and have saved just enough to buy and renovate a property, be careful! There are always unexpected costs and delays associated with repairs. Make sure you have a cushion in the bank for the worst-case scenario. I suggest at least six months of mortgage payments, taxes, and insurance as reserves for each property you own. This would be money on top of the initial investment used for repairs and carrying costs.
You may need as much as $30,000 to buy a $100,000 house, but that can increase if many repairs are required or if you have to put down more than 20%. You need to make sure you have enough reserves if things do not go as planned. Remember, if you are purchasing more expensive homes, that number will increase significantly and it will decrease if you are buying lower priced homes. For information on putting less money down on rental properties, check out this article.