How Much SHOULD You Put Down on an Investment Property? (Rookie Reply)

Ashley:
Let’s get your questions answered. I’m Ashley Care and I’m here with Tony j Robinson.

Tony:
And this is the podcast to help you kickstart your real estate investing journey. And today we’re diving back into the BiggerPockets Forum to get your questions answered. And for all of your rookie that are listening, the BiggerPockets Forum are the absolute best place to get your real estate investing questions answered quickly by experts like me, Ashley, and so many others. So here’s what we’re going to cover today. First, we’re going to talk about how to determine how much you should put down on your first rental property. We’ll talk about whether or not it’s a smart move to pay off a mortgage on your primary residence and the things to keep in mind when you’re analyzing your first flip. Now before we jump in, we want to thank Corporate Direct. This episode is sponsored by Corporate Direct where you can protect your properties with an LLC and let corporate direct take care of the paperwork. Head over to biggerpockets.com/direct for a free 15 minute consultation and $100 off if you mention the podcast. Now let’s get into the show.

Ashley:
So the first question we pulled today is, am I putting too much down on a new rental property? This is a single family home. This is my first investment in real estate. Apart from my own, I’m investing in a rental property, an Airbnb in California. The sale value is 515,000. I’ll be putting down around 300,000 in finance. The rest I expect to make 2,500 per month on average through the year as an Airbnb rental. This is based on actuals from the prior owner. They gave us an Airbnb statement that we could verify for the last couple of years. The current mental map is to look at what my total annual costs are, my mortgage plus property taxes, plus insurance, plus property management, plus a approximate maintenance and utilities, et cetera, and figure out what’s the minimum I need to put down to balance most of those costs against the income expected. I would also expect the property to appreciate in the next five years or so, after all it’s California, is it foolish to be putting down 60% on a rental property? Does this smell like a bad deal? Not, Hey, I think this is a great question and honestly, I don’t know if we’ve ever gotten this one before.

Tony:
Yeah, we’ve answered a lot of questions, but none like this that I can recall either. And this person’s talking about Airbnb, but I think this question can apply to both long-term, medium term, short-term, single family, commercial, whatever it may be. I think there’s a lot there. I don’t know, where do you think we should start asking because I feel like there’s a few things that we need to focus on. I guess my first question would be why are you putting down so much? Is it because you have to for financing reasons? Is it more so just for your own personal risk profile? What is the actual reason behind putting down 60%? Because that does feel like a lot. Now obviously you’ve got some risk mitigation there because you’ve got a bunch of equity now built into this property on day one. So if things do go south or don’t go according to plan, you can sell and still be net positive. But I think that’s the first question that I would ask is what’s the actual motivating factor to putting down such a big dollar amount?

Ashley:
And I think my first thought after reading the question was that the reason he wanted to put so much money down was because he wanted better cashflow after paying all of those expenses and figuring out what was the minimum he needed to put down to balance. So I don’t know if 60% was the minimum to have a little bit of cashflow or 60% will be actually a lot of cashflow that’s coming in. So I think the first thing that I want to go over first is that cashflow shouldn’t be your only metric as to if this is a good deal or not. You should also be looking at cash on cash return. Tony and I could buy the same exact house, he could pay it in cash, a hundred thousand dollars. I could go and get a mortgage where I’m putting 10% down and $10,000 into it and then financing the rest and I have a mortgage payment.

Ashley:
Tony’s cashflow is going to be higher because he doesn’t have that mortgage payment. Wow, Tony, you have such great cashflow, what a great deal you got. But if you look at the cash on cash return, it might actually show that my deal is better because I didn’t put as much money into it, or maybe it would actually net out to be the same money even though he’s getting higher cashflow. So I think really you have to look at all the factors of it and not just, okay, what’s going to be my cashflow? I think the appreciation play is also very important and definitely a metric you should be factoring in as to, okay, you’re not going to be getting the best cash on cash return, you’re not going to be getting the best cashflow, but is there appreciation and do you want to hold the property for five years to get that appreciation and having that balance, I wouldn’t lose thousands and thousands of dollars every month waiting for appreciation in five years because what if it doesn’t come? So I think the first thing is to understand, there’s other metrics to look at cash on cash return to see if the deal works besides just looking at cashflow

Tony:
And looking at the numbers that he listed here, that 2,500 bucks per month, if that is like net after everything, if we did 2,500 over 12 months, that’s 30,000 bucks. So in a $300,000 investment, that’s a 10% cash on cash return, which isn’t terrible, it’s a decent cash on cash return. But I think the question I would ask is could you potentially deploy that 300 K maybe across multiple properties and get a slightly higher cash on cash return on each deal? Probably yes. So again, I think that’s why it goes back to a lot of the motivation piece. Why are you doing this? Why are you putting so much down? But I feel like if I had 300 k, I could probably get a better return than 10% depending on what kind of deal I’m looking at.

Ashley:
And also, Tony, you would know this better than me, but he says that he got a Airbnb statement for the last couple of years. Maybe talk a little bit about how the market is different now compared to 20 21, 20 22, things like that. And is that something you should factor in when looking at the historical data for Airbnbs?

Tony:
100%. I don’t know which city in California, and obviously every market is somewhat unique, but I think just at a national level, 2021 was a bit of a banner year for pretty much every single market, at least the bigger markets I should say. So I would definitely take with a big grain of salt, any data from 2021, and I would focus really, really heavily on the year over year change between 2022 to 2023 and then how that property is paced in 2024 in comparison to 2023. And then I would also look at the entire market and see how the market is shifting from 2023 to 2024. Is the market occupancy going up or is it going down the percentage or the number of listings? Is that percentage increased massive or is it small? These are all things I would take into account because while the financials from the previous owner are solid, you want to get a better sense of which direction those are actually headed.

Ashley:
The last thing I would add to this piece is I’m definitely behind putting more money down. I think it’s great because you have less risk. You already have equity baked in because you put your money into that instead of leveraging yourself to the max. And when I first started investing, that’s what I was doing. I was putting as little money down as possible leveraging to the max, and then after a couple years, I actually started to pay properties off. And let me tell you, you can sleep so much better at night knowing that you are not over leveraged. So think about this scenario when you’re trying to think about should I put all my money into one property or should I spread it out over five properties, run the numbers, what do those two scenarios, not you in five years, but also look at, okay, you now have five properties that you need to manage.

Ashley:
If you’re going to self-manage, that’s more overhead, that’s more people you’re going to have to respond with for guest communication instead of just one property. So run the numbers in different scenarios and see not only what the financial outcome is, but think about your time those next five years. Do all those five properties need rehabs where you’re going to be running from property to property, managing contractors, things like that, or are you going to end up kind of the same if you have one property compared to the five properties too? So definitely something that took me a long time to learn is it’s sometimes beneficial to add more to the properties you already have by increasing the nightly rate or the daily rate. And even for long-term rentals, being able to increase the rent by reinvesting my money back into that property instead of being in that consumption acquisition phase as much as it’s so addicting and accumulating more and more and more properties.

Tony:
Yeah, couldn’t agree with you more. Ashley and I, again, I feel like it does go back to this person’s motivations, which is why I keep hitting on this piece. But if their goal is really just to maximize cash flow, I wouldn’t put down 60%. And if this deal only works, if you put 60% down, then it’s probably not a great deal. But if your goal is just a solid base hit, mitigate your risk, reduce your risk as much as possible. And yeah, 10% return on a property in California that’s going to appreciate and give you cashflow is probably not a bad deal. I feel like it’s hard to give a definitive answer without knowing what those motivations are. But just going back to the point that you made about focusing on not always just the smallest down payment, but maybe how do you protect some of the equity in your home?

Tony:
As I’ve talked to more real estate investors who are way more successful than I am, especially the ones that have been through 2008, all the real estate invested I know that have been around long enough for 2008, a lot of them have very much like a risk mitigation mindset and they tend to kind keep bigger cash reserves. They want to make sure that their loan to value is 65% or lower, whatever it is. So as obviously there are some ups and downs in the real estate market in the last couple of years, and I think those are the kind of lessons that allow people to have long real estate investing careers and not short, successful, these short burst real estate investing careers.

Ashley:
Before we jump into our second question rookies, we want to thank you so much for being here and listening to the podcast. As you may know, we air every episode of this podcast on YouTube as well as original content, like my new series rookie resource. We want to hit 100,000 subscribers and we need your help. If you aren’t already, please head over to our YouTube channel. You can go to youtube.com at realestate rookie and subscribe to our channel. Okay, welcome back Tony. What’s our next question?

Tony:
Alright, so our next question here says, I have some great cash flowing rentals bought before the pandemic. They have a low interest rate and turn to the mortgage, and I’m kind of addicted to real estate investing. I’m always looking at listings and tracking the market, but I’ve come to the conclusion that the juice just isn’t worth the squeeze in my market and potentially likely most markets. There are some exceptions if you have a ton of cash for large scale projects, which I don’t. So I’ve come to the conclusion that my best bet is to focus on paying off my primary residence mortgage. The home was bought in 2023 with a 6.9% rate. Since I can’t get better than 6.9% in terms of return by buying more real estate, I can’t justify buying more. Anyone else shifting their strategy to focus on payoff of higher rate loans. I know it’s not the sexy strategy, but to me it seems like the best bet for my situation. This is another really good question, one that I feel like we haven’t tackled before. So producers, great job for giving us some new perspectives for today.

Ashley:
I think this question, the answer to this question would’ve been so different if this was a 20 20 20 21 interest rate too. My first initial thought is they were saying, should I pay up my primary? No, that’s the best interest you’re going to get, but 6.9% that is kind of a high interest rate.

Tony:
Yeah, I guess there’s a few different ways you can kind of approach this question of, should I pay off my primary mortgage or should I not? I get the idea of what he’s saying. He’s saying right now I’m paying a 6.9% rate on my primary mortgage and I don’t feel that I can get better than a 6.9% return on any investment that I make. So just mathematically, if we only looked at the cost of the debt versus the return you can get by deploying that money elsewhere, I can see the argument, but I feel like it doesn’t necessarily paint the entire picture. What are your initial thoughts?

Ashley:
My initial thing is that at least this is passive. All you’re doing is paying this loan off. So it’s not like you’re having to buy property and to manage tenants because if you go and invest, even if you can get a better rate of return, you are going to have to actually do some work for it. So maybe in this circumstance it is more beneficial to pay this off and then now you have what your mortgage payment was as kind of your extra cash that you now have. So I see that point there. The next thing I think about is, okay, could you go and refinance your home instead? What would that look like? Can you get a lower rate right now than 6.9%? What would the interest rate be if you went to go and buy an investment property and then fully run the numbers on that investment property? Because even though the interest rate may be higher than what you’re paying on your primary, if the rents make sense, it doesn’t matter what your interest rate is. If those tenants are paying off your property, they’re paying down the mortgage every month and you’re getting cashflow from it. So I think in the beginning of the question kind of mentioned he already has some great cashflowing rentals, but now it’s kind of harder to find what he had before the pandemic. So maybe he goes and pays off some of the rentals. What are those interest rates?

Tony:
I feel like there’s two things, right? Because one piece of it is he’s saying that he can’t get better than a 6.9% return on anything right now, which I feel like is debatable. He’s also saying that the juice isn’t worth the squeeze in my market. And then he makes a pretty broad statement of saying, and likely most markets there are 20,000 plus cities in the United States. And it’s somewhat unfair to say that out of all 20,000 of those cities, not a single one can get you better than a 7% return on your investment, right? So I think part of it is that as real estate investors, we have a preference or we’re very partial or maybe biased towards markets where there’s familiarity or proximity. And because of that, sometimes we avoid opportunities in places that maybe we aren’t super familiar with. But where there are great opportunities, I think also we lean on strategies that we’re comfortable with.

Tony:
And sometimes it’s a market shifts. Maybe you need to switch up your strategy somewhat to find where the better return actually is. So whatever market this person is investing in, maybe buying and renting out single family homes as a traditional long-term rental won’t get you better than a 7%. But what if you rent it out by the room? What if you use something like a pad split to help you facilitate that? What if you go after midterm rentals where you’re renting to traveling professionals or nurses, people coming in to visit their kids, whatever it may be. What if you switch your strategy just ever so slightly to get a better return on that investment? So I think there are other ways to kind of get that return than just focus it on your own market and your existing strategy.

Ashley:
That’s a great point, especially the tax benefits, looking at that portion of it because maybe you’re a high W2 income earner, you go and pay off your mortgage, maybe you itemize on your tax return now you don’t have that mortgage interest to actually deduct anymore, and then it’s end up going to be worse for you in your tax situation. So that’s a great point. So if you can’t already tell Tony, and I love talking about real estate, we love answering questions like this with all of you, and we’d love it if you’d hit the follow button on your podcast app. Wherever you are listening, we have to take one final break and we’ll be back with our final question. Okay, welcome back and we have one last question today. This question is, I have an opportunity to buy my first flip but have to use hard money to obtain it.

Ashley:
The loan amount is 170,000. I have to come in with 43,000 based off a purchase price of 200,000. I have questions. Are these terms pretty standard and is there a way to negotiate the upfront points? Do hard money lenders typically negotiate 12% interest only. So I’m at 1870 per month. I’m at a cost basis of 213,000 and materials in labor, 36,000 with 12 to 15,000 of the labor being run through my contracting business, assuming a four month hold, I’m looking to profit after carrying costs around 55,000, assuming my middle sale price based off of comps of 325,000. Anyone have any input or tips for me? Am I crazy for doing this deal based on these numbers? Okay, so let’s go back to the top here. And the first question kind of is do hard money lenders typically negotiate? I’m never actually negotiated with a hard money lender. I’ve just accepted what they have given me because the deal still works. So Tony,

Tony:
I’ve actually never used hard money either. We’ve done quite a few rehabs and flips, but it’s always been through private money. And for our Ricky’s that are listening, slight difference between private money and hard money. A private money lender is typically an individual who has some sort of active income and they just use their active income to build these big chunks of cash, which I then go out and lend to real estate investors like me and Ashley and is usually very much relationship based. A lot of times they don’t have websites where they’re going out there and promoting the businesses that they do. They don’t have these massive teams. It’s one person that’s a private money lender, a hard money lender is a company. It’s a business that is in the business of making money by lending money to other real estate investors. A lot of times they’ll raise money from other people and then use that money to go out there and fund all these hard money deals for their folks.

Tony:
And typically their money’s a little bit more expensive, sometimes significantly more expensive depending on the experience level, on the hard money lender than what you’ll get from a private money lender or traditional financing. So those are the differences. Now that being said, obviously Ash and I have both talked with a lot of folks in the space who use or even run their own hard money companies. And usually what you see is that there is a bit of a sliding scale, right? If you’re a brand new, you’ve never done this before, flipper, the debt is usually more expensive because there’s more risk. If you’ve completed X number of deals in the last 12 months, well then the rates get a little bit better. So I would say there’s no harm in negotiating with any lender, whether it’s a private money lender, hard money lender or conventional lender, right? I’ve asked many times, Hey, can we cut this cost? Can we do this thing? What about this? And you would be surprised that a lot of times folks are willing to negotiate. So first answer, at least in my case, is that no, I don’t think there’s any downside in trying to negotiate.

Ashley:
Yeah, it doesn’t hurt to ask. The only thing I would have caution on is to, if this person is taking a chance on you, you’ve never done a deal before and they are the first lender that is even offering you a loan, maybe you do just take it and grab it and don’t try and nitpick it because making X amount is better than making $0 at all too. So remember, you don’t want to be the only one making money. You want your team, you want the people around you to also be making money. So if the deal still works, don’t be afraid to be paying somebody. And that goes a lot with wholesalers too. I always see people pay the assignment fee like you’re getting the deal or else you would’ve got $0. You never would’ve got the deal brought to you. And I think the same can go with hard money lenders too.

Ashley:
And like Tony had said, I’ve had hard money lenders that have me fill out an experience sheet where I go through every single deal that I’ve done, that I’ve bought, I’ve held, I’ve bought and sold all of them. And what it was, was it a rental? Did I rehab? How much was the rehab? What was the cost of the property? What was the after repair value? What did it rent for? Did I flip the property? Everything like that. So as that sheet continues to grow for you, yes, you may get more favorable terms, but just starting out as a rookie investor, it may not be the best. And you may look at it and be like, oh my god, that’s a lot of money. I went to a bank. They wouldn’t charge you that or whatever. But you have to remember that these companies, these lenders are taking a risk with you. And if you do perform and they’re getting paid and you don’t ask for extensions and things like that, then that’s where you can have the ability to negotiate and get to get more and more favorable terms once they realize that you actually are a great client to work with and do perform your end of it.

Tony:
And I said, don’t be afraid to shop around. I mean, there’s so many hard money companies that are out there do a little bit of due diligence. If you jump into the BiggerPockets forms and you just type in hard money lender, there are probably thousands of results that pop up about hard money lenders that folks in the BB community have worked with. So don’t be afraid to shop around and compare. Now to Ashley’s point, don’t also get greedy If you find a lender, and these are actually really solid numbers and better than anyone else that I’ve talked to. I like the process, like how you guys lay things out. Maybe don’t try and nickel and dime them even further to the point that you lose that relationship. But I definitely think there’s some value, and this is hard money lending or traditional lending and shop around a little bit before you commit to the first person you talk to.

Ashley:
Yeah, and I agree. I think the understanding their process too of how the money is received, what’s your responsibility on your end at their end and understanding that whole process is very important.

Tony:
Lemme add one thing before you go on to the last piece there because like you said, understanding how the private money lender or the hard money lender in this case sets things up from a payment structure. I think a lot of people don’t understand that it’s very common in the world of hard money lending where you have to pay out of pocket for a lot of the expenses upfront and then you get reimbursed in the backend. And I’ve met a lot of first time flippers who didn’t understand that they end up buying this property, then they’ve got to write a check for 10, 20, whatever, $30,000 to buy materials and get their team started not knowing where that money’s going to come from. Then they got to scramble and bring someone else into the deal to help float the money. So just make sure that you understand how things are going to flow from a money perspective before you actually sign on the dotted line there.

Ashley:
So the last piece of this question is, is he crazy for doing this deal with a profit of 55,000? And I think it had said it would take around four months for the hold period of this property. So from the point of purchasing it and rehabbing it and selling it, it would be a four month period making $55,000. Okay, so you got to look at your time. What’s the time value? How much time are you putting into this property? If you’re going to be working to sun down for those four months, maybe the $55,000 isn’t worth it to you and you actually would make more than that working your W2 job. So you have to look at your circumstance as to what is the value of your time right now in your job? What do you make? You can even break it down to an hour and see over the four months, if I’m going to be working as a contractor in this deal, does it make sense for me to make 55,000?

Ashley:
This is going to be really passive. You’re outsourcing everything. Yeah, making 55,000 in four months can be a great deal if you don’t even have to do barely anything for it except or put the money in order, hire the contractors and then just let it go. So I think it’s hard to say, is this a good deal for you? For me, if I was doing a flip, and honestly the last flip, I just did my first flip on my own, I made about 50,000 on it and it was over a six month period and I was very happy with it because it was so passive for me. It was very little involvement on my part because of my great general contractor. So in that case, it was worth it for somebody else who is making a better return somewhere else, this may not be a great deal, but for me it would be. Tony, what about you?

Tony:
Yeah, I think the other piece too is four months. And again, this is very market dependent and we don’t know the condition of the property, but four months does feel maybe a little tight for me. For someone who may be doing this for their very first time, it sounds like you have some contracting experience, which I’m sure will be super helpful, but I didn’t say general contracting. So maybe you’ve got some kind of trades background, but I would probably give yourself a little bit more time than those four months because four months you’re going to need 30 days at least a month for escrow. So that means you’ve got three months to both complete the rehab, get it listed, and find a buyer in 90 days. And for your first flip, I would just want you to have maybe a little bit more time then that at least six months maybe that way.

Tony:
Because what happens to that deal if you do it and taking six months or eight months? So I would kind of stress test against a few different variables there. And then you said that you’re assuming your middle sales price based off of comps of 3 25. Again, if this is your first flip, one of the things that I would do is I would approach an agent in that market, show them the current condition of the property, show them your anticipated scope of work, and maybe some photos of what you believe it’ll look like, maybe the comps that you found and ask, Hey, do you actually believe that the 3 25 is the right number? And get their input because the last thing you want to do is assume it’s 3 25, but maybe it’s really 300. Assume that it’s four months and really it’s eight, and now all of that 50 5K has gone to zero or maybe negative. So again, for your first flip, I would really try and make sure you have some margin around your projected after repair value or a RV and that you give yourself some padding around the time to actually get this deal done. But assuming that you can do those things, I think 50 5K for your first flip is a really solid number, right? Is a really solid number. So I feel like if we could handle all those other things feels like a decent deal.

Ashley:
Yeah, just having those contingencies in place over estimating how many months it’ll take overestimating your rehab. I think James Dayner does like a 20% contingency whenever he does a rehab, he does his estimate, his budget and then adds 20% on top of that too.

Tony:
What did you do for contingency on your last flip, Ashley?

Ashley:
I did 20% because I did everything James did.

Tony:
We usually do about 10% for contingency for ourselves, but yeah, 20% is even better, especially that first time. Right?

Ashley:
Well, if you want to get involved in the community, all these other real estate investors asking questions, go to biggerpockets.com/forums. Thank you guys so much for joining us for this rookie reply. I’m Ashley. And he’s Tony. And we’ll see you guys on the next episode of Real Estate Rookie.