Am I Being Crazy About Low-Money Down Loans?

Question

Hello BP world!Longtime lurker, first time poster here.In May of '21, I bought a duplex with the intention of house-hacking. After a bad experience with the tenants I inherited, I opted to convert the unit to an Airbnb, and my experience has been awesome. On average, I net about double the income I would've received from a long-term lease while still retaining complete control of the property, experiencing the benefits of Aircover and being able to offer the space to friends and family who come to visit. Instead of having a tenant pay a portion of the mortgage, I get to live here for free and the property makes me money. My wife's full-time job is raising our children, but her side hustle is managing the day to day operations of the Airbnb, so we have a unique situation that would allow us replicate this model in the future :). I've also gained invaluable experience in DIY repair and improvement regarding everything from basic cosmetics like painting and changing light fixtures to completely redoing the old caste-iron plumbing on the property.Despite the increased cashflow, my family has had some unexpected medical costs that set back my savings goals for the next investment. Initially, my plan was to buy one property a year. It's a little over two years since my first purchase and now I'm finally on track to purchase this winter and get the listing ready for busy season. However, I don't know how much money I want to use on my next deal.Since my first purchase, my W2 income has increased by a lot. I should be preapproved for almost any duplex I would want to purchase in the greater Milwaukee area, but I'm nervous about the idea of only putting 3.5% down on a property worth hundreds of thousands of dollars. On paper, this is the best option. In my head, I know that as long as the numbers work it will be okay (for my full-time job I'm a deal analyst, so I'm very familiar with building models and providing recommendations that take into account risk and various probabilities, etc). With a low down payment, I worry about bigger picture impacts down the road, particularly when it comes to getting access to equity for the sake of scaling my portfolio. If I purchase a property with 3.5% down and put money into it to improve it for my own residence and for Airbnb, doesn't that greatly increase my time horizon for getting that capital back out of the property? I'm young and just getting started, and one of my lessons I learned from my first purchase was the value of having cash in my pocket where I can use it rather than sitting in a home. Am I being crazy? What do the pros think? Has anyone been in this position before?

Marcus Auerbach · Answer

@Seth Nightengale one of the biggest mind shifts is to make financial decisions not based on your gut feeling, but based on cold, hard math. In this case, you might be worring about the wrong thing. When you consider your overall risk exposure (which BTW in real estate should always be as close to zero as possible) with a 1920's duplex it has a lot more to do with the condition of a 100 year old property, than with your downpayment. Condition transaltes into future capex and what you need to budget for the next 10 years (or otherwise could catch you by surprise) is the main concern, but also easily mitigated if you know what you are looking at.Second, I am not a big fan of FHA 3.5% loans. Seller's don't like them, so it's hard to get a good deal under contract. And you have to pay PMI for life, which adds up. A low down conventional loan is much better suited and is a lot more attractive you a seller. We have a lender who does not require PMI on a owner occupied duplex, so that help with cash flow.

Kyle Spearin · Answer

@Seth Nightengale I think you have to evaluate what you view as a comfortable safety net/emergency fund for your family. Personally, I like having 6 months-12 months of mortgage payments in the bank or otherwise liquid in the event of a worst case scenario. This is probably on the conservative end, but it's important to have this conversation and conduct this exercise before taking the next step.As for your point on using low downpayment loan options, it sounds like it worked really well for you before with your AirBnb house hack. Why not leverage this again? While you might not be able to do a cash out refi early on, it will build equity over time and you can also get cash flow to safe up for the next deal. Think about 5+ years down the line rather than just tomorrow. It may seem slow, but it will snowball faster than you think!

Don-Carlos Moniz · Answer

@Seth Nightengale, I think your concerns are valid. As @Kyle Spearin said, it's about your risk tolerance and investing goals. The potential cash flow from STRs is great, but I would encourage you to run the numbers as a traditional long-term rental in case the short-term option doesn't work out. Are you planning to do another house-hack on the new property, or will it be exclusively a STR? In the case of the latter, it may be difficult to secure a low downpayment loan because it will be viewed as an investment, not a primary residence. Now take what I say with a grain of salt - markets are in flux, and my expertise is on the commercial side, so I am sure someone can provide more insight on that side of the debt market. Midterm rentals seem to be gaining popularity, so maybe reach out to corporate groups and hospital staffing departments/agencies to try and get some longer-term bookings. There was a recent podcast with an investor that is focused on mid-term rentals that was doing really well (I think it was on the main BP podcast).

David Mitchell Halls · Answer

Run the numbers as a normal rental. If they make sense go for it. I have friends that are only running numbers with airbnb income where if they can make it cash flow they will buy it but if they can't airbnb it they would go negative with long term renters. To me that seems risky as we have seen airbnb prices fluxuate over the past year with ours, covid shutting down a lot of airbnbs in 2020, and different cities such as dallas banning airbnb. If you run the numbers with a 3.5% downpayment and can still make money with long term rentals even though you are planning on airbnbing it I would go for it. That may be too conservative for some people, but it depends on what your risk tolerance is and what the market is like over there as I am not familiar with Milwaukee. If you can make it work with 3.5% down, you could save that money you would have spent for repairs or upgrades to increase the value of the home or even buy another one.

Ash Hegde · Answer

While scaling up, you generally don't want a lot of equity so a 3.5% down loan is great. You are correct that you won't be able to tap that property any time soon for equity, but you will be getting into a property months (maybe years) ahead of what you be able to do with 20% down. You can use that time to save up W-2 income while still collecting rent. Save up enough cushion to your comfort level before the purchase, but if you can get 3.5% down I would do it, even if you have the cash to put down more.

Jarell McGrew · Answer

Lot of great info in here, appreciate everyone sharing their thoughts.

Seth Nightengale · Answer

Hey Don,I'm looking to make it another house hack with a STR as the source of income. I appreciate you pointing out the need to run the numbers in what would essentially be the worst case scenario (long term rental agreement). Always need to make sure the property can sustain itself in the long run.I am familiar with MTRs and Jessie Rodriguez, as I've been a longtime follower of his. I'll take your advice and reach out to some midterm rental people in the area if I can find them. Ideally I would balance them with both properties and have short-term during the peak season and midterm through the winter. If I can establish a relationship like this before the next purchase I would be much more comfortable with a low money down option.

Seth Nightengale · Answer

Hey Kyle, thank you for your reply. I apologize that my post wasn't clear about how I financed my first property. I did so with a traditional 20% downpayment. I understand the angle of playing the long game and cashing in on the equity someday. I suppose a healthy cash reserve could make me feel better, but man it feels like there's a good amount of opportunity cost there and I want to try to balance solvency with making sure I'm investing as much as possible as early as possible.Thanks again for your comment! A lot to think about.