Is it worth putting down a larger downpayment (indepth analysis)

[Jackson Pontsler]

I recently engage with a conversation with a fellow investor and we discussed the merits of putting down a larger down payment with the property doesn’t cash flow. After discussing several points I wanted to dive deeper into the merits of large vs small down payments, mainly could a larger down payment make a non-profitable deal more profitable. This is mainly for individuals who feel that investing out of state is not an option.

I currently reside in Salt Lake City, UT. In certain A+ neighborhoods a rental house can cost 400k, the rent for these houses are around $2,000. Some real estate investors argue that it is alright to be a couple of years in the negative is ok because appreciate would equal things out, however I do believe many people overestimate the amount a person can raise rents year over year and the true costs of a rental property.

To simplify the analysis I will follow with the basic rule:

Market Rent: $2,000

Rent Appreciation: 2%

Property Tax (monthly 230)

Insurance (233)

Interest Rate: 5.5

Real Life Cost: 10% Repairs, 10% Property Taxes, 10% Vacancies

Yes I know that there are many more factors but then this article would be absurdly long.

                      $80,000 Down Payment        $120,000 Down Payment

Year Rent Annual Cashflow ROI Annual Cashflow ROI

0        2000        -10560                -13.2%         -7836                     -6.5%

1       2040         -10080                -12.6%         -7356                     -6.1%

2       2080.8      -9590.4              -12.0%         -6866.4                   -5.7%

3       2122.41  -9091.01              -11.4%         -6367.01                -5.3%

4       2164.8    -8581.63              -10.7%         -5857.63                 -4.9%

.......

29   3551.68   8060.273                 10.1%        10784.27                9.0%

30   3622.72   8912.678                 11.1%        11636.68                9.7%

Ok so we have a bunch of numbers but what does it mean? Well let’s first look at the big picture.

Total Cash flow for 80k: -$54,253

Total Cash flow for 120k: $30,190

So looking at these numbers we can see a difference of over 80k. The argument of you are paying for negative cash flow upfront with a larger down payment is debunked here.

Let’s get even fancier

So we looked at a basic comparison but there are more factors here we can tweak and compare. Let’s look at some other scenarios.

With a 120K down payment we can get a lower interest rate of 5.25%

What about getting a property for 5% down payment at interest rate of 6%

What about only positive cash flow?

                 $120,000 @ 5.25%                        $20,000 @ 6%                              $230,000 @ 5.25%                                     

Year Annual Cash Flow ROI Annual Cash Flow ROI Annual Cash Flow ROI

0              -7308                       -6.1%                 -16092          -80.5%                    -24                  0.0%

1             -6828                        -5.7%                 -15612           -78.1%                    456                 0.2%

2             -6338.4                     -5.3%               -15122.4         -75.6%                    945.6               0.4%

3             -5839.01                 -4.9%                 -14623            -73.1%                  1444.99            0.6%

4            -5329.63                  -4.4%                 -14113.6         -70.6%                 1954.37184       0.8%

...

29         11312.27                  9.4%                  2528.273         12.6%                   18596.2726      8.1%

30         12164.68                10.1%                  3380.678         16.9%                   19448.678        8.5%

Interesting Stats:

Total Cash flow for 120k: $46,557

Total Cash flow for 20k: -$225,745

Total Cash flow for 230k: $272,362

Time to equalize everything! Let’s take the cash flow and subtract the down payment to get a clear view of costs. We will take the lowest number and set it to zero and add the difference to the other numbers.

                                       80k                      120k @5.5                         120k *5.25                      20k                                 230k

Equalize Cash flow      $111,492          $155,936                           $172,304                            $0                               $288,108

We can see from here that putting down the lowest down payment is not always a great option. Sure it’s good for acquiring a property however the total cost of mortgage and renting it out was overall 100k more expense than its other counterparts.

Don’t be fooled

By looking at what we have concluded it would be easy to state that the more money you put down would be better however you are using 230k. Which is almost 3 times as much as the first option so let’s compare taking that 240k and break it up into buying 1, 2, and 3 properties.

                                     3 Houses   80k Down Payments                    2 Houses 120k Down Payments                     1 House 240k Down Payment

Total Cash Flow                     -$162,760                                                           $93,117                                                                 $292,822

Total Increase                        -$402,760                                                         -$146,883                                                                $52,822

We can see from this analysis that the only truly positively cost option is the large down payment however we can see that if we bought 2 houses we at least would have some positive cash flow over the 30 years of owning the property.

So clear winner right?

NO, the final part of this equation is looking at the properties after the 30 year mortgages. We now have cash flowing properties that are all flowing more than 30k a year.

                                   3 Houses 80k Down Payments          2 Houses 120k Down Payments1 House            240k Down Payment

Total Cash Flow               $92,150                                                            $61,433                                                             $30,716

By projecting 10 year more we can get a clear picture of when each option is worth it.

We can see that after 10 years of holding the properties after they are paid off we are now in the positive and in the lead for overall cash flow with buying 3 properties with 80k down payment each.

	0	1	2	3	4	5	6	7	8	9
80k	-$402,760.00	-$310,610.00	-$218,460.00	-$126,310.00	-$34,160.00	$57,990.00	$150,140.00	$242,290.00	$334,440.00	$426,590.00
120k	-$146,883.00	-$85,450.00	-$24,017.00	$ 37,416.00	$ 98,849.00	$160,282.00	$221,715.00	$283,148.00	$344,581.00	$406,014.00
240k	$ 52,822.00	$ 83,538.00	$ 114,254.00	$ 144,970.00	$175,686.00	$206,402.00	$237,118.00	$267,834.00	$298,550.00	$329,266.00

So what does this all mean?

For those who are looking to optimize their investment for the long game congratulations you bought 3 houses and held them for 40 years you can now sit back earning over 90k a year from your investment congratulations!

Clearly buying 3 houses will give you the best long term investment however many of encounter problems and difficulties where we may need to liquidate our investments. In this case I would say take a better look at a bigger down payment you may start cash flowing positively right from the start or at the very least it will take you less time to turn around and start making a profit. However that advise my friend received from a real estate agent saying just buy it for 80k and wait for appreciation to catch up my friend would have paid over 100k in expenses till he starting making a dime from positive cash flow obviously he might want to look at working with an investor friendly realtor who would know the ramifications of buying negatively flowing houses.

DISCLAIMER:  Obviously if you can't positively cash flow properties in your market it might be time to look for another market.