First SFH Rental Property Financing Question

[David New]

Hello all,

I have a question regarding my first potential rental property and it cash flowing properly. 

I don't have any hard numbers on a property yet to analyze as we are just now getting to that phase of our research. I'm still educating myself at this point. I would love to hear what others would do if they have bought a property in the past that did not cash flow to what their expectations were.

1. My wife wants to put as little down as possible and then if for some reason the property is not cash flowing positive, then she thinks it's best that we have our extra cash to the side and we can just make up the difference this way. However, everything I have read says this is the quickest way to lose everything by having properties that don't cash flow positive.

2. My view point is to go ahead and put a little extra down since we have the money laying around to make absolutely sure that it does cash flow positive. 

Lets say that we go my wife's route and put down the minimum of what we will be required from the bank. If it is NOT cash flowing positive, does it make more sense to refinance and put more equity into the deal to make it cash flow positive or just leave it like it is and make up the difference from our cash reserves that we didn't put down on the house initially?

I'm sure this is a very dumb question to a lot of people here, but I haven't found answers to this in the podcast and books I have researched. Of course, I plan on taking my time to make sure I analyze the properties throughly, but I'm also being realistic and understand that people do make mistakes their first time or two in doing things and I want to be prepared for every type of scenario. I would love to hear everyones input.

[Guifre Mora]

Originally posted by @David New:

Hello all,

I have a question regarding my first potential rental property and it cash flowing properly. 

I don't have any hard numbers on a property yet to analyze as we are just now getting to that phase of our research. I'm still educating myself at this point. I would love to hear what others would do if they have bought a property in the past that did not cash flow to what their expectations were.

1. My wife wants to put as little down as possible and then if for some reason the property is not cash flowing positive, then she thinks it's best that we have our extra cash to the side and we can just make up the difference this way. However, everything I have read says this is the quickest way to lose everything by having properties that don't cash flow positive.

2. My view point is to go ahead and put a little extra down since we have the money laying around to make absolutely sure that it does cash flow positive. 

Lets say that we go my wife's route and put down the minimum of what we will be required from the bank. If it is NOT cash flowing positive, does it make more sense to refinance and put more equity into the deal to make it cash flow positive or just leave it like it is and make up the difference from our cash reserves that we didn't put down on the house initially?

I'm sure this is a very dumb question to a lot of people here, but I haven't found answers to this in the podcast and books I have researched. Of course, I plan on taking my time to make sure I analyze the properties throughly, but I'm also being realistic and understand that people do make mistakes their first time or two in doing things and I want to be prepared for every type of scenario. I would love to hear everyones input.

I suggest you pick a few properties and play with the numbers to see how they look when you put less money down or more. 

If you want to get into rental property investing, you need to learn how to evaluate whether or not a potential rental property is a good investment. The following two formulas will help.

The Cap Rate.

First, calculate the capitalization rate, or "cap" rate, on your intended investment. This is the profit you can make from net income generated by the property or the rate of return you'd make on a house if you bought it with cash.34

The cap rate is the net income divided by the asset cost. For example:

• You buy a home for $200,000.
• It rents for $1,500 per month.
• Your expenses (taxes, insurance, management, repairs, maintenance) average out to $500 per month. (Remember, this does not include the principal and interest payments on your mortgage, but it does include the escrowed sum for taxes and insurance.)
• Your property's net operating income is $1,000 per month or $12,000 per year.
• Your cap rate is $12,000 / $200,000 = 0.06, or 6%.

Whether 6% makes a good return on your investment is up to you to decide. If you can find higher-quality tenants in a nicer neighborhood, then 6% could be a great return. If you're getting 6% for a shaky neighborhood with lots of risks, then this return might not be worthwhile.

The ONE percent rule.

This is a general rule of thumb that people use when evaluating a rental property. If the gross monthly rent (before expenses) equals at least 1% of the purchase price, they'll look further into the investment. If it doesn't, they'll skip over it.

For example, a $200,000 house—using this rule of thumb—would need to rent for $2,000 per month. If it doesn't, then it doesn't meet the One Percent Rule.

Under this rule, the house brings in gross revenue of 12% of the purchase price each year. After expenses, the property may bring a net revenue of 6% to 8% of the purchase price.

This is generally considered a good return, but, again, it depends on what area of town you're considering. Nicer neighborhoods tend to have lower rental returns, while shakier neighborhoods tend to have higher returns.