Higher downpayment - helps or hurts for a long turn investment?

Question

First time investor here. We are only getting into this market because we are trying to help a family member, but we would like the plan to help our future too. Original idea - buy a duplex in Sacramento, CA with 25% downpayment (which we have). Elderly grandmother would live in 1/2 for a reduced rent and the rent of the other half would subsidize the payments for aprox. 5-8 years. The idea was just to break even while taking care of my grandma. However, the hope that is through CA real estate, we would be gaining equity with increased home value and when my relative is no longer with us, we would be able to rent both sides and actually make a profit.

Unfortunately, the prices compared to the rents don't quite make the numbers work with this idea, since my grandma has such a low fixed income and can contribute so little. Anytime there is something that fits the bill, it is snapped up in less than 24 hours.

There are not many available, but there are a few small SFH that are a little over 1/2 of the price of the duplex. If we put down the same money we saved for the downpayment, it would be about 50% downpayment instead of 25%. There won't be many where we can get the ratio just right for my grandma, but if prices dip just a little, I think we can find something that works.

However, it occurred to me that as a person who is new to buying an investment property, are there downsides to having a 50% downpayment in terms of taxes, write-offs etc.? I wonder if anyone has some insight into the financial considerations for these 2 scenarios?

Thanks

Dave Spooner · Answer

@Emily Wilson, Charles is spot on with his guidance here. If you invest for cash flow, you'll greatly mitigate the risk of that investment going bad. Tax benefits and appreciation are great, but they should be viewed as icing on the cake. To directly answer your question, putting down more money will impact your tax benefits, but not tremendously. You'll still receive the full benefit of depreciation, you'll just have less to deduct for mortgage interest and points (not a huge deal).

The philosophy behind putting less money down is that you're using someone else's money to acquire an asset. If you have $50,000 down on a $100,000 property, your depreciation benefit is less than if you use that $50,000 to buy a $250,000 asset. Likewise, if your $100,000 asset appreciates at 3% year one, you've gained $3,000 in equity. If your $250,000 asset appreciates at 3%, you've gained $7,500 in equity.

Deciding on how much to put down should be more a question of appetite for risk than it is maximizing return (although of course return matters!). Everything going on with coronavirus is a big reminder that it is not always the best course of action to take on as much leverage as possible. Putting 50% down will result in lower monthly payments and more ability to weather the storm if you're struggling to rent or if prices go down.

Hope this helps!

Gary Pilkington · Answer

I'm a Sacramento County resident and investor with both SFH and Duplexes in the area. The answer is, it depends on your personal needs and goals. In my experience in this area, SFH have always beat the duplexes in appreciation. For more rental income per square foot, its easily the duplex. I would no longer put larger amounts down just to make the numbers work as you lock up too much capital for too long. What people don't think about is rehab costs and maintenance. These costs will usually be higher and more often in duplexes vs SFH. While the duplex does bring in greater income per square foot, there is also more turnaround than with SFH (people stay longer in SFH than in duplexes) and as such, there are more costs (vacancy, cleaning/repairs, marketing etc.) The other thing to consider is where your grandmother would be living in each scenario and if she is comfortable working with the tenant in the other side. For me personally and in my experience, I wish I had more SFH and less duplexes.

Charles Carillo · Answer

@Emily Wilson

I would never purchase a property or edit my investing strategy for tax reasons. I feel that the tax benefits of real estate are benefits that are in addition to why you are really investing. There really is no downside of putting more down on a property except that it decreases your return. I would rather have a decreased return with less leverage though. I would not purchase for appreciation either. This is an investing strategy that only works in certain parts of the market cycle (however if you hold this for 10 years, there will most likley be a great appreciation). In regards to SF verse duplex, I personally always opt for more doors, more income streams and less volatility.

Higher downpayment - helps or hurts for a long turn investment?

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