Investment Properties Part II
Ok, so down payment is the biggest challenge most face to buying rental properties. 15% down on a $200k single family house is only $30k, much more reasonable then $75k down on a 4 plex. But aside from down payment, another challenge people face when doing this is the structure. Like I said before, rumors are that we’ll soon accept smaller down payments. But is that wise? Cash flow is one of the challenges many landlords face.
Many tax returns come to me with rental properties on them showing a net loss each year. Why is this? It’s simple. They have more expenses than they have income. Solution? Lower your expenses and raise your income (rents). If you put less than 15% down, there’s a reasonable chance that your expenses will remain too high. Once your expenses exceed your income, you now have a liability. You know, a debt. A tap on your budget. Some can handle this is stride, but I’d like to point out that it’s not always sustainable. And since this is a LONG term strategy for making money down the road, be careful on this step. Remember, if the property can make money every month, even after all expenses, even if it’s only $50/mo, it’s infinitely sustainable. And we like that when we lend you the money for it.
For the purpose of qualifying, we’re very conservative. We assume 25% of the gross rents are lost in expenses including repairs and vacancies. Most investors I know do not actually experience that much loss. But if you also followed such a plan, and calculated your cash flow based on that expense it would look like this: 75% of rents less mortgage equals cash flow. So if you collected $2000/mo in rent. You’d remove 25% of that. That’s $1500 left over. If your mortgage was $1400/mo including taxes and insurances, then you’d be cash flow positive $100/mo. Make sense? Positive cash flow means it’s sustainable despite any mess you might have going on in your own personal life. Again, this is assuming 25% for expenses. That would be $500/mo and $6000/year in the example above. You see how this could cover almost any expense you could have?
In conclusion to this part 2, the two biggest struggles I believe investors face is saving for a down payment and next, creating the right cash flow positive situation.
Next post I’ll discuss reserves and include some FAQs.