finance property

How Much Money Do I Need To Buy A Rental Property?

With volatility returning to the stock and bond markets, many investors have turned to hard assets such as real estate as a way to shield themselves from market madness. The temptation is undoubtedly strong.

But if you find that the temptation is more significant than your financial resources, don't give up. There are several ways to get a start in real estate investing without an enormous outlay.

One of the biggest roadblocks to investing in rental properties is the money required to buy a rental property. I believe purchasing rental properties is one of the best investments for increasing wealth and creating passive income. I am relying on my rental properties to give me enough income for retirement as well as offer a luxurious life. However, it is not easy saving money to buy rentals. Although there are ways to buy rentals with less money down, this article will focus on how much money you need to buy a rental the traditional way with a bank. I have purchased 20 rental properties since December 2010, and I see at least 15 percent cash-on-cash returns on them.

Rental properties are a significant investment, but they require a lot of money in most cases. It is simple to figure the cost on a rental property if you are paying cash, but things get more complicated when dealing with financing. Most banks require 20 percent down when buying a rental property and you have to consider carrying costs and repairs as well.

The most significant barrier for first-time real estate investors is simple: money. It's not just finding and obtaining the money needed to buy a property; it also knows how much you'll need. So how much do you need to buy a rental property? It might be less than you think.

Let's break down what you can realistically expect to have on hand, and also show you how to reduce that amount when possible. After that, you can confidently move towards your first investment property with a realistic plan.

So how much money do you need to invest in real estate? And how much does it cost to invest in real estate?

In this article, we'll explain the 4 major expense categories for your first real estate investment so that you can answer the question "how much money do I need to invest in real estate". These categories include:

  • purchase price
  • down payment
  • repairs and maintenance
  • reserves

If you have the option, owning assets that produce income is a better financial strategy than owning assets that generate expenses. Suppose you own a house or apartment for your own residence, for example. In that case, you need to pay for maintenance, repairs, taxes, mortgage interest, landscaping, utilities, or a homeowner association fee that covers some of these expenses. If, however, you own a house or apartment available for renting or lease, you can generate income with the property, and in some cases, end up with positive cash flow after all those expenses are paid for.

Being a landlord is a viable vocation; after all, landlords exist for every rental tenant, and they often thrive financially. Sasha, a former writer for Consumerism Commentary, owns several properties. She shared tips for buying a rental property for prospective landlords based on her own experiences.

Succeeding in the business of rental properties requires a certain set of skills and desires, and making a living isn't always as easy as others would lead you to believe. If you want to earn a living, for example the equivalent of a $50,000 salary, you'll need to profit more than $4,000 per month. That's a lot of pressure. Consider these questions and tips before you decide to get into the rental property business to determine if you have what it takes to be a landlord.

Investing in real estate can make you a lot of money eventually, but saving up for your first rental property is going to take some time. Here's how to start saving.

Investing in real estate can be a great way to increase your income and build wealth.

Investing in real estate can be an excellent way to build wealth over time and create an additional income source, but it is also one of the more capital-heavy types of investments you can make. While you can get started in stock or mutual fund investing with just a few hundred dollars, that simply isn't the case when it comes to buying rental properties.

If you've just entered the real estate game and are looking to buy a rental property, you'll need to save up a decent amount of money first.

Prepare to put down at least 20 percent

If you're going to finance your rental property, consider the fact that you'll probably need to make a down payment of at least 20 percent of the purchase price. Making a 20 percent down payment is not a universal requirement to obtain a rental property, but it is a requirement for many mortgage lenders, and it's a good idea nonetheless.

You want to have some equity in your property right off the bat in order to cover all your bases and increase your potential profit in the future.

Keep in mind that you may also have to pay for additional expenses like closing costs, updates before renting the property, realtor fees, and insurance.

Are You Financially Ready To Invest At All?

Before you even consider buying a rental property, it's important to do a quick financial health checkup. In a nutshell, there are two basic financial things you should do before you become a rental property owner:

  • Pay off high-interest debt: The average credit card's interest rate is more than 17%. It's possible to earn returns in this ballpark on rental real estate, but it isn't exactly common, especially for new investors. The point is that it's silly to invest money in the hopes of earning a 10%–15% annualized return (the most common range), while simultaneously paying a higher rate to borrow money. If you have high-interest credit card debt, you should aim to pay it off or at the very least get a 0% APR balance transfer before you buy a rental property.
  • Establish an emergency fund: What good is an investment if you'll have to sell it if you face any unexpected expenses? Before you start investing in real estate or anything else, it's a good idea to build up a bit of an emergency fund to help you deal with unexpected expenses or financial hardships. Most financial planners suggest that you should aim to keep six months' worth of expenses in an easily accessible place. This is certainly a good goal to aim for, but you don't necessarily need to get there before you start to invest.
  • Mortgage concept by money house from the coins

How Much Can You Afford?

This should be your first question before you even think about how much you could earn. You can use a mortgage calculator to help you determine this, and you should specifically focus on a buy-to-let mortgage and not just an owner-occupied mortgage.

Buy-to-let mortgage lenders look at the potential property as an investment as opposed to whether you can afford to live there and pay the bills. This means you'll need to focus on how expenses for the property will affect cash flow.

Realize that you'll need to be honest with yourself in terms of what you can truly afford. You know what your income is, what savings you have, and how much time you can dedicate to managing and maintaining a rental property.

If you can't afford to start out with a $250,000 property that you'll need to pay property taxes on, don't go that route. Instead, settle with something that fits within your budget.

 

 Do You Have Enough Money To Buy A Rental Property?

Once you've established that you're ready to invest, the next step in rental property affordability is determining whether you have enough money actually to purchase a property. This depends on the cost of the property itself. All other things being equal, it's going to require more capital to buy a $300,000 property than a $100,000 home.

The great thing about buying a house with cash rather than seeking a mortgage is that you can eliminate the expense of the mortgage payments. Every cent of rental income you receive, after maintenance expenses are paid, is profit. That can make the difference between a rental property business that succeeds and one that struggles.

Leveraging your property purchase by using other people's money — a mortgage — can turn out to be profitable when property values increase, but that's not guaranteed. Loans open up the possibility of becoming a landlord to more people, easing the affordability of properties. Having the cash to buy the property outright is not necessary, but if you have the money and are willing to invest in your own business, it will be much easier to generate positive cash flow.

How Much Money Do You Need?

It can be expensive to buy rental properties since most banks require at least 20 percent down. If you are looking to purchase many rental properties as I do, it is tough to avoid putting 20 percent down. Many banks start requiring 25 percent down once you have four mortgages in your name. Most banks will stop lending to you all together once you reach ten financed properties. There are ways to invest more than four and more than ten properties with a portfolio lender. Down payments are not the only factor when determining how much money is needed to buy a rental property.

How much money is required to buy a rental property? That question is a moving target, based upon the condition of the intended property, the state of the economy, the cash flow the property generates, etc. Historically, lenders would generally be content with a 20% down payment on non-owner occupied properties and would therefore make an 80% LTV loan ("Loan to Value"). After the "Great Recession" in 2008, lenders got exceedingly nervous about lending for awhile and dramatically increased their demands.

If you are going to live in your first property, there are still lenders out there who will allow you to move into a duplex or 4-plex, requiring only approximately 5% in downpayment. You do have to intend to live in the property, and you must then live there for some time, but it's not a prison sentence you cannot get out of if your situation changes. We bought our first duplex that way, and 8 months later I got a great new job in another city. Moving out under such circumstances is not fraudulent, and lenders would be very unlikely to come after you in court because they know they would lose.

 

In general, if the income supports the investment lenders are back presently to requiring a 20% down payment. But the best way to buy real estate is to do it without banks!

That brings up the related question in this stream, the one from George Carrington: "How much money SHOULD you put down on a rental house?" First, buying rental houses are an excellent way to get rich slowly with a significant amount of safety, as long as you invest prudently and manage your finances well. But I have always had MUCH better results from my investments in multi-family properties, whether duplexes, 4-plexes, or apartment buildings. Investing in MFR is a safer way and a much faster way to get rich, with the same caveats about investing wisely. And wisdom will dictate how much you should put down!

Closing costs

Depending on house values in your area, a 20 percent down payment can be a lot of money. The houses I buy are usually right around $100,000, which is about $20,000 needed for the down payment. You will also have closing costs when purchasing an investment property, which consists of interest, insurance, recording fees, origination fees, tax certificates, appraisals, and more. It is usually safe to assume closing costs will be at least three percent of the purchase price, but you can ask the seller to pay all or part of your closing costs. I usually ask the seller to pay part of my closing costs to reduce the amount of cash I have into a property. You also may have to pay for an inspection, which can cost $250 to $500 and some sellers such as HUD do not pay for title insurance, which can add another $500 to $1,000.

Unless the seller has agreed to pay for closing costs, you'll need to budget for this as well. Closing costs can vary considerably and can be higher on investment properties than primary homes. For example, property taxes are often higher for investor-owned homes than for owner-occupants, and you'll be expected to prepay a certain amount of your property taxes at closing. Origination fees also tend to be higher on investment property mortgages.

keys handed over in front of double storey home
Handing Over the House Keys in Front of a Beautiful New Home.

Repairs and carrying costs

Repairs can add a considerable chunk to how much money is required to buy a rental property, and you have to wait for the repairs to be completed before it can be rented. While you are waiting for repairs, you are paying to carry costs on that property, which also increases the money needed. You will have to pay interest, utilities, taxes, and insurance until the home is rented. In a perfect world, it should only take a week or two to have a professional contractor complete most repairs, but it usually takes longer.

As for repairs, they usually cost more than you think they will. On a house that needs minimal repairs, I still assume that I will need at least $5,000 in work done before it can be rented. On a house that requires more repairs and updates, I can easily spend $20,000 or more. It is always the little things that take time and add up to big repair costs. As a general rule of thumb, I always add $5,000 for unknown costs on any rental or fix and flip that I buy.

Make sure you get bids if you are not an expert at estimating repairs. Estimating repairs can be a very difficult thing to do, even for experienced investors. Repairs always seem to cost more than the investor thinks they should and contractors always seem to find more things that need to be repaired.

Turnkey rental properties are one way to save money on repairs and put less money into rental properties.

If you buy a rental property that is 100% rent-ready and in overall great shape, you may not have to worry about this, but if you buy a property in need of any rehab, be sure to include this in your budget.

Your inspection report can be a good indicator of the need to budget for repairs, even if the property is in good working order. For example, I recently bought a property where everything was operational. Still, the inspection report revealed the water heater was on its last legs, so I set aside money to replace it shortly after closing.

Total amount needed

Here is a breakdown of the costs that I would generally have on a $100,000 rental property.

Down payment: $20,000

Closing costs: $3,000

Repair costs: $10,000

Carrying costs: $1,000

Total investment: $34,000

 

These figures would be on a home that needs moderate work. I am a real estate agent, which means that if I had purchased this house, I would get back about $3,000 in real estate commissions. I could also ask the seller to pay $3,000 of my closing costs if I thought it would not jeopardize my chances of getting the deal.

Having to put 25 percent down on a property would greatly increase the amount of money needed. Repairs costs will affect how much money you would need as well. Another factor to consider is that the bank will want you to have money in reserves when you get an investment property loan.

The Purchase Price of Your First Real Estate Investment

It goes without saying: the lower a property's price is, the less money you need to buy it.

Yet, people gravitate towards buying rental properties in the same locations and standards they would want to live in personally.

A rental property's job is not:

  • to be close to your work
  • be in your preferred school district
  • have the fancy granite countertops and wood floors you've always wanted

Can You Buy Rentals With Less Money?

There are ways to decrease how much money is required to buy a rental property. You may find a gem that needs no repairs at all, but it is rare to find a home that is a great deal and in good shape. Rental property number ten and rental property number nine were both in decent shape and purchased below market value. You can ask the seller to pay part of your closing costs when making an offer. It is very common for a buyer to ask for two or three percent of closing costs to be paid by the seller. If the seller does not want to budge on price, raise the price of the property to make up for the closing costs. The cash you save up front will make up for the slightly higher loan and purchase amount.

If you are a real estate agent, you can also save a lot of cash on each property you buy. I am a real estate agent, and I keep thousands on each property I believe because I am paid a commission for my side of the transaction. This decreases how much money is required to buy rental property tremendously. Here is a much more detailed article on how becoming a real estate agent will save you money when investing. Here is another article on how much money real estate agents can make.

What about reserves?

If you find yourself looking to invest and have saved just enough to buy and renovate a property, be careful! There are always unexpected costs and delays associated with repairs. Make sure you have a cushion in the bank for the worst-case scenario. I suggest at least six months of mortgage payments, taxes, and insurance as reserves for each property you own. This would be money on top of the initial investment used for repairs and carrying costs.

Summary

While saving up for your first rental property can seem quite challenging, it's not impossible and there are plenty of ways to plan and save. Try to stick within your budget, live frugally, and earn more in order to accelerate the savings process.

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