I often get asked the question "How do I buy rent houses without having to make a 20% down payment". A few years ago this was very easy. It is still pretty easy but you need to be very careful due to new lending and appraisal guidelines. I have many clients who use different investment models but for those who want to build a profitable rental/ rent to own portfolio and want to get the most bang for their buck I typically recommend what I refer to as the Return On Investment (ROI) Model. Here it is... Please forgive the lengthy post.
ROI Model
This Real Estate Investment model allows you to do more with your available cash versus simply putting 20% down on each purchase. The concept revolves around acquiring severely discounted houses and exploiting this equity position to reduce down payments and total out of pocket expenses thus maximizing return on investment (ROI). Careful property selection, price negotiation and proper financing are key to your success with this strategy. Here are the basic steps in the process:
- 1) Purchase a house at a significant discount with temporary financing (with least possible out-of-pocket, paying cash is not a good option here).
- 2) Perform any necessary repairs (funded through temporary financing).
- 3) Carefully select a quality tenant.
- 4) Rate and Term Refinance rolling in closing fees (your only out of pocket is equal to initial fees upon purchase and carry costs during vacancy period).
- 5) Repeat.
Property selection is extremely important. Focus on stable neighborhoods (careful with new developments and declining neighborhoods) and avoid communities with a higher than usual number of foreclosures. This may cause appraisal issues during the refinance. All properties must be purchased at a significant discount otherwise this method will be a challenge and will require more money out of pocket. And finally, it is important to be sure that properties produce a positive cash flow after the final refinance. A little due diligence goes a long way.
Finance strategy is arguably the most important aspect of the ROI model. A few years ago Cash-Out-Refinances were common and very easy to attain. Those days are gone and this type of loan is a real challenge especially with investment properties (Without 12 Months Of Ownership). Today the ROI investor should focus on a strategy that employs the more available Rate and Term Refinance which allows you to refinance the initial loan balance for better terms without putting money in or taking money out. It is important to put the least possible amount of cash into the initial purchase because you are unlikely to get this money back in a Rate and Term Refinance.
A Typical Example:
- Single Family House
- After Repair Value (ARV) = $100,000
- Necessary Repairs = $10,000
- Projected Rent = $1,050/ month
- Purchase Price = $58,000
- Purchase Price + Repairs = $68,000 (68% of ARV)
- Closing Fees (including Loan Origination Fees) = $3,400
- Initial Out Of Pocket = $3,570 (5% down)
- Initial Loan = $68,000 + $3,400 - $3570 = $67,830
- Initial Loan Payments = $678/month
- 3 Months Of Vacancy = 2,034 (during repair and marketing phase)
- 4 Months Of Occupancy (before refinance) = Breakeven Cash Flow
- Marketing Fees = $1,050
- Refinance In Month 7 = $0 (roll closing fees into loan)
- New Monthly Cash Flow = $318 – Management – Vacancy/Maintenance budget = $80/month
- Total Out Of Pocket = $3,570 + $2,034 + $1,050 = $6,654
- New Loan Amount (After Refinance, Including closing fees) = $70,543
- Initial Equity (after refinance) = $29,457
- Return On Investment 1st Year = (Initial Equity + 1 Year Mortgage Paydown + 1 Year Cash Flow) Total Out Of Pocket = $31,274/$6,654 = 470% Return (plus potential appreciation)
You can see that this model has many more moving parts and unknowns than simply purchasing a turnkey property which is already occupied but if executed correctly, the return on investment can be through the roof. This is a very real model that investors exercise every day however it is important to work with experienced investors in order to implement this strategy successfully.
I hope this helps.
Johnny Burks
jburks@txreipartners.com
