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Real estate for starters. How much do I need to invest in real estate? Active investment.

Purchase Price. Downpayment. Reserves.

last update Tuesday, September 13, 2022





Are you thinking of investing money in real estate without any hassle? Paying money for a house might sound a little intimidating if you are new to this. Nowadays, buying real estate and selling it afterward isn’t the only way to invest money in real estate. You can buy a rental property that can help you make decent money if done the right way! Let’s have a realistic look at what will you expect to have in terms of money.

The purchase price of a real estate

If you are aiming to buy a rental property, keep in mind that you are not choosing a house for your own benefit. A good rule of thumb when choosing a property to invest in is staying away from a property at the lowest price. If the property is available at an unbelievably cheap price, the chance is it has problems. If you end up giving a thought about the cheapest property, do run a thorough check and figure out why you are getting a property so cheap.

However, not every cheap property is bad. If you have found an affordable house that needs a few repairs to be done, consider taking it up. And make sure you price realistically the cost of potential repairs.
In most cases is better to own a few small properties than to invest all your money in a big one, diversification. This strategy lowers the market risk and makes it easier for you to sell.

3 tips, purchase price

tip 1.
Buy around the median price

Finding out a median price is fairly easy. Seek help from a realtor or check the list of homes that have been sold recently.

While you go through the price from the least to most expensive, you will find the median price. The medium price that falls on the list is the median price. Set your initial price at 25-50%. Any price point lower than 50% is a no-no as these areas are most labeled as crime zones. Any price point higher than 25% over the median and your mortgage payment would soar high, making your cash flow negative.

note #1: for the residential USA market good tools: Zillow, Trulia
note #2: for the first-time investor an ideal market - a local market, the one where you fill maximum comfort, still may not be the most profitable.


tip 2.
Run an analysis before the contract

Once you have found a suitable property, the next step is to run a real estate analysis. Compare the overall property by finding out similar properties in the area that are sold over the past several months. Once you have identified similar properties, compare their selling prices. This should give you an idea of what should you be paying before you start the negotiation process.


tip 3.
Negotiate

This is not rocket science! Most of the time people forget to negotiate and buy whatever they are charged. It’s always better to negotiate the price as this can increase the chance to get a fair share of price-off from the marked price. Many people fail to reap this benefit because they don’t see a point in negotiating. Now, if you do try to negotiate, make sure you know the fact and statistics. 

Saving the downpayment

In general, the less money you spend on a property, the better. For a mortgage, the more leverage you have the less cash out of pocket is needed and hence you get more cash return. Keep the amount of the payment a little higher per month, but first, make sure that your rental income covers the amount of the mortgage payment (industry standard for each 1$ mortgage payment you have at least 1.2$ of Net Operating Income). 

The 20 cents, the cash flow translates to  Return On Investment (ROI), the downpayment. ROI is important because the sooner you get your investment back, the faster you can buy another property, pay off the mortgage or live off the cash flow. Some conservative investors choose the higher downpayment, which would mean tying up all cash in one house which can be a massive failure if things aren’t going right. Putting money on more than one property is sensible as I have described earlier.
Here is the simplest strategy to save money for a downpayment. And you do it by investing. 
You do it by house hacking. House hacking means getting an owner-occupied loan instead investor loan. House hacking strategy: you are buying a multi-unit property (multi-family house or single-family house where you can rent individual rooms), living in one unit, and renting out the other(s). That way you can save quite a lot of money.

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Repairing and maintenance

And you thought buying the rental property will be the end of your cash requirements? When you buy a property, you need to think about two critical investments: the initial work needed to get the property rentable to the market you target and then ongoing annual maintenance costs.

First things first, you need to factor in a repair budget for items like painting, cabinets, doors, floors, appliances, and other utilities to repair and make the house looks marketable. You don’t need to make the house look brand new, repair the basic but significant things in the house.
Holding cost. You will need to have cash for holding costs on hand which means you have enough cash at hand to pay the mortgage, taxes, and property insurance while you're fixing the property.
Note: be conservative. Most repair projects are miss budgeted by the cost of capital and time.

Secondly, be aware of the ongoing maintenance costs. Things you will need to pay for monthly, seasonally, or annually, like cleaning the gutters, snow, pool, fixing the pipes, etc. It’s always better to keep an amount in your hands to fix them in case you need it in an emergency.

Saving reserves

It is also important to keep in mind the vacancy and other unexpected costs when buying a rental property. If you are going to replace the tenants, you have to pay the mortgage and spend money on (turnover) paint and other items to get the house ready for a new tenant. While you can’t escape every situation it’s better to have a backup plan. Saving some reserves thus will help you in this situation. But keep in mind once you spend your money inside the house, there is no direct way you can get that back, the only option is by collecting cash flow.

How much to invest?

So, let’s calculate a rough amount and break down your first investment.

  • Down payment – House hacking with an FHA loan of 3.5% of the purchase price, or a regular investor loan of 20% of the purchase price.
  • Closing costs – Generally 3.5% of the purchase price.
  • Reserves for financing (hedge the vacancy risk) – 6 months of mortgage payments. 
  • Reserves for maintenance - minimum 10% of the first-year rent.
Example:
House on market = $330k
Purchase price, after negotiation = $300k
Downpayment (investor loan, 20%) = $60,000
Closing cost = 3.5%*$300k= $10,500
Repair on start (case by case) =  $10,000
Reserves for financing (5% interest, loan term 30-yr fixed rate)  = $1,288 monthly * 6 = $7,728
Reserves for maintenance (monthly rent $1,500) = $1,500*12*10% = $1,800

Total = $90,028

Note: the example may not good investment, after operational expenses it doesn't produce a positive cash flow.


Now, that you know the estimation for buying your first real estate, you should be able to add or cut the budget according to your capability.

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