This strategy requires access to seed money, a cash-contributing partner, or a line of credit. You will also need to have a good credit history and score so you can finance the property after you have paid cash.
So you are probably thinking “yeah that sounds like a great idea but how is that possible?”
Let me tell you about a couple of ways I have done this in the past.
The first is to pay cash for a property, knowing that you have negotiated at least a 25% discount. The second is to negotiate a lease option and gain control over the property.
First, let me cover how this would work as a cash buyer (if you don’t have cash a line of credit works the same way).
The example below shows a duplex that was purchased for $43,000 that had $7,000 worth of upgrades added. The property was then rented and brings in $17,520 per year with expenses of $4,850 resulting in a net profit of $12,670 before mortgage payments.
Go through this example a few times to familiarize yourself with the concept of responsible leveraging:
2 Family Rental – Duplex
Renovations & Upgrades
2 Bedroom $730
2 Bedroom $730
Total Income $1,460
Annual x 12 $17,520
Rubbish Removal $500
Total Expenses $4,850
Net Profit $12,670
This property would only have to appraise for $67,000 to qualify for a 75% LTV Mortgage that would cover the cash investment of $50,000.
Cash-flow is a primary driver of value in an investment property. Because cash-flow is so strong, the appraisal for this property might come in as high as $80,000. If the appraisal comes in higher than your costs, you could walk away from this closing with cash in hand. The only time I recommend this strategy is if you are going to use that money to invest your profits in another property.
To summarize: A property with an $80,000 appraisal and a 75% LTV means a $60,000 mortgage. At 5.5 percent interest over 20 years the monthly payments for this property would be $412.73 per month, or $4,952.76 a year. The net income in the example above was $12,670. If we subtract the mortgage, it leaves us with an annual profit of $7,717.24.
Return on Investment is infinity and you walk away from this closing with approximately $10,000.
Even if a conservative appraiser estimated the value of your property at $67,000, you would still be able to cover your initial investment cost of $50,000. The payment per month would be less and your annual profit would be higher.
What I love about this strategy is that can you keep rolling the seed same money over and over again. If you repeated this strategy 10 times in one year the results be exponential:
$50,000 x 12 = $600,000 in mortgages on 12 duplexes
$70,000 x 12 = $840,000 in property value with $240,000 in immediate equity
$7,717.25 x 12 = $92,607 per year
Here is what is important:
The rental income needs to be strong. Strong rental income drives the appraisal value for banks. Invest in areas that are up and coming so the value of your investment increases over time as your property value appreciates.
Here is what you DO NOT WANT TO DO.
Buy cheap properties with strong cash flow, in areas that have little to no chance of holding their value or appreciating. I run into investors quite often who brag about buying a property for $35,000 and then getting a 20-25% cash-on-cash return. The property is often in an undesirable area, worth $20,000 or less, and these “investors” will never be able to sell it for what they bought it for.
I buy inexpensive properties every week. The difference is… I do my research! I research the area, the value of the neighboring homes, recent buying and selling trends and I try to determine if there are renewal efforts in place or emerging. These measures give me a really good feel for whether the value of my investment will increase over time. I do not recommend investing in areas that you have not visited yourself unless you are working with a real estate investment expert you can trust with a great management team in place.
I will use the same example to show you how you can get into a property with as little as $1,000 using a lease option purchase.