Summary: People often ask us about how much money they need to have to start investing in real estate. We find that question difficult to answer directly, because how much money an investor needs is directly related to the approach that person takes towards investing.
There is a massive difference between what an investor can build with no money down versus $400,000 down when using traditional financing. There’s a massive difference between how much money an investor needs if he/she is focusing on the BRRRR strategy vs turnkey rentals. And there is a massive difference between buying for appreciation and buying cashflowing properties.
This is all to say, that much of how much you need down to invest comes down to you. In this two-part series, we look at six different case studies modeled out over five years to help you decide what type of investor you want to be. Given the size of these scenarios, we split this post into a two-part series. You can read part one here.
Before we get started with the numbers….
We mentioned this in part one, too, but in case you’re jumping in at part two of this blog series, here are a couple of things to keep in mind, which apply to all of the scenarios shared in this post.
One, all of these case studies are based on buying in a relatively cheap cost of living area.
If you live in California or Hawaii and are determined to invest locally and buy $600,000 duplexes, it’s going to take you a much much longer time to get to financial freedom (or you’re going to have to save up $150,000+ a year for down payments).
Second, all of these case studies are based on you buying cashflowing rentals. These are rental properties that put money in your pocket after expenses each and every month.
If you buy properties that do not cashflow, and you bank on market appreciation only, you are taking a risky path and will either crash and burn or get lucky. Because we do not believe in gambling on your future, all the case studies below assume that you buy properties with a base return of 10% cash-on-cash (cashflow made on the cash you invest).
Third, every case study has either you or your spouse achieving real estate professional tax status at some point. This is because the tax benefits of achieving this status are so phenomenal that they will lead to exponential growth.
If you are single, when you’ve built your portfolio up enough, achieving REPS will pay for you to cut back to half time just in tax savings. You will just have to do the math each year to determine when cutting back at work is justified (if you even want to do it in the first place!).
Fourth, you must put all of the cashflow you earn from real estate investing early on back into more property. It is imperative to exponential growth. Otherwise, you will not achieve Fast FIRE in a timely manner.
Finally, keep in mind there are lots and lots of ways to make money in real estate. These scenarios are just a few very basic ones. You may even choose an approach that is more blended and combines these different scenarios. Ultimately you will have to find the approach that works for yourself and your family.
Case Study #3: The BRRRR approach
With $50,000 saved to spend each year on real estate, all cashflow is reinvested
In brief, when you BRRRR a property, you buy a property that needs work, do the rehab, then rent it, get a bank to then give you a loan on it’s new value and then pull out your money and do it again. You keep that original property as a rental. Here’s a rough theoretical example.
Year 1:
You take your $47,000 of your $50,000 and buy a single-family house at $47,000. You get a short-term hard money loan for $20,000, which you use to rehab the property. You then rent it out at $1,100 a month and have a local bank appraise it (it comes out to $100,000). You pull out $70,000 and have $30,000 in equity.
You use your extra $3,000 saved to pay off the hard money lender fees as well as pay off the original loan from them for $20,000. You come out of the deal in two months with your $50,000 intact. You are also earning $3,000 per year on this house in cashflow.
Now, you do this same process three more times in the first year.
You still have your original $50,000. You now have four houses, generating $12,000 per year in cashflow (but you’ve probably earned closer to $6,000 this first year in cashflow since you rehabbed your properties and then started earning cashflow on them right away). Your renters are also paying down $4,400 a year in mortgages for you.
My guess is you probably have the hours to gain real estate professional status. But let’s put that off until year two for the sake of this model.
Year 2:
Year two, you add in your second $50,000. In this case, let’s say you are able to rehab eight houses since you have this extra $50,000 down.
You now have $24,000 in cashflow and 12 houses.
You’re claiming real estate professional tax status this year. So, you start writing part of the rehab costs off. Let’s say 50% is an immediate loss (capitalized) and the other 50% is depreciated. So, you get $40,000 in losses from your rehabs a year, bringing you in $10,000 in tax savings.
If you cost segregation and apply bonus depreciation to your 12 houses. Since you bought them at only $50,000 a piece ($600,000 total), that means you collect about $150,000 in losses, sheltering $37,500 in taxes on top of the $10,000 we already mentioned.
You now have holdings worth $1.2 million. Your renters are paying down $9,000 in mortgages per year.
Year 3:
Year three gets crazy if you keep up the same pace (16 houses!), plus you come in with an extra $47,500 in tax savings, your $50,000 down and $24,000 in cashflow from the previous year.
If you are able to do 16 houses, you’re near $50,000 in cashflow, not taking into account all the money you already have for more down payments. Your holdings are worth $2.8 million.
For the sake of keeping things relatively brief, I’m not going to write out years three, four or five, but you can imagine how it goes.
About now, some of you may be wondering, “How realistic is it to be BRRRRing 15+ houses a year?” If you (or your spouse) doesn’t have another job, it is actually quite possible.
We’ve met people doing over 60 houses a year, for example.
But it is a full-time job and it does take a good team and close oversight. So, this scenario isn’t suited for most physicians. But I do include it so you can see how achieving financial freedom is possible in a few short years if you or your spouse is focused and willing to do significant work.
Case Study #4: Higher Down Payment
Start with $200,000 down with $50,000 saved to spend each year on real estate, all cashflow is reinvested
In this scenario, you start out with more money to work with. Maybe you get this from getting a HELOC on your primary residence. Maybe you take it out of the stock market. Maybe you tap into your 401K. Maybe you just have this in savings.
In this case, you want to use your $200,000 the first year towards getting the maximum number of units possible. You do this in order to achieve real estate professional tax status as fast as possible.
You can approach your purchases two ways.
One is to stay with small multi-family properties (4-plex and below) and put down 25% on your loans. The second way is to get one large property with a commercial loan and put down more like 30%. For the sake of simplicity and to do something different from above, we’ll stick with one large property.
Year 1:
In this case, you buy a $670,000 14-plex. Yes, these deals do exist. If in doubt, check out properties in major cities in the Midwest.
Because you have so many units and you meet the time requirements, the first year you achieve real estate professional tax status.
Your tax write off for cost segregation and bonus depreciation is approximately $167,000, which shelters $42,000 in taxes. Your cashflow with 10% cash-on-cash is $20,000. Your renters are paying down $7,500 a year in your mortgage.
Year 2:
The second year you take your $50,000 in additional money and put it together with your $20,000 in cashflow and your $42,000 in tax savings to put down $112,000 on a $448,000 fourplex (back to conventional financing with 25% down).
Cost segregation and bonus depreciation yields you another $112,000 write off ($28,000 in tax savings in the 25% bracket).
Your cashflow increases to $31,000 per year, assuming 10% cash-on-cash. You add another $5400 in mortgage repayment a year from your renters (bringing your total to near $13,000).
Year 3:
Year three, you combine your $31,000 in cashflow with your $28,000 in tax savings and your $50,000 saved investment to put down another $109,000 down payment on another $436,000 fourplex.
Cost segregation and bonus depreciation gives you a $109,000 write-off ($27,000 savings) and you gain $10,000 in cashflow to bring you up to $41,000 per year. Your renters are paying off near $19,000 a year in mortgages.
The value of your property holdings are $1.55 million and you’re three years in. Plus we haven’t taken into account rental appreciation, market appreciation and you haven’t forced any appreciation (which is the fastest way to grow your money).
You get the picture, so we’ll skip over year four and five.
Case Study #5: Highest Amount to Start $400,000 to spend
With $50,000 additional savings per year, all proceeds back into real estate
This scenario is not dramatically different in substance from the $200,000 one above. But I’ve decided to include it here to show you how tapping into a significant amount of money up front will get you to financial freedom quickly, even without doing things like rehabbing and creating forced appreciation.
Some of you might be wondering, “How could anyone even have $400,000 to invest in real estate in the first place?”
Certainly, that amount is a stretch for most people. However, there are a couple of ways that we’ve seen fellow physicians and high-income professionals come up with significant money for investment down payments.
First, we’ve seen a lot of people take HELOCs on their primary residences. If your house has appreciated since you’ve purchased it, this could be a good option for you.
Second, people sometimes sell other assets to get the money. We, for example, liquidated our $401Ks to get a down payment in 2019.
Third, some people choose NOT to buy primary residences or to sell the one they currently own and rent instead (I bet there’s a significant down payment just sitting on your primary residence right now, not making you any money). We’ve chosen that option as well.
Now some of you are going to balk at the idea of selling your primary residence, liquidating a 401K or taking out a HELOC on your home. And, that’s ok. It may not be the right fit for you.
But, if FAST FIRE is for you, at least check out the scenarios below. Because one important thing they show you is that if you take a big leap in the beginning, you will grow your wealth much faster over time because of compounding.
As a result, you will be financially free much sooner than you can even imagine.
Because this model is not greatly different in substance from the case study above, we’ll just cover it briefly.
Year 1:
$400,000 down payment buys you a 1.3 million dollar property. You get REPS. Cost segregation write off $325,000. $81,000 tax savings. Cashflow $40,000. Renters pay off your mortgage $14,500 per year.
Year 2:
$50,000 invested + $81,000 tax savings + $40,000 cashflow = $170,000 down. Buy $680,000 worth of property, do cost segregation studies resulting in $170,000 tax shelter ($42,000 tax savings). Cashflow $57,000
Year 3:
$50,000 invested + $42,000 tax savings + $57,000 cashflow = $149,000 down. $596,000 of properties. Cost segregation $149,000 loss. Tax savings $37,000. Cashflow $72,000
Year 4:
$50,000 + $37,000 tax savings + $72,000 cashflow = $159,000 down. $636,000 worth of properties. Cost segregation shelter $159,000. Tax savings $40,000. Cashflow $88,000.
Year 5:
$50,000 + $40,000 tax savings + $88,000 cashflow = $178,000 down. $712,000 of properties. Cost segregation $178,000 shelter. Tax savings $45,000. Cashflow $106,000.
You now have a $4 million size rental portfolio. And you haven’t even traded up any properties.
This is not even taking into account rental appreciation, market appreciation or forced appreciation. As you saw previously, you can more than double this return if you rehab your properties and then get your lazy equity mobilized, working for you.
Case Study #6: Forced Appreciation
With $200,000 to start and $50,000 saved to spend each year on real estate, all cashflow is reinvested
The final scenario we are going to cover is my favorite. That’s because it involves forcing appreciation, which I believe is the most powerful way to reliably grow your money quickly (as compared to market appreciation, which is anything but reliable).
As an investor, you frequently force appreciation when you put money into rehabbing your properties, resulting in increased rents and increased income. But you can also force appreciation by putting minimal money and effort in. This can happen when you buy something with under-market rents, and just increase rents and get new tenants.
It can also happen when you add other money makers such as storage units, laundry facilities or paid parking. You can also force appreciation by decreasing expenses such as by billing back utilities to a tenant or having a renter take over landscaping his/her section of the yard.
Because rental property values are based on the income they generate, if you increase the cashflow of a property by either increasing rents or decreasing expenses, your property will be worth significantly more, allowing you to then get it reappraised and to do a cash-out-refinance. In this scenario, you can then go and buy more properties sooner. You can also just simply sell the property using a 1031 exchange and roll it into a new property, tax-deferred.
When you see this model involving forced appreciation, some of you are not going to believe it. That’s because the amount of money you can make doing rehabs, especially once you have real estate professional tax status, is incredible.
This is where huge steps up in wealth are made.
Keep in mind that the returns I am using in this model are based on actual returns that we have regularly had on our properties that we have remodeled.
Let me say it again, forcing appreciation is where the real money is made.
Year 1:
You start by putting in $150,000 to buy a $500,000 10-plex. Now, you’re going to do some serious rehab to this property this year, so you’re still going to have no trouble reaching your real estate professional status hours.
So, you take the rest of your seed money, $50,000, and put it into rehabbing your 10-plex.
Because you have REPS, let’s say you can write off (capitalize) 50% of this as repairs immediately and depreciate the other 50% over the next several years. The 50% immediate write-off creates an $25,000 paper loss (saving you $6,000 on taxes year two).
You also do a cost segregation study and take bonus depreciation on your 10-plex, yielding you a $125,000 tax write off ($31,000 in savings for year two).
But what happens to your cashflow?
When you first put $150,000 for the property, you bought at 10% cash-on-cash, so you expected $15,000 in cashflow a year. However, because you put in $50,000 in rehab, you increased your rents significantly.
Each unit cashflows an additional $100 per month ($12,000 per year). So you are making $27,000 total cashflow.
Now, there are a few expenses that have gone up as a result of your rents increasing. The big one is your property management costs, since property management collects a percentage of the rents each month in fees. But, for the ease of this model, let’s ignore this one for now.
Your property is now worth a lot more too (because the sales price and appraisal value of your property is based on your net operating income!).
Assuming a 6 cap, your property has now gained $200,000 in value due to your rehab, so you have a $700,000 portfolio. Your renters are paying down $5,500 of your mortgage. And your cashflow is $27,000.
As you can see, rehabbing properties results in exponential growth. Not only do you get a multiplier of the amount of money you put into a rehab project, you also get additional tax savings. This means that the government effectively pays for a large chunk of your rehab.
This is why I say forced appreciation is where you make your money.
For the sake of brevity (yes, I know this post is >12 pages long), let’s stop here and not tackle years 2-5.
So how much money do you need to start investing in real estate?
My hope is that this article illustrates why there’s no easy answer on how much money you need to start investing in real estate.
You can start with minimal money and do a series of BRRRRs or secure seller-financing or house-hack and grow your real estate portfolio quickly with some sweat equity.
Or you can start with $400,000 down and traditional financing and grow really quickly with minimal effort.
Or you can start with a little money and force appreciation and grow exponentially.
Either way, when you add in a little time and compounding, your real estate portfolio has the potential to expand substantially over the years.
If you’d like to learn more about how we’ve grown our personal portfolio, check out our article on Fast FIRE here.
Want to share how you grew your real estate portfolio? Join our FB groups!
For part one of this two-part blog, click here.
