When getting started in real estate investing, knowing the difference between good vs. bad debt is crucial. More tips for real estate beginners.
Q: I enjoy Ilyce’s radio show very much. Thank you for what you do.
I’m a new investor in my late 20s seeking to build a portfolio of rental properties for the purpose of both positive cash flow and general wealth creation. With the help of your book, 100 Questions Every First-Time Home Buyer Should Ask, I recently purchased my first investment property and now I’m hooked!
I hear a lot of different opinions about leveraging debt verses building equity in real estate. My basic understanding is to maximize debt when it’s an income producing asset and minimize debt when it’s not. Is this correct or are there other factors I should consider?
Also, I want to build my portfolio in a quick, but responsible way. Would you recommend that I reach a specific equity threshold in a rental property before to pursuing the next deal? Is there more information you provide that I can tap into?
A: When looking at debt versus equity, we’ve always chosen to get the biggest mortgage possible on our investment properties, so that we can write off the expense of interest against the income the property generates. So, we purchased an investment condo with an interest-only loan and put 20 percent down plus paid another chunk for upgrades (we bought it off of the blueprints nearly a decade ago). We had an adjustable rate mortgage on that property and have managed to stay cash positive for most of our ownership.
Today, it’s tough to purchase investment property with less than 25 to 35 percent in cash. But, it can happen depending on the deal and what you’re buying. A friend recently purchased three commercial office buildings that were in a distant suburb from downtown Atlanta. But they happened to be close to where he lives and he was looking to move his office space closer to home. He and his partner bought the properties which were 30 percent leased, hired a new leasing agent who found new tenants, and moved their offices into the buildings. The property is now nearly 60 percent leased and is profitable.
When you’re just starting to invest in real estate, it’s difficult to get lenders to cut you special deals. Once you own four residential properties (including one that you live in), you may find it difficult to get financing through a Freddie Mac or Fannie Mae loan. Building a portfolio of rental properties (or other types of investment properties) means making connections with several commercial lenders who can guide you on what kind of equity they’ll require in order to provide financing.
Some lenders will require that you put down 35 percent in cash for deals 2, 3 and 4, but by the time you own a half dozen properties, particularly if they each have a significant number of units, you may be able to refinance all of the properties together with a single loan.
Keep in mind that the amount of debt you carry on your investment properties must be repaid. You need to consider the rental income you have for your properties, how stable they are, your federal income tax situation, and other details relating to the number of properties you wish to buy in the future in making your decision about how much debt to carry on your properties. Given this information, you can also sit down with a lender and he or she can walk you through the different scenarios that could affect your decision on how many properties to own and how much debt to carry.
The best piece of advice we can give you is to not try to do this all on your own. Build a group of trusted advisors who can help you create the real estate investment portfolio. If you take the right steps, and continue to make this a central goal of your life, you’ll undoubtedly get where you want to go.
We’re glad you found Ilyce’s book be helpful. She recently completed an 18-part webinar+ebook series called: “The Intentional Investor: How to be wildly successful in real estate” which you can find at ThinkGlinkStore.com.