Some of the perks of investing in real estate are capital preservation, cash flow, property appreciation, tax benefits—all words that are music to an investor’s ears. But how much money to start investing is actually needed to make a minimum investment?
Unfortunately, no one will (or can) give a definitive answer. Usually, experts and investors will say is that it depends. So how can a person build their portfolio? Where do they even start? Well, it depends.
The first question a newbie should ask
Ask yourself this: “Do I want to create some passive income, or do I want to become a full-time investor?” It is important to learn as much as possible about real estate to figure out which purchases to prepare for and what is a realistic minimum investment. Keep in mind that a substantial amount of time is needed for investors to learn the ropes.
Oftentimes, it’s recommended to hire a coach knowledgeable in real estate or to find a mentor. This way, these experts can guide newbies through the process, including building a portfolio, limiting risk tolerance, putting together an emergency fund, and most importantly, figuring out how much money is needed for real estate investing.
Another recommendation from experts is for beginners to dedicate at least an hour to learn the business. They should wake up 30 minutes early, spend half of their lunch hour consuming content, and read a book before they hit the sack. Everyone has at least one hour per day to dedicate toward their future. It does not matter what type of content it is, as long as it imparts real estate knowledge.
There are many to choose from, such as books, podcasts, audiobooks, or even YouTube videos for visual learners. The key is to continuously access information about real estate to keep motivated and engaged. And, of course, join websites such as BiggerPockets to engage with professionals.
Why padding your savings is critical
While it’s true that people can get started in real estate for no money down, one of the best recommendations is to have at least $50,000 saved up. Not that $50,000 is needed to buy that first property (it may be far less), but more importantly, it provides a shored-up financial foundation and starts from a position of strength.
Think of this as having a financial moat. This financial moat generally consists of saving up a minimum of three months of personal expenses (having six to 12 months of expenses is better) and any deductibles in cash. This emergency fund can help navigate a job interruption, broken-down car, health crisis, or help buy time to figure out the next steps financially when life throws a curveball (like a pandemic!).
Are you ready to invest?
One of the most frequently asked questions in the BiggerPockets forums is “How can I start investing in real estate with no money and bad credit?” The answer? You shouldn’t. You need to fix your situation and invest from a position of financial strength.
Preparing financially to buy an investment property
Now that there is a financial moat in place, it is time to figure out how much money is needed for a minimum investment. In most cases, to buy a property, these are the bare minimums to consider:
- Down payment: This can vary widely depending on the investment strategy, market, and lending strategy. If the investor is using an FHA loan for a house hack, this may be 3%–5% of the purchase price. If they use conventional or commercial financing, this may be 20%–25% or more of the purchase price.
- Closing costs: This too can vary widely depending on the investment and lending strategy.
- Reserves: This can vary from lender to lender, with most lenders post-COVID-19 wanting to see six to 12 months of expenses in cash or escrow. Some lenders request the insurance deductible be set aside as well.
- Rehab vs. rent-ready: The make-ready expenses on a property can vary widely, from simply changing the locks to a full gut rehab. In either case, make sure to have the full rehab/rent-ready scope estimate locked in prior to closing on a deal, and add a contingency to this budget to account for surprises.
- Lease-up expenses: Unless the property is turnkey with a tenant already in place, investors should be ready to add in lease-up costs anywhere from 25%–100% of the first month’s rent.
- Vacancy expenses: Be certain to factor in, at a minimum, one month of vacancy costs in underwriting—if not more—for the next year or two. (Average vacancy rate is around 8%, but be sure to calculate the vacancy rate for your area, too.) The property will be vacant at some point—it’s just a matter of when.
- CapEx/maintenance reserves: It’s not uncommon for a new investor to “fudge the numbers” on their first property and not set aside adequate CapEx (capital expenditures) and maintenance reserves initially. Many stories go like this: An investor closes on a property, and the water heater that’s supposed to have five years of life breaks down suddenly. As the new owner, they will have to replace and repair items. A water heater costs the same whether it’s a $60,000 home or a $200,000 home.
These seemingly small amounts of money needed to close a property and get it to profitability can add up quickly.
How to get started investing in real estate
So, how can you start navigating this process, figure out how much money to start investing is needed, build your “financial moat,” and build capital for your first investment? Here are a few steps to take:
- Pay down any consumer debt that will negatively impact your debt-to-income ratio (DTI) and prevent you from getting decent lending. Look to reduce these payments first:
- Credit cards
- Personal loans
- Car loans
- Set aside an emergency fund of at least three months of personal expenses plus any deductibles for health, car, a retirement plan or individual retirement account (IRA), and home insurance. Bonus points if there is wriggle room for six to 12 months. If some of the debt is paid down, you can now snowball your previous payments to build personal reserves.
- Investors should consider their Roth account as a double-duty IRA since they can liquidate it penalty-free for most emergency needs. Moreover, they can leverage their employer payroll deductions and potential match to build this IRA quickly.
- Have a minimum of three months of reserves set aside and begin to determine your investment goals, investment strategy, and market. This will help inform what you will need for other expenses.
- Talk to various lenders for a recommendation to determine lending needs for minimums, purchases, down payment, and reserves.
- Talk to local property management to lessen risk management and understand what fees to expect for your property expenses.
More on personal finance from BiggerPockets
Use leverage to your advantage
Leverage is a financial term that means applying a small amount of force to achieve far greater results. With real estate, leverage usually comes in the form of a loan. Although such a loan could come from several different sources, the practice is quite similar. The real estate investor supplies a small down payment, a lender provides the remaining balance of the property’s purchase price, and the investor pays that lender small amounts of money each month until the loan is paid off.
For example, an investor might consider a $100,000 property but get a bank to lend 80% of the purchase price. The bank would supply $80,000 via a loan, and the investor would need to come up with just the $20,000 down payment (plus closing costs).
Leverage, of course, can be both a blessing and a curse. The more leverage is used, the greater the risk the investor may be taking. For example, if they paid 100% cash for a property, they would not have a loan payment due each month, so a three-month vacancy on the property would not hurt as much. Or if they bought a house with just 5% down, and the value of that property dropped by 20%, they would then be “underwater” on their loan, meaning that they’d owe more money on the house than it is worth. This, in turn, limits future options and can make selling, refinancing, or doing pretty much anything else with the property difficult.
Ways to increase security when using leverage
First, the down payment is not as important as the deal the investor gets. If they purchase a house for $100,000 and put 30% down (thus obtaining a $70,000 loan) and another investor buys a house for $70,000 with zero percent down (thus obtaining a $70,000 loan), who is at more risk?
We can argue that the investor that puts down 30% is at greater risk because they have more cash invested, even if the loan amounts are identical. The second investor leveraged their creativity in place of a down payment since they did not put anything down.
Secondly, when investing in rental properties, knowledge can help decrease the risk of leverage. The better an investor understands the market, their investment, and how to manage that investment, the lower risk they have of something going wrong.
For example, if an investor does the math correctly before buying an investment property and knows that they need to account for the property sitting empty for a portion of the year. That vacancy, when it occurs, will not sting. It is just part of the business. Their knowledge helped secure the investment against the things that will inevitably go wrong.
There is no cut-and-dry answer for how much money is needed to get started in investing. It very much depends on the situation. By taking stock of your financial foundation and building your “financial moat” properly, first-time investors can start from a position of strength. That way, you will be well-poised to navigate the wonderful world of real estate and begin to build your portfolio.