How much do you really need to invest in real estate?
Even if it starts with just a few hundred dollars, it’s never too early to start investing in real estate. From direct ownership to joint venture partnerships, real estate investment trusts, crowdfunding funds, and so on, there are many ways to start investing in real estate.
In this article, we’ll explain why real estate can be an ideal investment for those looking for passive income, how to use someone else’s money (OPM) to maximize your return, and why the answer “How much do you need” invest in real estate? ” It’s a lot less money than you think!
How Leverage Turns a Little Money Into A Lot
With leverage, real estate investors can use a small amount of money to get a bigger return. In real estate investment, the concept has a variety of names, including financing and other people’s money.
When you consider it, real estate is the only asset that can make a minimum down payment, finance the remaining purchase price, own and control assets that generate monthly cash flows and appreciate over time.
Cash-on-cash return
In order to understand the power of leverage, it’s important to know how cash-on-cash return works. Cash-on-cash is a percentage that compares the amount of money you invest in an asset to the amount of money you receive:
- Cash-on-cash return = Annual net cash flow / Total cash investment
Generally speaking, the higher the cash-on-cash return is the more profitable the investment is, because you are receiving more net cash flow compared to the amount of cash invested.
Now, here’s an example of how cash-on-cash return works in the real world of real estate investing. On Roofstock you find a rental property priced at $75,000 that ticks all of the boxes and matches your long-term investment strategy that focuses on cash flow.
You can pay the full cash for your home, or conservatively reduce your funds by 25% and use the rest to leverage your leverage. After the first year of ownership, cash gains in both cases will be shown as follows:
- Option #1: $5,318 Net Cash Flow / $75,000 All Cash Purchase = 7.09% Cash-on-Cash Return
- Option #2: $2,096 Net Cash Flow / $18,750 Down Payment = 11.18% Cash-on-Cash Return
As you can see from the above example, your cash-on-cash return is almost double (11.18% vs. 7.09%) when you use a conservative amount of leverage compared to buying a rental property for all cash.
So so far we’ve been able to buy the first property for less than $20,000. However, another benefit of using conservative leverage is that you can diversify your portfolio by buying a few places instead of one.
The combination of leverage and diversification can significantly increase your total net cash flow.
For example, if you have $60,000 in investment capital available to pay for all cash on a property, use $18,750 to finance a property, or use your $60,000 to invest in three rental properties, but still have cash remaining:
- One property, $60,000 all cash generates $5,318 net cash flow
- One property, $18,750 down payment generates $2,096 net cash flow
- Three properties, $56,250 total down payments generate $6,288 total net cash flows
These cash calculations use net cash flows, which are the difference between the annual rental income received and the funds spent annually on items such as property maintenance and mortgage payments.
The advantage of owning a rental property is that the tenant’s rent can cover your mortgage and all other expenses:
- Property tax
- Property management
- Leasing fees
- HOA fees
- Insurance
- Repairs and maintenance
- CapEx (capital expenditures reserve)
- Mortgage
In other words, by using leverage to invest in real estate, you can:
- Control a large income-producing asset for very little cash
- Use the rent from the tenant to pay for the cost of owning and operating the property
- Have net cash flow left over as profit at the end of each month
However, not every house makes a good rental property. When investing in real estate, it’s important to find property that’s average and affordable.
Why Average Affordable Houses Make the Best Real Estate Investments
Many new investors mistakenly believe that the more expensive, bigger, and unique a property is, the better it is. The fact is that the exact opposite is true. Here’s why:
Cash flow is stronger.
People often make the big mistake of buying rental properties in the same place and with the same quality that they want to personally live in. Places with high-end finishes in the best school districts that are 30 minutes or less from your own home normally don’t make the best rental properties.
That’s because average (and affordable) is better when you buy real estate:
- Average houses generally are affected less during routine downward market cycles and economic recessions
- Affordable average homes make it easy to diversify your investments by owning several rentals in different parts of the country
- Buying property around the median price point for your real estate market ensures you’ll be able to rent to a wider variety of tenants because your fair market rent will be average for the market
- Cash flow is usually stronger and more predictable, while vacancy rates are lower when you invest in average affordable homes
To be fair, one dilemma many investors face is that home prices and the cost of living are high in the market where they live. That’s an obstacle that is very easy to overcome.
Online resources such as the Roofstock marketplace simplify the process of investing long-distance in markets where homes are affordable and yields are double-digit.
At any one time, Roofstock has hundreds of single-family homes available for sale – some even turnkey with a tenant already in place – with asking prices of less than $100,000.
Wrapping Up
Instead of asking how much money you need to invest in real estate, ask a better question: “How much do you want to invest in real estate?” “
For those with only a few hundred dollars to invest, options such as REIT or crowdfunding can be a good option. If you have more money to invest in real estate, using conservative leverage is the ideal way to use a small down payment to directly own and control a rental property in order to generate a stable net cash flow for yourself while using the tenant’s rent to pay all the costs, and still make money on your own.
