How Putting a LOWER Down Payment on an Investment Property Can Yield a HIGHER Return

April 13, 2015 Posted by Tyler Cruz

Some or even most of you may already know this and even consider it as common knowledge, but it’s something that I didn’t really realize or consider before. And if I didn’t consider this before, then chances are some of you haven’t either, which is why I’d like to share what I’ve learned with you.

I was e-mailing back and forth with my realtor the other day when he asked me if I had checked if one of the properties I was looking at would benefit from a lower down payment.

This confused me.

After all, wouldn’t a higher down payment always be better since it means that I’m reducing the amount I’m borrowing, and hence the added interest?

After playing around with the numbers myself for 2 hours, I realized that in my real estate market, that 99% of the time it would make sense to put the highest down payment possible, at least in terms of a ROI perspective.

This is because the real estate market here doesn’t have very high cap rates (5% is average), meaning that 99% of income properties for sale here will not have cashflow high enough to the point where the point of balance shifts and it makes sense to put a lower down payment.

So, 1% of the time here, a smaller down payment would actually yield a higher cash-on-cash return (CoCR) than a higher down payment.

HOWEVER, I ran more numbers, and it seemed silly to me because in all the scenarios I ran, the end result would either be to put the HIGHEST down payment possible or the LOWEST down payment possible.

After some thought, I realized that this is because I was missing an important variable: cashflow.

And so, I took the cashflow factor and incorporated all of this by creating a Down Payment Optimizer tool into my Investment Property Analysis Super Spreadsheet in Excel.

My sheet is getting pretty damn advanced if I may say so myself. I’ve spent a lot of time learning VBA and creating and improving my spreadsheet to help me analyze properties and returns.

After countless hours (actually, I did count them but am too embarrassed to say just how long I worked on this here), I finally finished my Down Payment Optimizer tool.

It meets a minimum user-entered cashflow number before it decides what the optimal down payment would be to yield the highest CoCR.

Here’s a screenshot of it in action:

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In the scenario above, I took the 2-House Property as mentioned in my previous blog post and gave it around $500 more in gross revenue in order to show the benefits of this tool (otherwise, it would just give the highest down payment…).

As you can see, it calculated that the optimal down payment (rounded to the nearest $500) to be exactly $67,500.00, which would in turn result in a $501.32 cashflow after all expenses, which is just $1.32 over my requested cashflow, and yields a CoCR of 8.91%.

So, in such a scenario, it would make the most sense to put this exact down payment down, then look for another similar property and grab that as well, as the end cashflow would be higher over time (closing costs being the only negative factor).

Lower Vs. Higher: An Example in Numbers

For example, in the above scenario, let’s say I put down the highest down payment possible: 100%. Paying for it in full, it would have a CoCR of 5.75% and a net cashflow of $1,269.42.

Now, let’s take the optimal down payment as kindly given to us by my little handy new optimizer tool, a down payment of $67,500.00. This yields us a higher CoCR of 8.91%, but a lower cashflow of $501.32.

So, that’s $1,269.42 vs. $501.32 a month. It’s not looking good for the lower down payment right?

Well, that’s not fair, because we put down $265,000 in the first example, but only $67,500 in the second. That means that we could find 3 other similar properties with similar cashflow, and buy them! Okay, so we’re $5,000 short and this doesn’t factor in the added closing costs, but that’s nothing.

So, we have 4 properties now for the same price as paying for 1 in full, each cashflowing at $501.32 a month. That works out to $2,005.28 a month in cashflow, which is $735.86 more than if we had just paid the highest down payment possible.

That’s $15,233.04 vs. $24,063.36 a year. Quite the difference.

Now remember, this is only when I ran the calculation at $500 cashflow a month. Ultimately, you’d have to decide what would be best for your particular situation. For example, maybe such properties are nearly impossible to find, in which case you may want to put a higher down payment on. Or, you may have trouble being approved for 4 separate mortgages.

The point is, that you can really play around with the numbers. There’s a lot of "play" and wiggle room and you can get really innovative with how you work them. Real estate investing is largely about leveraging borrowed money (or so I hear), and so playing with the numbers is a huge part of it.

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Posted: April 13th, 2015 under Income Properties  

6 Responses to “How Putting a LOWER Down Payment on an Investment Property Can Yield a HIGHER Return”

  1. For me, it all depends on the overall market long term in your area.

    If the real estate market is going up then all things being equal, I’d personally put the lowest down-payment possible on each property and buy as many properties as possible. For income properties most banks will want at least 20% down, which means you’re leveraging their money 5:1.

    Using your $265,000 available cash for down-payments example, you could buy approximately $1.3M worth of real estate, with you putting in $265k and the bank the other $1M.

    Assuming you’re able to at least break-even on your monthly property income vs expenses, you’d own $1.3M worth of property… and if the market goes up by let’s say 2% average over a 5 or 10 year period, you’d be gaining approx. $26,000 in equity per year.

    That’s like 10%/year on your original investment/down payment, plus anything you make on rental income profits.

    The only thing that you’d have to watch out for is if you’re in a market that is going down long-term then that 2%/year downswing would hit you on the way down too.

    In that way it’s a gamble. 🙂

    -Paul

  2. WOW…this is what I call a detailed guide. Putting a lower down payment on an investment property is really a very good idea. It indeed yields a very high return in long run. The only thing that you’d have to watch out for is if you’re in a market that is going down long-term then that 2%/year downswing would hit you on the way down too.

    Awesome.

  3. Tom says:

    Great post Taylor!

  4. issac paul says:

    Why still using Windows XP ???

PeerFly

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