For many Ventura County residents, the idea of investing in rental properties probably never crosses your mind. You may be thinking that buying a rental property costs a lot of money and that you have to be very well off in order to afford it. So how much money does it actually take to buy a rental property in Ventura County? In today’s post we will attempt to answer that question and maybe give you a couple more tidbits to consider. Hopefully, by the end of the post your eyes will be open to possibilities that you might not have considered in the past.
To begin with, let’s come up with some numbers to use for example purposes. In March 2016, the average sales price of a home in Ventura County was approximately $570,000. In many cases, buying rental properties at this price may not make much sense. For this post, let’s assume a purchase price of $300,000. Although this is significantly lower than the average price, you can definitely find condos, townhomes, and even single family homes for this price in several cities throughout the county.
Using Leverage to buy rental properties
According to Investopedia, Leverage “is the use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.” When it comes to buying rental properties, leverage can come in the form of using bank loans. Different banks will have different requirements, but it is not uncommon to find financial institutions that require a 20% down payment. So instead of paying $300,000 cash for a rental property, you can finance the purchase with only $60,000 out of pocket. Obviously $60,000 is not a small amount of money, but it is definitely much less than $300,000.
Another way to use leverage is through a concept known as house hacking. House hacking involves buying a property in which you will live in while renting out rooms (in the case of a single family residence) or other units (in the case of a multifamily property). Since you will be using the property as a primary residence when you house hack, you could be eligible for obtaining a Federal Housing Administration (FHA) loan that requires only 3.5% down payment. In the case of our $300,000 home in this example, that would equate to a down payment of only $10,500. In the case of multifamily homes, you can buy a property with up to 4 units and qualify for a FHA loan, as long as you live in one of the units. There are many cases where investors start their investing career by house hacking a multifamily home and renting out the other units which then covers the monthly expenses for the whole building. In this case, the tenants are paying your mortgage and you are basically living mortgage free.
The Downside of Using Leverage
While using leverage is a powerful tool, it does not come without risk. One of the major advantages of paying cash for a property is that you do not owe a bank any money and there is no mortgage to pay. The house could sit empty for years and you will not have any banks banging on your door for payment (this does not include property taxes, insurance, etc.). When you use leverage, you are responsible for making a payment each and every month to the financial institution that owns your loan. The bank will not care if your tenants do not pay or if you have unexpected vacancies. They will still expect to receive your payments. Also, if property values decrease for whatever reason, you can find yourself underwater and owing more on the home than it’s worth. This was the same situation that many homeowners found themselves in during the last housing market crash. If you are going to use leverage to purchase a rental property, make sure you understand the risks involved in doing so.
Besides the money needed for the purchase of the property, any responsible investor should have money set aside for reserves. Something will eventually go wrong with your rental and you need to make sure that you have some money in reserves to cover these unexpected expenses. This can be anything from an extended vacancy to replacing a major item such as a roof. I have seen most experienced investors recommend anywhere from 3 months of reserves to 9 months, with the monthly amount being the expenses you have to pay each month. So for example, if your property costs you $2,000 a month in expenses, you should have anywhere from $6000 to $18,000 in reserves.
What does this all mean?
Although we cannot tell you exactly how much you need to invest in a rental property, hopefully this post has shown you that you may not need as much as you think. By using leverage, you can get into a property for much less than the total price to purchase the home. Just as most of us did not pay the full amount on our primary residence, the same method can be used to purchase rentals. Although there are slightly different requirements for obtaining the loan and some extra considerations and risks that you have to take into account, leverage can be a powerful tool for Ventura County residents to use to obtain a rental property.