Before we get into the six different methods for purchasing your first investment property, I have noticed that there is one differentiating factor that separates those who invest in real estate and those who are constantly learning to invest in real estate. Finding other people who are already investing in real estate and learning from them, and then going out and making offers on properties.
These Six Methods will help you to get you into your first investment property.
1 – Save to Invest – Use the 10 – 20 – 70 Rule (Future/Past/Present)
This will take you the longest in order to implement and is also the most conservative approach. This methodology is one that I recommend those who are looking for some direction when they need to get their finances in order or who already have a problem with bad debt. (Often I will refer people in poor financial shape to do this, before I will consider them for a coaching program. )
This strategy originates from something I learned from David Chilton, in his book “The Wealthy Barber“. Where you take a percentage of your income to save it automatically towards the future. I have modified this a bit and also take a percentage to focus on paying down past debt, and the rest you use for the present.
10% – Save for future – this goes into an investment account which you will use for the down payment your first investment property.
20% – Past Debt – this goes to pay down your existing debt. This whole amount is used for your debt each month you will see that there are maybe some debt that you will be paying down a little extra each month.
70% – Present – this is what he is live off of for your present lifestyle.
Let’s use the example of a family that earns $16,000 a month after taxes. $1600 a month would go towards savings. $3200 a month would go towards past debt. $11,200 a month would go towards present expenses.
The next step is a variation of using the snowball strategy for paying off debt. So that more and more debt gets paid off over time. Take your total debt for each loan and divide it by your monthly payment. You will get a score. Organize your debt depending on the amount of debt score that you get, from lowest to highest.
|Score||Type of Debt|
|25||Credit Card |
(4% Min Payment)
|88.7||Car Loan |
(8 year loan)
(4% Min Payment)
|3%||$1682|| 400,000 ||237.8||Mortgage |
(Fixed 5 year/ 30 Yr am)
After you pay the minimum payment, use the extra amount that you have for your past debt towards the lowest score. In our example, $2208.44 is past debts and $3200 is what is set aside for them each month, leaving $991.56 to be paid extra towards the past debt. First towards credit card, store credit, then the student loan and so on, most likely leaving the car and mortgage loan in place.
2. Cash In Underperforming Investments
Many investors are unhappy with the returns that they have been getting from the stock market. They turned to real estate in order to get the returns that they need in order to fulfill goals such as creating income streams in order to replace the income that they were getting from their job, or being able to enjoy a better lifesyle.
I recently was reviewing a chart with research done by Dalbar, an
independent expert for the financial community, that shared the average equity fund investor made a 3.88% return annually on their investments over the last 20 years. Annual returns on the S&P 500 for the last 20 years was 5.62%.
The next method would be shifting investments away from lower yield stock and bond investments to higher yield real estate investments, by selling the lower yield investments. Now you should always talk to your accountant and advisor if there are taxes or fees involved. For example, if you were to purchase a single cash flow positive duplex ($400 month cash flow) in Oshawa with 20% down, with just your cash flow and mortgage paydown your annual return would be around 10%, and appreciation and that becomes over 20% annually.
3. Secured Line of Credit
This next method is one that is used by those who already have purchased a property as their principal residence. If they have owned the property long enough they would have gained equity over that period of time.
I will often suggest that they utilize the equity gain by adding a secured line of credit against their principal residence. The can often release up to 80% of the equity of the proeprty depending on the fincnail insitution that they are with.
As long as they use the secured line of credit only to invest in the rental property or investments the interest on the secured line of credit interest becomes tax deductible. Make sure to talk to your accountant around how that works.
4. Gifts from Family
This is a method that requires a family that his support of of your real estate goals. As parents or relatives start to get older want to be able to pass on some of their wealth to the next generation and may want to be able to see them enjoy the benefits. In other cases, a relative that already invests in real estate may want to encourage other family members to do so gifting them a down payment for their investment property.
5. Unsecured Lines of Credit or Other Debt
this method is one that requires you to meet with a number of financial institutions in order to acquire lines of credit that you can use for the purposes of investing in real estate. Although it is more likely for them to give you the line of credit spend on vacations doing home renovations, it is still quite handy to have available and if the numbers make sense use for your investment property purchase.
It is much easier to obtain unsecured lines of credit before you start investing in real estate then after you have purchased a few rental properties. Usually once you have access to these lines of credit, as long as you continue to use it responsibly, and perhaps carry a small balance you’ll be able to continue to use these lines of credit.
you always need to be careful to keep in mind the interest that is being paid on this line of credit as an expense towards your overall cash flow on the rental property. The objective would be eventually refinance your property and use the funds to pay back this line of credit. If you are using this strategy like the buy fix refinance and rent strategy outlined in the book the ultimate wealth strategy using a line of credit works particularly well.
6. Joint Venture Partner(s)
Finally the last method is to come together with others who are interested in investing in real estate and forming a co-venture. It is like a little business where each person who joins the partnership would bring various strengths to the partnership. I have seen a number of friends and family come together to purchase an investment proeprty, as well as new investors work with experienced investors.
Usually partnerships falls along the lines of finding the deal, financing the deal, and funding the deal. Typically you have active partners and passive partners that make up a co-venture. It is important to understand the seriousness of who you are partnering with, as this can be amazing or a very painful process.
The active partners manage day-to-day functions of the property and the passive partners provide financing and funding support to the deal.
For example, on my last partnership my co-venture partner brought the funds for the purchase, and the seller of the apartment building provided the first mortgage financing. Through my team, I actively manage the day to day operations of the building and the strategy around repositioning the asset to refinance it in a few years. I am always seeking the right partners (Click here to contact me if you think we might be the right fit) who fill my need of downpayment funds and financing, and I bring the deal and real estate expertise.
Which ever method that you choose to use to get started investing in real estate, take some time to learn, and build your team, but don’t get stuck in analysis paralysis. It is better to move forward to purchase your first property and make mistakes, than never have invested at all.
Quentin D’Souza is the Chief Education Officer of the Durham Real Estate Investor Club. Author of The Property Management Toolbox: A How-To Guide for Ontario Real Estate Investors and Landlords and The Ultimate Wealth Strategy: Your Complete Guide to Buying, Fixing, Refinancing, and Renting Real Estate.