How Much Should a Rental Property Cost Me?

I recently had a coaching call with a newer investor. The investor is looking for their first property, has their financing lined up and had some great questions. They are seeing just how hot the market is in the city they are looking to buy in. Like in many markets, you are competing with other investors as well as end-user buyers.

I gave them kudos for being able to ask the questions they did. These included topics such as investing goals, financing, renovations, tenants, etc.

One question that we discussed was, “How much should I expect to leave in a deal?” In other words, the investor is asking how much is reasonable to be “out of pocket” to own a rental property.

If you are buying a turn-key rental property, the formula is simple. Your out of pocket costs will include your 20% down payment (unless you plan on living in one of the units, then this is 5% or 10%), plus closing costs (roughly 1% of the purchase price).

If you plan on renovating the property and adding value with new units or updating existing units and refinancing after, then the formula is a bit different: cash outflows (20% down payment, closing costs, reno costs) + cash inflows (refinance cheque from the bank).

Let’s say you buy a $400k house and you spend $80k on a down payment, $4k on closing costs, and $50k on the reno. At this point you are $134k out of pocket, with a mortgage of $320k. Then, let’s assume that the bank reappraises your house at $500k post-reno, allowing you to refinance up to 80% of that value or $400k. You refinance and get a cheque for $80k from the bank. At this point, you are only leaving $54k in the deal.

The question of how much any investor is willing to leave in a deal is based 100% on their financial goals.

If you have $100k of available capital and are focused on cash flow, you may be okay leaving that amount in the deal to find a property that provides the $1,000 or $1,500 in cash flow per month.

If you cannot afford to leave any money in the deal, you may look for a perfect BRRR (easy to google, not easy to accomplish) in order to recycle out 100% of your down payment, closing costs and reno capital after the refinance.

If you are not a fan of renovations and prefer a turn-key investment, you will have to be okay leaving in 20% of the purchase price plus closing costs and waiting for a period down the line to potentially refinance some of that money back out.

There is no perfect answer to how much money should be left in a deal. There are investors that will not purchase a property unless they believe they can get all of their money back and “own the property for free” after the refinance. Other investors have no issue buying a $800,000 property, putting $160k down plus closing costs and just setting and forgetting about the property. The majority of investors fall somewhere in between these two extremes.

My goal is to maximize the ROI of each dollar that my partners and I put into any deal. The less money you leave in the deal, the higher your ROI is for that property. In a perfect BRRR, ROI is infinite because you have pulled all of your cash out and still own a cash-flowing asset. When you leave a significant amount in the deal, you are typically hoping that you have a really strong monthly cash-flow to make up the majority of your ROI calculation. Remember, return on investment (ROI) is the total of your cash flow, mortgage pay-down and appreciation, divided by the money invested (left in the deal).

Your task: go out there and don’t buy a rental unless your pro-forma tells you it will be a perfect BRRR. (That’s a joke).

Instead, go out there and find a nice cash-flowing asset that increases your net worth each month.