This is the actual basement door of my first property. – Not a very interesting door, but I like it.
A number of years ago I remember looking around at my cubical walls and thinking, “this is certainly not going to be the best long term solution”. I knew, from the moment I had my first job as a kid, that there was a lot of money out there and I needed to get a hold of it. As most young people do, I started working harder and trying to get higher paying positions. But, I soon realized that as one makes money and gets older, expenses will also increase. I needed another way to generate income. The best financial decision I ever made was buying a Multifamily property.
I bought the building with about $25,000 in the bank total. Now, while some might argue that this is not wise, I was (and am) young and more than willing to take risks. As one of my mentors put it “you have almost nothing to lose”. I could “afford” to buy the building with such a small amount only through the existence of the FHA loan program.
The FHA (Federal Housing Administration) program insures loans to encourage banks to lend to potential borrowers with smaller amounts cash and lower credit scores. Here’s the kicker, the program will allow buyers to finance properties with up to 4 units. That means that joe down the street, with semi okay credit, a little money and a willingness to work can become a landlord and real estate investor.
Here is what I did: I paid 3.5% down on a $250,000 building and rolled the closing costs into the loan. This translated to about $9,000 cash out. That allowed me to get in the game and get experience / start building equity early in life. There are a whole bunch of requirements that are ever changing, but lets look at all of the important ones:
- Most banks will require that the borrower has at least 6 months reserves for expenses. In my case, I needed about $12,000 in the bank after I had written the check for the downpayment.
- A Credit score of around 650 or higher is necessary.
- Having 12 continuous months of credit history is sought after by most banks. This essentially means having paid back money on some sort of credit line for at least 12 months.
- The lenders also want to see that the amount they are lending is not too high. That means they will generally look for a debt to income ratio of no more than 36%. That varies, and there is some flexibility, but the bank won’t lend much beyond that. So an income that is high enough to pay the mortgage is necessary. But, and this is very important, almost every bank out there will consider 75% of the rental income as regular income providing there are leases already in place. That means that if the building grosses $30,000 / year in rental income, you can claim $22,500 as future income. That will substantially increase the chances that you will be able to get the loan.
- Gifts are permissible providing there is proper paperwork done. If you have someone willing to give you the money for the down payment (or unofficially loan it to you and call it a gift) this is an option.
- Finally, being employed full time for 2 years in the same company or a similar company is usually required. Personally, I had only been at my job 1 year when I bought the property, but I was able to say that my work at a health food store was close enough to my work at an engineering firm (obviously it wasn’t, but most mortgage brokers will do whatever it takes to make the loan happen).
The building has been the most profitable investment I have made to date. I recommend it to anyone willing to shoulder the burden of taking care of tenants needs and maintaining a property. It can be done, and it actually isn’t that difficult to accomplish initially. The above bullet points are a good place to start in getting qualified for the purchase.
I will post more about how I have been able to keep it 100% occupied without a single day of lost rent, how I collect rent effectively, among other things in future posts. I will also go into detail and post actually yearly returns (both in cash flow and equity) over the last four years to demonstrate the potential profitability of a multifamily. In sum for this post, let me say that in four years, it has generated an average annual profit of $12,000. Once again, that is $12,000 per year on a $9,000 initial investment.