There are lots of people in the world who are in the business of teaching people how to get rich by buying real estate without a down payment. Note, that I said they are in the business of “teaching” people to buy real estate, not in the business of “buying” real estate.
The following explanation may help you to understand the risks involved with buying real estate with nothing down.
Teachers in this industry are fond of suggesting that a property bought without a down payment will generate a positive cash flow. While this may happen, it isn’t the norm. Without a down payment, financing costs are likely to be significantly higher than normal, meaning that your interest expense will be high and so will your monthly payment. Add to that the operating costs for the property, including maintenance, taxes, insurance, management fees (if any), homeowners association fees, utilities, etc. The rent, if it is paid on time, will rarely cover all of the costs.
Real estate is often thought to change in value relatively slowly. In fact, it does tend to move with the rate of inflation over the long haul, but in the short run, it moves up and down, sometimes quickly. If you own the real estate outright, those swings in value are appealing. If you own the real estate with a 25 percent down payment, those swings can be exciting. If you own the real estate with no down payment, a downward swing can be shocking. Lose a tenant while the market is down and you could quickly lose the property. If you guaranteed the loan, the difference between the value of the property and the original loan amount could be coming out of your other assets.
When you want to sell the property, you’ll face costs approaching 10 percent of the sales price. That means that the first 10 percent of appreciation in the property (which could easily take three years at 3 percent per year) will leave you with no profit. If you survive the first three years without losing the property, you may hope to see the appreciation accrue to your benefit. Keep in mind, that if you’ve been losing a few hundred dollars every month in cash flow because the property doesn’t cash flow, holding that property for five years to make a small profit on the sale may not result in actually making a profit. A mere $200 per month for 60 months would be $12,000. On a small duplex or a rental home or condo, you may only make $12,000 on the sale after five years. In other words, it could easily take more than five years before you make a profit on your “nothing down” investment.
Real estate can make a great investment. Most people find there is less risk and less work in owning financial assets (stocks and bonds typically owned in mutual funds or ETFs) that don’t have lawns to mow and toilets to unclog. Once your financial situation allows you to comfortably acquire a rental property with an appropriate down payment, you may find real estate to be an excellent investment.