If you’re not local to the Cleveland area, or you’ve never invested in real estate before, there is a pretty decent chance you have the notion that it would take far greater than $20,000 in savings to become a first-time real estate investor in 2019. This is particularly true if you’re from a pricey state like California or Washington. The purpose of this post is to dispel that myth, and to show you how someone can turn $20,000 (or potentially even less) into a cash-flowing rental property this year!
The Power of Leverage
First off, I will say right up front that in the current market, $20K will not get you into any sort of cash deal that is suitable for a newbie investor. Though there are plenty of residential properties still selling for less than $20,000 in markets like Cleveland, Detroit, Philadelphia, and Indianapolis, these are typically risky properties that require a more seasoned investor. If you’re going to pay 10 or 20 grand for a house in 2019, expect it to be in an overwhelmingly rough area, need a ton of rehab work, or (most likely) both.
With mortgage interest rates within spitting distance of their all-time lows, now is a great time to utilize leverage (i.e. mortgage financing) to acquire rental real estate. With a 20% down payment, you will likely be able to acquire a 1-4 family property using what is called a conventional mortgage and land yourself a fixed rate of about 5% (+/-) for a 30-year term, assuming you have decent credit, you’re not already in debt up to your eyeballs (your overall “debt to income” ratio will be assessed), and you have stable income history (typically 2+ years at a regular W2 job will suffice). Some lenders do offer loans to investors with even less down, but that will require private mortgage insurance (PMI) and I don’t recommend spreading yourself quite that thin.
The interest rates you can expect on an investment property mortgage will be a bit higher than on an owner-occupied property. Typically .5% to 1% will be added to the interest rate, but other than that increase, a conventional mortgage on a non-owner occupied property will effectively be very similar to one on an owner-occupied property.
With a financed property purchase, in addition to the down payment it will be necessary to have a few thousand dollars to cover closing costs, about six months of reserves (meaning enough additional savings to cover the cash outlays associated with the property), and enough funds to cover any necessary updates/repairs prior to renting the house (assuming it is not already rented).
Let’s work backwards to see what you can afford with $20K of savings. If we assume you’ll put down a $14,000 down payment, allocate about $3,000 for closing costs, and keep $3,000 as reserves, the math says you can buy a house for about $70,000. And great news! There are plenty of houses in good condition, effectively rent-ready (and possibly already rented) in C grade (or even better) parts of the Cleveland area!
Understanding the Cleveland Market
Despite the fact that the market was never particularly over-valued relative to incomes levels or rental rates, Cleveland-area real estate values were hit extremely hard in the aftermath of the mortgage crisis and the Great Recession a decade ago. It all happened in an astonishingly short span of time, in some cases just a year or two. houses that had been selling for $100,000 or more in 2006 or 2007 were suddenly selling for just $25,000 or even less in 2008 or 2009. It was particularly pronounced on the lower end of the market, but really almost everypart of the Cleveland area took a hit at least to some extent.
After sinking to nominal price levels last seen in the 1970s or even earlier, the property value decline hit its floor by about 2010-2012, and then remained at these low levels for a number of years. Because the market was so flooded with REOs (bank-owned
foreclosures) and short sales, distressed property pricing became the new norm.
Finally, in about 2014 and 2015, values started to stabilize and increase across the board. The market abnormality, of houses in solid B or C grade middle-income areas selling with a 3.00 or less gross rent multiplier (or “GRM”, meaning the ratio of total cost to acquire a property to its gross scheduled annual rent), was finally noticed en masse, and investors and owner-occupants finally started to come back into the market in sizable numbers.
Fast-forward to 2019, and the values have increased even further. But fortunately for potential present-day buyers, the price level is still below the previous peak in the vast majority of areas. That means that solid investment properties that in 2006 would have sold for $100,000 or more can still be purchased for $75,000 or less in many cases.
Cleveland neighborhoods such as North Collinwood and Old Brooklyn are great places for newbie investors to snag a deal on a property that can still be acquired for less than $100,000 and easily financed with conventional financing. The same holds true for several Cleveland area suburbs, such as Garfield Heights, Maple Heights, Euclid, Warrensville Heights, and potentially some parts of Parma. These are generally B and C grade areas where there is strong rental demand, thus presenting a situation for investors that offers a manageable level of risk and still offers the potential of a strong return, both in terms of cash flow and price appreciation as prices revert to their pre-crash levels.
Formulating an Action Plan
To turn your $20,000 of savings into a solid real estate investment in the Cleveland area in 2019, it’s important to set up an action plan with the specific steps you should take to make it happen. Neither the mortgage interest rates nor the property values are likely to be quite as low as they are now a few years down the road, so now is the time to set up that action plan and put it into motion.
The first step is to fully familiarize yourself with the Cleveland market and get a sense of the properties currently listed on the market using a site like Redfin or Zillow. A great resource to help you get started in your understanding of the different areas is the Area Guide here on Cleveland Investor Primer. You should also try using Google Maps Street View, which allows you to enter almost any address and see what the street scene looks like out front. Additionally, check out the rental listings on Craigslist and Zillow to get an accurate picture of what the rental market looks like in each area.
The second step is to get pre-approved with a lender. A 15-minute google search using terms like “investment property mortgage” will likely yield a nice list of potential lenders to contact. Call and email a bunch of them right off the bat. Don’t agree to a credit inquiry until you get a feel for the lender, and don’t be afraid to ask them specific questions about the process along the way. Once you find a lender that you feel comfortable working with, have them take you through their pre-approval process. This will involve a credit inquiry, and may involve you providing some minor documentation, such as your past few paystubs and bank account statements.
The third step is to devise a plan for how to handle property management. If you are local to the Cleveland area, self-management is an option to consider. If you’re not local, however, this will be the time to start talking to property managers to determine who is the best fit. A great spot to start on this step is the Property Management guide in the Cleveland Investor Primer Toolkit.
The fourth and final step is to work with a real estate agent to actually start checking out properties in your area(s) of interest! Once you are pre-approved, you’ll receive a letter from the lender, it will be easy to get an agent to work with you, even if you are not local.
Prior to getting pre-approval, it could be a bit tough to get much attention from agents and brokers, as you’re less likely to be perceived as a legitimate buyer, especially if you are not living in the Cleveland area. The best way to find an investor-friendly agent once you are pre-approved and have identified your preliminary targets is to start following the forums on BiggerPockets.com or check out the Cleveland Investor Primer Investor-Friendly Agent List.
It’s entirely possible to start investing this year, even as a complete newbie, if you’ve got a decent stockpile of cash. It just takes action and dedication — once you take these steps you will be well on your way to becoming a legitimate real estate investor!