Bobby from Fresno, California, has done what many Americans dream of — he’s fully paid off his home. In the three years since, he and his wife have managed to save up $175,000.
Now, Bobby’s thinking of purchasing a $292,000 house as a rental property, and he called into The Ramsey Show to ask whether he should put the full amount down or split it to buy multiple homes.
But instead of answering, host Dave Ramsey offered Bobby a bright red warning.
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“When you talk about rental property, people particularly struggle with one issue,” Ramsey responded in a clip posted Aug. 13. “Debt equals risk. More debt equals more risk.”
Here’s the lesson Ramsey, who owns hundreds of millions of dollars worth of real estate himself, bestowed upon Bobby.
Risks and hidden costs
Ramsey went into further detail about the risks of investing in rental properties.
“More debt equals lower cash flow, less cash position and more risk,” he explained.
Putting everything into one property lowers debt and can simplify management, but even one lengthy vacancy or major repair bill could derail your financial situation. Multiple properties may mean more rental income, but it comes with increased debt and a bigger chance things could go wrong.
“So, when you don’t get a renter for four months, or one doesn’t pay for three months, or you put in a heat and air system that’s $14,000, or you have to put on a roof because it’s leaking, and you’ve got to pay property taxes and insurance … it is an incomplete picture when you don’t consider all the expenses,” Ramsey said.
Bobby could make some of these costs less painful by putting aside funds for expenses. Some experts say investors should expect 50% of gross income to go toward operating costs. This includes property taxes, home insurance, maintenance, repairs and utilities. It should be noted, however, mortgage payments are excluded from this list.
Read more: Do you own rental properties in the US? These 6 hacks can help you boost your income and lower your tax burden
These hidden costs can cut down on cash flow, even after a chunky down payment like the one Bobby can make.
“Real estate is an excellent investment, but it is an investment that requires a cash position,” said Ramsey, who recommended Bobby wait until he could pay for the second home in full.
Co-host George Kamel noted Bobby was already on track to do just that.
“The good news is you saved up $175,000,” Kamel said. “[You’re] $120,000 short of [that] goal. That’s a solvable problem.”
To pay cash or not to pay cash?
Paying for a house all in cash may be ideal, but is it realistic? The price of housing has gone up significantly in recent years, which has made even purchasing a home as a primary residence a difficult prospect. Plus, as Ramsey noted, debt comes with risk. If you’re investing in a rental property it’s best to avoid over-leveraging.
It also helps if you have cash reserves to cover unexpected repairs or vacancies. Buying property dirt cheap can also soften the debt blow.
Ramsey knows the temptation that Bobby is facing firsthand. He leveraged millions in property in his 20s before it blew up in his face.
“I had $4 million worth of real estate by the time I was 26 with a $3 million debt, a $1 million net worth, making $200,000 a year in 1984,” he said. “And that portfolio bankrupted me.”
Now, his advice is simple: “If you’ll go slower, you’ll have a much greater rate of return over the long haul.”
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
