Some property investors regard “no money down” deals as the holy grail of investment opportunities because they offer the potential for unlimited ROI. But the truth about these types of deals is they aren’t always what they seem…
If you’re considering a no money down deal, it’s crucial to clarify exactly what the terms of the deal are to avoid getting yourself into financial trouble. In this article, we’ll explain what a no money down deal is, explore its different interpretations, and discover the potential benefits and risks of this type of investment. Let’s get stuck in!
What is a no money down deal?
The idea behind no money down deals is based on established financial principles, and they generally work in one of two ways:
- The investor doesn’t use any of their own money for the down payment on a property. Instead, they use a mortgage or funds from a joint venture or private lender to cover the initial costs.
- The investor uses their own money to invest in the property but later reclaims these funds after adding value to the property, often by borrowing money to finance the investment. By reclaiming their funds, the investor frees up their capital.
Once there are only borrowed funds in the deal, if the investment is profitable, any positive return on the investment can be considered an unlimited return on investment (ROI).
Still confused? Let’s look at how the calculation works.
Calculating ROI
ROI is calculated by taking the profit over a period (usually a year), dividing by the personal investment, and then multiplying by 100.
With a no money down deal, personal investment becomes zero once the investor has recovered their initial funds. If we plug this zero into our calculation, the ROI becomes, theoretically, unlimited.
An example of a no money down deal
Let’s illustrate how this works with a fictional example.
Sarah wants to purchase a property for £200,000. She does so using a £150,000 mortgage and a £50,000 deposit that she’s saved. She then spends £100,000 of her own money on improvements to increase the property’s value, which means £150,000 of the initial investment has come out of Sarah’s own pocket.
After the renovations, Sarah has the property revalued at £400,000 – great news! This means she can refinance the property at 75% of its new value and her new mortgage is £300,000. Now, Sarah can pay off the original £150,000 mortgage and withdraw the remaining £150,000 to cover the cost of her invested funds.
In this scenario, Sarah has successfully recovered all of the personal funds she invested in the property and the property is now fully financed by borrowed money. Any income made from the property henceforth represents an infinite ROI.
What are the risks associated with no money down deals?
While the benefits of no money down deals are obvious, and the strategy sounds great in theory, it can carry some very real risks. It’s important to be informed about the potential challenges and pitfalls of the strategy before investing. Here are some risks to be aware of:
Increased vulnerability to market fluctuations
High levels of debt expose investors to greater financial risk. If the property market experiences a downturn and the value of the property falls below the amount borrowed, the investor could find themselves in negative equity.
Dependency on investment success
A no money down deal is only successful if the property performs well. If the property fails to generate sufficient rental income, the investor could struggle to cover the mortgage payments, let alone make a profit.
High monthly payments
Because no money down deals involve such a high level of borrowing, monthly repayments can be very high, particularly today when interest rates are inflated. Covering these repayments each month can put a strain on the investor’s cash flow, particularly if the property is not performing as well as expected.
Traditional bank mortgages typically offer lower interest rates, whereas private lenders, joint ventures, and bridging finance options usually come with high interest rates. High interest options can significantly impact the deal’s long-term profitability.
Potential for inflated property valuations
Property end valuations are often overinflated, so it’s important to always do your due diligence. If the property’s real market value is lower than expected, refinancing might not provide enough capital to cover the initial funds invested.
Impact on credit
Borrowing large amounts can also impact an investor’s credit score, affecting their ability to secure future loans.
Over leverage
Properties financed as HMOs are often refinanced at inflated commercial values despite their lower “bricks and mortar” value if sold as family homes. This can create significant exit strategy risks if there is a market shift, legislative change, or drop in demand, potentially leaving investors unable to sell or meet their loan obligations.
While the potential to achieve a very high ROI using a no money down deal is enticing, this outcome is by no means guaranteed.
Can you still find no money down deals today?
While no money down deals used to be a common investment strategy, they are proving to be more elusive in today’s market. Currently, high demand and low supply are driving property prices up. On top of this, the low supply of properties also means that investors are facing more competition from first-time buyers and it can be much harder to secure an affordable deal.
Another factor to consider is that the cost of materials and labour has risen sharply in recent years. This has increased the cost of property renovations, which are crucial for improving a property’s value in a no money down deal, and can lead to lower profits.
Rather than waiting indefinitely for the “perfect” no money down deal before you start investing, it’s important to consider the broader investment landscape. Returns of 5-10% are considered good, and chasing excessively high returns can lead to missed opportunities.
Short-term versus long-term property investment strategies
Short-term property investment strategies, like no money down deals, often require investors to purchase, refurbish and refinance properties quickly. This quick-fire approach aims to free up capital ready for the next deal and lures investors in with promises of quick gains using minimal initial outlay. However, these high-pressure strategies can push investors into high-risk situations. The need to move quickly can lead to hasty and poorly considered decisions such as refinancing properties at artificially high values or overestimating potential rental income and market appreciation.
In comparison, long-term property investment strategies focus on acquiring and retaining properties, allowing them to appreciate in value naturally over time. This method aligns with natural market cycles and helps to protect investors against economic downturns, helping them to build a more robust and stable property portfolio.
Get your tailored investment strategy from Purseglove Property
At Purseglove Property, we know that successful property investment is about more than finding the perfect no money down deal. Our team of property sourcing agents have extensive experience in helping investors structure and negotiate successful property deals. We can help you create a property investment strategy that is not just profitable but sustainable too!
Need help or advice with a property investment deal? Contact us today to get started.