Whether I Should Buy an Investment Property in The Current Housing Slump
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With the housing market in one of the biggest slump in decades, I’m contemplating the possibility of buying an investment property. Those who know me will probably think that I’m nuts because I don’t even own a primary residence but let me explain the reasons why I haven’t bought a house in more detail.
Current Living Environment
I just got married in February and moved into a gorgeous apartment. There are lots of free amenities and activities for residences that we truly enjoy. The rent is not cheap but at least it is still affordable and we decided when we moved that it was worth the extra cost. In fact, the apartment turned out better than we originally thought. After we moved here, we were both happier and found ourselves enjoying life much more.
It is impossible for Emma and me to afford buying a house with all these amenities in our current financial situation, so if we buy a property, we will in effect downgrade our quality of life.
The Unused Space
We currently live in a one-bedroom apartment and although you can argue that we can use a second bedroom, the space we have is plenty for the two of us. If we buy a place, we will at least get a 2-bedroom, if not a 3-bedroom condo/house because we don’t plan to move when we have kids.
This means that we will just be paying extra property tax for the unused space until we can grow into the house.
Renting Part of the House
Many homeowners in California rent out unused rooms to help pay the monthly mortgage. I thought about buying a home and doing this too but since I work on my blog so many hours of the day, I don’t want to run the risk of my tenants causing distractions when they are in the house.
Why an Investment Property Seems to Make Sense
Since I convinced myself that buying a house might not suit my circumstances, I thought about buying a smaller piece of property and renting it out. The reasons below seem to make this a sound choice.
We are in a Housing Slump
Most people are much happier buying a house when the market is going up but all we end up doing is overpaying for the properties. I remember hearing stories of bidding wars in California where people were putting in bids of 15-20% over asking price in hopes that they will get the property.
The story is completely different these days. Realtors are begging potential home buyers to look at houses and buyers who are interested are putting in bids as low as 40% below asking price. It is in these markets where a first time home buyer like me can take my time and pick a good location.
Practice Makes Perfect
This investment property will be a smaller and less expensive place than my primary residence down the road. If I can use this time to learn what I like and dislike about houses and sharpen my skills in the home buying process, it will only benefit me down the road.
Long Term Investments
Unlike my primary home where the emphasis will be on livability, the emphasis of an investment property is return on investment. As long as the rent is generating a positive cash flow after expenses, I can ride the highs and lows of the market and still come out ahead.
Alternative Investments
There are so many other options out there for my money like stocks, bonds, CDs, and even investing in businesses. Why am I thinking about real estate?
Real Estate versus Stocks
I currently own some stocks, but it is almost a part time job keeping up with them. I want to get into a more passive approach and something that will generate an income for me. If I buy any individual stock, I run the risk of it never recovering. If I buy the index fund, I don’t get the income.
Another major benefit is that I won’t check my property performance like I would my stocks. This will keep me from being emotional when the market tanks so I can focus on my other day-to-day operations (like writing on my blog).
Real Estate versus Bonds or CDs
Since this is a long term investment, I need something that gives me a higher rate of return. Bonds and CDs are great for safety but the return on investment when my time horizon is taken into account is unsatisfactory.
Real Estate versus Investing in Businesses
This is an interesting alternative but I will definitely want to be involved with the business if I ever invest in one. This is the total opposite of passive!
Real Estate versus All
It is a nice feeling to own a piece of real estate since it is an asset that you can actually see. Furthermore, there are amazing tax incentives in the United States for owning real estate. I believe the specific rule is tax free capital gain for the first $500,000 as long as you have been living in it for 2 out of the last 5 years. So if we are lucky enough to pocket some gains on this property, all we have to do is move there for 2 years and then sell it.
What Do You Think?
Even though in theory this all make sense, it does not mean that it’s necessarily practical. Does anyone agree with what I’ve said or can anyone think of something that I’m not seeing? As a next step, I will start looking at the closing and renting prices of various properties to see if I can generate a positive cash flow. I will keep you updated and I look forward to hearing your thoughts!
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Friday Linkstuff - lots and lots and lots o’ links! on August 8th, 2008 at 2:04 am Says:
[...] Money Ning has too much money on his hands and wanted some input as to whether he should buy an investment property. [...]
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Weekly Roundup: Guess where I’m going this weekend at Clever Dude Personal Finance & Money on August 8th, 2008 at 7:04 pm Says:
[...] Money Ning wonders whether he should buy investment real estate in this housing slump, as does Blunt Money. We’ve considered buying some rental property in my hometown, but we [...]
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The Financial Blogger | Financial Ramblings on August 9th, 2008 at 4:32 am Says:
[...] Ning is wondering if he should buy an investment property considering the market in the US. I would buy one for sure if I had [...]
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Carnival of Financial Learning #11 | Financial Learn on August 10th, 2008 at 11:33 am Says:
[...] presents Whether I Should Buy an Investment Property in The Current Housing Slump posted at Money Ning, saying, “Is now the time to buy investment [...]
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Don’t Overpay for a House, Even in Today’s Market on August 13th, 2008 at 8:55 am Says:
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One key item when considering something like this is would you be able to cover the property expenses without a tenant in the property? We rent out 3 rooms of our home and have experienced times where it has been 2 months trying to find a tenant for one of the rooms. We spread our risk out by having the 3 renters, so at any one time we have no more than 1 room normally unused.
One option you might consider is a two-flat, which allows you the privacy of not sharing your home with someone else, but you’ll be able to keep an eye on your property easier.
Some friends and I are in the same position. We feel like this is an excellent time to enter the housing market, but it’s definitely a hard decision to make if you weren’t planning on buying a house right now. It’s a great opportunity we’d love to take advantage of, but we’re also young, and aren’t sure if we’ll want to live in this city forever. Tough call. Sounds like you guys have a great situation going on where you currently are, though.
It’s worth looking into.
Two reasons I’m not interested in real estate investing for myself:
1) it can be a lot of work - finding the place, getting renters, problems with the house etc.
2) lack of diversification - even a cheap house is a huge chunk of most portfolios.
Mike
The thing is - before you invest in real estate ask yourself why you want to do it and what you want to get from it. If you’re investing and don’t plan on selling right away, now might be the perfect time to do it. If, however, you don’t want to carry an inventory of properties and you’re living in an area hit by the economy, now probably isn’t the best time to invest.
Sam
Fix My Personal Finance
http://fixmypersonalfinance.com/
It could be a great time to buy in many markets right now, and real estate can prove a solid investment. Just don’t forget the worst part about being a landlord- you’re a landlord. When you have good tenants in place, an investment property can be a dream- however, if your tenants aren’t great, it can be a terrible nightmare, and dealing with a bad tenant can wipe out any gains you may have made. Unless you contract out your responsibilities to a property management company (which reduces your earnings), renting a property is anything but passive.
If you’re handy at fixing things yourself and can deal with collecting rent on time and dealing with trouble tenants, go for it. If not, one of the other options you suggest might be better suited.
The thing that turns me off about rental real estate is the lack of diversification as well as the amount of work involved in maintaining the place. I don’t know how to deal with this.
I don’t believe that rental real estate is a passive income generation approach at all for those reasons.
I own real estate investment trusts ( REITS). That way there’s someone else unplugging the toilets and changing roofs. I only collect my dividends monthly or quarterly.
In addition to that most reits own a variety of properties - apartments, office buildings, restaurants, stores, malls across the US.
One advantage of rental properties that I see is leverage. If you can buy a property where the monthly mortgage payment is $400/month and yet you manage to rent it out for $800/month, you can do pretty well. Of course if the property becomes a money pit and you spend $1000/month to maintain the premises, then you could be in a bad situation..
1. It’s a good time to buy. (my opinion)Buy a minimum of 2 bedrooms, 3 or more is better as it allows more folks to be able to rent it, and you to move in more easily when the time comes. Buy something you ‘could’ live in, should the need arise. It’s your backup plan for hard times.
Eviction for non-payment of rent can take awhile if you have to go thru legal proceedings.
2. Be very careful with the tenant background check. Once a meth lab moves in, you’ve totally lost your investment.
3. Buy in the best neighborhood you can afford, but not the best house in the neighborhood. Most important features (I feel) are that the foundation is solid, the electrical is up to code, the septic tank and drainfield are adequate (if applicable), and that the roof doesn’t need replaced soon. Most everything else will be cosmetic and less cash outlay to repair.
4. Be a handyman - especially be able to paint and do minor plumbing/carpentry. Or have a good relationship with your service providers for those things.
5. The property should have a positive cash flow, plus put something into your pocket or extra for paying down the mortgage. Make sure you can cover ALL the expenses if the place is not rented for 6 months
6. Once the property is paid for, try carrying the land sales contract when you sell it. I’m carrying an old contract now for 11% interest…better than I could be making most other places. And as I sold it to my renters of many years, the payments have been most regular.
7. A duplex or triplex is great - more income plus if one unit is not rented, at least something will be coming in.
8. Limit or ban inside pets. You’ll never know the full “JOY” (major sarcasm there) of being a landlord until you have to scoop a foot of dog/cat feces out of a basement… Yuck!
There’s nothing passive about this type of income - but it can be a great money maker, especially once the properties are paid for. And then when the sell time comes, I usually sold on a land sales contract for better than average interest. I am still carrying one property at 11% interest - over 20 years now - that’s a very good return on my money
and that’s passive 
Do your research, and if you’re comfortable with it, go for it
From: Been there, done that - Many times
I’ve been tempted into purchasing an investment property as well here in the UK with prices currently so cheap in some areas.
However I’ve decided it’s just too much hard work. Plus the fact that you can get much better returns from shares in my opinion.
Property prices generally double every 7 years on average, but there’s some fantastic companies out there, particularly miners and oil companies that have fallen a lot in the last few months, that could well double in price a lot quicker than 7 years.
If you’re okay with buying an investment property, you’ll also be simultaneously building and investing in a business, which was one of your other goals. If you incorporate and purchase other properties, hire employees, etc., you now have a true business with a value that exceeds simply what the basic assets are worth.
It’s not a good time to buy yet if you’re a beginner. Valuations are still going down, so you’ll be buying into a dropping market.
This is not a decision you should make quickly. You’re not hurting right now, so take six months or a year and do some serious research. Then when (or if) you decide to go for it you’ll be able to make a much better purchase.
Like any risky investment or deal where you have little experience, just be prepared to lose your shirt
As others have said, if you can afford the payments without any tenants, that’s a good start.
If you’re financially strapped with an apartment, buying real estate isn’t the place to put what money you have. You have to be able to pay the mortgage on the rental plus do all the maintenance and repairs and have enough cash to cover expenses if you don’t have a tenant.
If you have a bad tenant, you may have someone living in your house and not paying the rent while you have to go through eviction proceedings, and trashing the property to boot.
Real estate isn’t an investment unless you know what you’re doing, and it doesn’t sound like you do yet.
I recommend building a cash reserve (emergency fund) of 3-6 months of expenses in a money market account. Pay off any debt you currently have, then start saving cash for the purchase of your primary residence (20% down, 15 year fix-rate mortgage that doesn’t take up more than 25% of your take-home pay).
Then invest for retirement. After retirement is fully funded, invest for kids’ college, pay off the house early if you can, and then build wealth after you have no big payments.
You’ll also need to have cash savings for buying cars and other things. Debt is a huge risk. So be very careful whenever you look at an investment that costs you money up front. If you had a paid off house, would you get a mortgage on it to invest in other properties? I hope not.
Good luck and may I suggest a growth or value stock mutual fund that isn’t an index fund? Small and mid cap funds do much better than the overall stock market.
Sherri
As someone who owns rental properties, you need to make sure the numbers work out, accurately accounting for vacant periods (I use 10%), and that there are often expenses such as plumbing, showers, etc that sometimes come up each month. Make sure you have enough in the bank to cover at least 4-6 months of mortgage payments for the property should it become vacant for an extended period of time.
Buy where you can cashflow. Properties in AZ and NV are starting to look attractive now.
One of the most important points is to find good tenants. Don’t skim and think that you rather fill the property and pick a not so good tenant. Bad tenants can cause a lot of sleepless nights.