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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{ 43 comments… read them below or add one }
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.
I think buying real estate is a great idea. I have one rental property that provides steady income and I’m about to move out of my house and convert to a 2nd rental property because it will be paid off. My advice would be that if you buy a property and expect the rental income to pay the mortgage, you really need to have a downpayment of >20% to be safe. You have to plan on repairs and some damage between renters (screen them well), which can erode your profit. However, you do have new tax write offs like mileage and repair expenses that can help even out the revenue vs cost.
Another piece of advice would be to purchase raw land in an area where you believe growth will occur. For some states, the government will allow exemptions for trees, animals, farms, etc. that reduce the taxes to a much lower rate. Additionally, raw land will likely increase in value over time and is usually less maintenance than dealing with renters.
My suggestion is to have both rental property and raw acreage to provide a balanced real estate portfolio……safer than the stock market if you’re wise.
Unless that raw land is ripe for commercial/residential development, actively supports agricultural purposes, or is being acquired for later donation for tax purposes to a land bank activity, you may want to think about the holding costs vs timeline for payback of investment.
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..
REITS work well if you want passive income. Real Estate also offers some considerable tax advantages. Between depreciation and tax deductability of mortgage and property taxes, the income you receive may be more than tax free, but be considered a tax loss (You make money, but it shows up as a loss on your taxes offsetting some of your other income). That is how some of the 1% earn millions a year, but pay no taxes. Another way into the market is by buying into a Tenant in Common. You buy a property with a number of other people and institutions. The property is rented, used, whatever for a set period of time determined before the deal takes place. The property is sold at the predetermined time (with some flexibility based on the desier of the “Owners”). Once the property is sold, the procedes are distributed to the investors.
Another way to go is a NNN income property. You buy a commercial property with a tennant in place. They have agreed to rent the place for a number of year (15, 20, 30, whatever) with a rent increase every year, 5 years, or whatever. They assume the expense of property tax, property mainenance, so on. They just send you a check for your rent. They take care of the rest.
You can also do a Land Lease. You own a piece of land and rent it to a business who builds and owns the building. At the end of the term (25 years, or whatever), the land reverts to you with the building on it. They are responsible for anything and everything on the property while they are tennents, you are responsible for the ground under the building. A key benefit here is that once they have a physical presnece, and a lond tradition in a location, they are heavily vested in renewing the lease, and now you own the building.
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.
Never buy a property that you have to maintain (such as residential rental) in an area far from where you live unless you can afford a management company and unless you can afford to pay someone for repairs.
I think this is a wonderful idea. I have been saying this to young friends for the past few years. I watched the real estate boom in Fl very closely and although I am not an economist or real estate expert, I have to say that I predicted the Rise and Fall of the Real Estate Empire. I listened to people who had never dabbled in real estate talk about flipping, and making a killing in pre-construction investing. TRhat was the wrong time. The right time is now. And if the property can become a vacation home, that would be an added plus. So just do it. My first adventure in real estate investing came unexpectedly when I was 25, newly divorced and with a baby. I rented the house and moved in with my parents. Thirty-two years later, here I am…I still own the house and several other properties, and I don’t regret a thing. One word of advice: live beneath your means. Most people cannot do it; but that has been my mantra and it has worked out just fine. Take it from this old timer.
It is a great time to buy real estate. Just make sure that you want to be a landlord. Many people got into trouble with the past bubble and most of them didn’t have the desire to be landlords. Just make sure you have the ability and desire to deal with tenants.
If you can do it I would suck it up and buy now. Some people are still scared and we could see more foreclosures and more downside. But in the long run this should be a great time to buy.
In some areas of the country you can buy property that is cheaper than the cost to build. At some point normal economics will come back in line. People don’t realize what a great time to buy this is.
Great time to buy…you may have to hold onto it for several years. Just make sure that you buy at a good price and you see long term appreciation in the property. You should make out just fine.
If you have got the money then pull the trigger. Just make sure that you plan on sticking it out for the long term. Prices may vary over the short term but in the long run you will be OK.
Great article and discussion. Real Estate is literally on sale across the country now, particularly in CA, AZ and FL. Get educated and learn how to take advantage of this great opportunity.
It is a great time to buy you just have to have the stomach for it. Unfortunately, most people don’t.
I just don’t think many folks can stomach the downturn. If you can then jump into the market.
If you buy that investment home and rent it out, then please save yourself a lot of hassle and engage a real estate management company to manage the rental situation for you. In many areas, the management company will charge you around 8% of the rent as their fee, but they will check out potential tenants, collect the rent, manage the upkeep and repairs, and be the bad guys when someone needs to be evicted. It is well worth the expense.
Time to go shopping.
If you have got any money left after this downturn, now is the time to wade in and gobble up as much real estate as you can get your hands on. Prices will rocket soon.
@Prior Year Tax Returns – Most people have always been broke. I wouldn’t say that it has anything to do with the economy, either. For those of us who have the money though, now is a pretty good time.
My wife and I think that it’s a great time to invest in real estate. We took the plunge. It will be a challenge but it should be fun. Vacancies scare us though. The other thing is bad tenants. We’ve heard stories of properties being destroyed by tenants and big money being lost. I think this is the exception.
I am 26, and I recently decided to buy a property as an investment. Simply because my mortgage is affordable even if I am not able to find renters for a month of two. I fell in love with a house that I wouldn’t mind moving into. Besides liking the house, I love the area it’s in. It is in the heart of the city where everyone wants to move in. I quickly decided to make an offer. Because my mortgage is going to be half of what I can easily rent it out for. Just like everything, it is a risk. But life is about chances. This blog helped me alot because I am reading feedback from some of you and you guys are experienced and know what you are talking about. That’s why I like to listen to the pros and cons.
Everyone keeps mentioning “if you have a bad tenant” It all depends on the quality of the home and how well you screen your applicants. I develop homes in “transitioning” neighborhoods that are close to walkable neighborhoods. I find a lot of young singles or couples who want to live in the neighborhoods, but can’t afford them or don’t want to live in a 1br apt and buy homes just outside those areas. I put just a tab more into the homes then the surrounding area, but make sure I keep the 1% rule. You should be able to generate at least 1% of the home in monthly rent. I’m handy, but hire subcontractors who are licensed and I make sure the home is in tip top shape. I was able to rent out my homes within 1 week, yes 1 week of putting them on the market. Because I made sure the homes are in good condition I haven’t had any 3am calls either.
Lastly, I’ve been able to buy some of the properties for less than replacement value. It’s a great time to buy and I’d buy more if I had more capital.
For families or individuals who have to move alot, buying a house to rent out once you move can be a great call. Like everything, it is a risk. Remember always to live below your means, what ever the bank offers, buy a house at about half that cost. This gives you flexibility for slow months. Also, a rental agency charging you 8% can be a deal, especially if you are going to be far away. Also, it insulates you against your tenants. My wife and I own 4 houses, the last one we are currently living in and the others are all rented. Make sure to keep paying down the mortgages as fast as possible while still having a nest egg for unforeseen issues.
Good luck!
Consider a vacation rental…
My husband and I have wanted to live outside the US for several years, but because his child from his previous marriage lived with us half-time, we needed to stay put. Now that child is off to college, and we have sold our house (in two days after putting it on the market). This summer we found a great apartment in Vancouver that we love, had a massive yard sale, and moved there in September. We are planning to live there half the year, which we can do as visitors/US citizens. We are fortunate in that his job in the States involves traveling and his company mandates that he work from home, wherever that is, when not traveling–they don’t really care; and I am a writer, so I can work from anywhere.
To keep a permanent address in the States, we also bought a fully furnished rental property that is our primary residence when we are there for the other half of the year in November. We found a gorgeous place with everything we wanted for a great price, and our agent saved us even more. And the best part is that it’s at the beach, in a responsibly developed resort community. We plan to rent it by the week in the spring/summer. We have a rental management company to handle most of the work, and it’s totally worth the fee. My husband is a handy guy so we take care of any major maintenance type stuff when we are there in the fall/winter. We have put away some funds to pay the mortgage until summer, when we expect to start renting and hope to save enough during the season to cover the mortgage for the following year. We are also considering renting out our apartment in Vancouver for executive stays while we are wintering.
So there are other options besides buying a house and renting it out to a single tenant for months at a time.
I love buying investment properties and I would think that when the market is in downturn is the time to buy. We have bought 6 properties in the last 10 years besides our own place, and have sold a few on, all at profit. There have been a few bad tenants, but that really only happened when we property managed those houses ourselves. Now we let the estate agents do that, and the threat of the ‘bad tenants register’ here in Australia keeps most tenants on the straight and narrow. The main things to consider in buying a property to let are: worst house in best street, it will cost less but be easily rentable; buy a house in good condition; make sure you can repay the loan if the house is untenanted for a while; buy in a popular spot. What makes a place popular can vary between being close to a large town/city, close to public transport, close to unis/schools, areas that have a good name/reputation. We all know the suburbs that don’t and if you’re not sure of a suburbs quality, check before you leap. If I was able to obtain loans in the US which I believe at the moment (feb 12) are about 0.1% I would be jumping. Our borrowing rates are around 7%+ but rents are also high. Good luck
Just FYI for tax purposes–any gain on the property will be allocated between the time the property was your principal residence, and the time that you owned it but did not use it as your principal residence (ie rented it). Any gain attributed to the period the property was not your principal residence is not eligible for the $250,000/$500,000 exclusion and would be taxable. For example, if you owned the property for 4 years and lived in it for 2, you would only be able to exclude half of the gain.
Tony – I believe I understand your reason for wanting to buy a
multiple type investment property. In your opinion, though, would some of the
same principles that go into a singular rental property be applicable to a
multiple one?… George
I recommend you buy where you may want to retire or a place you visit often. Back in the early 2000s when real estate was booming I borrowed from my primary home and bought a duplex and remodeled it. I’ve had it rented out since 2005 and had great tenants and horrible tenants. Over all I’ve made money. In early 2007 I sold my primary home in Southern California and moved to Colorado. I avoided most of the downturn and the sale paid off my investment property. The duplex is in another state where my mother-in-law lives. Now when we go visit her we can also check on the rental and write off our travel and hotel expenses going to visit Mom. I also no a guy who bought his future retirement home, spent a lot of money to remodel it and rented it out for 10 years prior to retirement. He wrote off all his improvements.
VERY BAD IDEA ! let me explain why?. first off, you need to evaluate rental as a % of investment. If you do this, it will be 2 to 3 % of the property value. & on top of all this, the base value of the house can & will go down. + tentant nuisance issues + legal problems + House maintaince costs + Property tax (i cannot in this world unstd why the hell i should pay so much to buy a house & then pay tax !) + if the house collapses for any reasons, u will be cooling your heels in Jail – LOL !!
You guys realize that this is almost 4 years old, right?
You do realize that the need for real estate is as old as the Earth, itself, and except for the Saudis, nobody is making new real estate.
Before you get too far along this path check out the landlord/tenant laws in the province/state you are considering purchasing a rental property in. If you are in a region where you can’t collect a security deposit forget it. Same if you can’t kick someone out within a short period of time for non-payment of rent. You may never need these hammers, but having them in your tool kit prevents a lot of problems.