| It is a long-standing belief that if you purchase one rental property each year for the next ten years, you will be set for life. Buy more and live in high style. That is true only if you know what you are doing and if you are working with professionals who can get the job done. Dean Graziosi different thinkers, the Robert Allen challenged, or John Beck wannabes may need to pull their heads out of the clouds ... or other places!
Fully 5% of all mortgages approved in 2001 were for the purchase of investment properties. In 2004, investment properties accounted for 8.5% of all mortgages approved. During the first half of 2005 that volume rose to 10% -- according to data that tracks 46 million mortgages. However, recent investor activity is likely to be understated, since owner-occupied multi-unit rental properties are not included in these data.
The National Association of Realtors (NAR) revealed data suggesting that during the first quater of 2005, 23% of homes purchased were for investment, while another 13% were second homes or vacation properties. This analysis is broader in scope than other recent studies, since it also includes cash-driven and equity-financed purchases. This revelation has all lenders tightening their underwriting guidelines to limit their exposure to inexperienced first-time investors and those hell-bent on rapid acquisition. Take it from a lender who routinely secures funding for investment properties ... namely me! 2006 update: 100% financing is still available for staunch investor-types who have a minimum of SIX months PITI reserves on properties that cashflow ... TWELVE months PITI reserves may be required when the property does NOT cashflow. Stocks, bonds, IRAs, and 401(k)s may be used to qualify. Clearly, the era of cashless investment purchases is behind us.
On a more optimistic note, the NAR reports the second-highest level of sales on record in May of 2005. This comes in the wake of Dr. Greenspan's gloomy observations regarding "froth" in some local markets. The only froth conspicuously evident at the moment is likely to be that which reposes in Greenscam's mocha latte.
The NAR suggests that Baby Boomers (that'd include me) -- flush with spectacular gains from their primary residences -- are extracting equity from their homes to purchase second homes and investment properties. Nothin' wrong with that! We do, after all, reside in a republic that still practices free enterprise. Nevertheless, all of this grandstanding leads doomsayers to predict that the entire market is vulnerable to price softening. To which I say "Poppycock and Bull Feathers!"
If everyone believed half of what the Wall Street gloom-mongers and Sunday Morning Financial Televangelists had to say about the real estate markets, we would have had a full-fledged market collapse one year ago. It is a pity that these disingenuous wing-nuts failed to factor the bothersome laws of supply and demand into their too-clever-by-half formula designed solely to woo disaffected stock market investors back to Wall Street. Flights to safety and quality take many forms (e.g., precious metals, real estate, etc.) and performance refuses to take a back seat.
Everyone wants financial independence, but that can mean different things to different people. Some strive for growth. Some desire income streams. Others want tax advantages. The great news about real estate is that you can often have all three -- growth, income, and tax advantages!
Many individuals scrimp and save their entire lives so that they can retire with enough money to live reasonably well when they finally quit working. The big question is “How many acorns do I need to squirrel away to support my lifestyle?”
The truth of the matter is that in order to achieve a given retirement income, you need to have twenty times as much invested to produce the desired amount of income. If you want to produce a $50,000 annual retirement income, you will need at least one million dollars in working assets. A $100,000 income will require two million in working assets, ad nauseam. Furthermore, you should double your income targets every fifteen years in order to keep pace with inflation. In other words, to achieve the equivalent of $100,000 (in 2005 dollars) it may require four million in working assets by the year 2020. Alas, inflation is the most insidious tax of all.
But enough about financial planning (not my field of expertise), and more about becoming a landlord. Here are a few resources that you will find very helpful in dealing with taxes, 1031(a) exchanges, and similar delights:
- IRS Publications Index
- Publication 523, Selling Your Home [.PDF format]
- Publication 527, Residential Rental Property (including rental of vacation homes) [.PDF format]
- Publication 535, Business Expenses [.PDF format]
- Publication 544, Sales and Other Dispositions of Assets [.PDF format]
- Publication 550,Investment Income and Expense [.PDF format]
- Publication 587, Business Use of Your Home [.PDF format]
- Publication 946, How to Depreciate Property [.PDF format]
- Tax Topic 414, Rental Income and Expenses
- Tax Topic 415, Renting Vacation Property/Renting to Relatives
- Form 4797 (PDF), Sale of Business Property
- Instructions for Form 4797
- Form 1040 Schedule D Capital Gains and Losses (.PDF)
- Form 8824, Like-Kind Exchanges (.PDF)
- Additional Rules for Exchanges of Personal Property Under Section 1031(a) Regulations
- Instructions for Form 1040, Schedule E, Supplemental Income and Loss (.PDF)
- Frequently Asked Questions - Keyword: Rental Property
- Eviction and Lease Notices from LawDepot.com
- Landlord &Tenant Rights & Responsibilities for Minnesota
- Minnesota Certificate of Rent Paid form and instructions (.PDF)
NOTE: Laws are subject to change and may be interpreted by the courts in many different ways. Use these links only as a guide, and always seek competent legal advice. Furthermore, some cities and municipalities will have laws that differ from State law.
States may change the links to their online laws and statutes. If you receive an error message when attempting to link to a particular site, please email a note. I will ferret out the proper link and correct this page so that others may benefit.
It takes money to make money. That's a fact. Nevertheless, it does not necessarily mean that it always takes your money to make money. Other People's Money (OPM) can make money just as easily as your own. One of the best things about real estate is that it offers leverage. Leverage can be your best friend.
Here is an example of leverage at work. A 5% return on $10,000 invested in the stock market yields $500. That's nice, but you could do better. Place the same $10,000 down on a $200,000 property that appreciates 5% and you double your initial investment. That is a 100% return -- a $9500 greater yield than the stock market investment.
Consider, if you will, that if you rented the property you can receive an additional income stream in the form of rent. The rental income will assist in paying down your loan. Then, of course, you have additional tax advantages such as accelerated depreciation on appliances, tax deductions for interest on the loan and other expenses, etc. It may be possible to realize a 200% return on investment in some instances. That is the power of leverage!
The bonus in buying investment properties that cash flow is what is known as a “cash on cash” return. If you take $10,000 to purchase a property that returns $250 a month ($3,000 a year) in positive cash flow, that provides a 30% annual return on your cash -- cash on cash. When was the last time your money earned 30%? But I have digressed.
Step 1 - Qualification:
The very first thing that needs to be done is to find out what you may be qualified to buy. A good lender can advise you in the most effective strategies and the types of programs for which you will qualify, based on your current credit scores, savings, and income. You need to speak with a lender that specializes with investment properties. That would be someone such as myself. Once we have determined your qualifications, we can proceed to the next step. Please go to the Fast App. page to initiate contact.
Step 2 - Representation:
If you have a Realtor® -- or if you are a real estate agent -- you may advance to the next step. If you do not have representation, I can assist in pairing you with an experienced agent who specializes in investment properties.
Step 3 - Goal Setting:
Determining which area is the right market in which to invest is only a part of this step. You also need to determine other aspects of the purchase. If you are looking for appreciation, you will want to focus on rapidly expanding areas. What other demographics are important? What are economic forecasts saying about the target area? What are the projected appreciation levels? If you are looking for cash flow, you may want to concentrate on established areas. The property will probably not be new or in the most glamorous area. You may be able to find properties which cash flow in areas that are appreciating. In some cases, you may have to choose between cash flow and appreciation, or depreciation.
Step 4 - Due Diligence:
There are no short cuts in this step. Patience and exhaustive research are required. You must perform your due diligence, otherwise if you purchase in haste you will repent in leisure. It is important to thoroughly investigate the property you intend to purchase. Evaluate, inspect, interrogate, re-evaluate, and re-inspect. Does that mean you need to spend the next month running back and forth to the property? Of course not. There is a wealth of valuable information right at your fingertips. The web is a wonderful resource. Here are a few things you will need to know.
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What is the property really worth?
You want to make sure that you don’t pay too much. This is where local agents can be of great benefit. I recommend that you pay for an appraisal or ask another agent to run comps for you. Formal residential appraisals cost approximately $300 for single family residences, $450 for duplexes, and roughly $200 per unit for 3- and 4-unit properties. AVMs (Automated Valuation Models) are available in limited areas at a cost of less than $100 for single family homes. An appraisal or AVM is cheap insurance, and they are often more accurate than some CMAs.
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What are the vacancy rates?
If you are buying a rental property, you want to know about your competition. The first thing you need to know is the number of similar properties are currently available for rent. Vacancy rates of 5% or less are good, and anything above 10% should be avoided. This is a lender required option to any appraisal of an investment property, and will add $75 to $100 to the basic cost.
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What are the property tax rates?
Some areas have very low property taxes, and some have very high taxes. This needs to be considered before you make your offer. Annual property tax rates of 1% to 2% is most common.
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What does the owner typically pay for?
This will vary. Sometimes the property owner will pay for essential utilities. At other times the tenants will pay all expenses. Quite often, it is a combination of both owner-paid and tenant-paid utilities. This may change between single family homes and multi-unit properties. Here are a few other questions to ask: What appliances are typical for the area? Who is responsible for maintaining the landscape and/or snow removal? What should I charge for security deposits? May I charge an application fee to cover credit and background checks?
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Is there a Home Owner's Association?
When purchasing town homes, condos, and PUDs for rental you usuall must contend with a Home Owner's Association. When you have a good tenant, they are often an asset. The HOA ensures that the neighborhood is nicely maintained, often provides hazard insurance, and generally keeps and eye on your property. If you have a bad tenant, they can be a pain in your posterior until the tenant is evicted. Some HOAs provide services such as cable TV access at below-market prices.
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What about Property Management?
This may be critical. If you have no practical property management experience, you may need to commission the services of a good property management company in order to be able to acquire a number of properties in a relatively short period. A good property manager can make your ownership experience a sheer delight. A bad one can make it a nightmare. When you talk to a potential management company, inquire into their background. How long have they been in business? How many properties do they manage? What is their current vacancy rate? What are their fees? Who handles security deposits? Who keeps any late fees? Do they charge to renew? Who performs maintenance and repairs and what are the costs? If you decide to sell, are you required to list with them? How long is the contract good? If you do not like their performance, what will it cost to terminate the contract? Do they have letters of recommendation? Review a copy of their contract with your attorney.
More to come ... when I have some "spare time".
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