BUYING RENTAL PROPERTIES: PRO’S AND CON’S
A rental property can be a great investment vehicle which offers both cash flow and appreciation over time. But it’s not quite as simple as dumping some extra cash into your IRA and watching it (hopefully) grow. A rental property takes some work- you have to find the right property and then manage it, or pay someone else to handle the tenants. However, a rental is a great way to leverage your assets. With as little as 5% down, you can finance the remaining 95% of a purchase. (For this article, we will concentrate on properties of 4 units and under, which fall into the “residential” lending category. Larger “commercial” apartment buildings are generally harder to finance.)
Many of us are worried that our 401-k and Social Security won’t provide enough income for us in retirement. A rental property can provide cash flow, but sometimes not immediately after purchase. Know your investment goals; Are you nearing retirement age and want an income stream, or are you younger and looking for a tax break? Investment properties can provide tax write-offs for interest and maintenance expenses (“cash” expenses) as well as depreciation (a “non-cash” expense that is still tax-deductible). Another way to avoid capital gains taxes upon the sale of the property is to do a tax-free exchange. In this scenario, you must invest your gain into the purchase of a new property, within a specific timeframe (usually 6 months).
Keep in mind the type of rental property you want to own: single-family or multi-unit (duplex, triplex or 4-unit)? Again, when looking at the property be clear on your goal- Are you looking mainly for appreciation or cash-flow? Single-family detached homes often will see the greatest price appreciation. However, it can be very tough to find one that provides good cash flow, unless you have a large downpayment. Single-family homes are generally easier to sell later, as they have the widest possible market of both owner-occupant AND investment buyers. A multi-unit property, such as a duplex, may not appreciate in value as quickly but generally provides a better cash flow when compared to a similarly-priced single-family home. Multi-unit properties also spread the risk of vacancy- if one unit is vacant, the others still provide income. In our area, there are many rental units that serve the college market. These units usually have annual turnover (vs. long-term tenants) but they may command a rent premium by being near a university. Another factor is that the leases are often signed by the student’s parents, offering a stronger tenant.
And finally, what if you find a rental property, but it needs a lot of work? There are loan programs available that can finance up to 100% of the cost to buy AND renovate the property. If done correctly, the added value can be used to the buyer’s advantage. This loan is called a purchase/renovation loan and involves only one closing for the buyer, saving money on attorney fees and closing costs.
Rental properties can be an excellent investment, but they do take some homework and management to be successful. But where else can you put down only 5% or 10% and buy a large asset, other than through real estate? For more information, I recommend the book “Rich Dad’s Advisors: The ABC’s of Real Estate Investing” by Ken McElroy