I am a Realtor, so it is sort of stating the obvious to say that I am a proponent of home ownership. More than just home ownership though, I am passionate about investing in real estate because I truly believe that owning and investing in real estate is one of the few ways that anyone can build wealth. That isn’t to say that there aren’t barriers to entering the world of investment property and like any investment, returns aren’t guaranteed, but unless you own your own business, what better opportunity is there to grow your net worth than real estate?
So first, let’s address the barriers. To obtain non-owner occupied financing you typically need 20-25% down, that’s a big barrier. However, low to no down payment loans are available for owner occupied properties. If you don’t already own your home, why not? Rates are still at historic lows and if you are paying rent, than you ARE paying a mortgage, just not your own. Your landlord thanks you for it! If you own a home but are considering a rental, you have some options. You could use the equity from your home as down payment for a rental, or you could take advantage of the low down payment owner occupied loan and purchase a new home, converting your current home to a rental property.
Cash flow is the primary factor that I consider when advising clients about a rental. We all believe the value of the property will appreciate and that’s where the real upside is, but for most of us, we need the property to generate a break even or positive cash flow. Talk to a lender and get an idea about what your monthly mortgage payment will be. Be sure to include taxes and insurance. Speak with a Realtor or property manager to get a feel for what you could charge for rent. You will also need to allow for some repair and maintenance costs. The goal is finding a property where the rents will cover or exceed your expenses. We are fortunate in Chico to have strong rental market and relatively affordable housing, so cash flowing properties are a reality. Prices in surrounding areas such as Paradise, Magalia and Orland are even more affordable with only slightly lower rental rates.
The next factor to consider is Depreciation. Generally, you can depreciate the value of the structure (not the land) over 27.5 years for residential property and 39 years for commercial property. In addition, almost all expenses related to rentals are tax deductible, including maintenance, mortgage interest, HOA fees, utilities and property taxes. Depreciation can be used to off-set rental income possibly generate passive losses. Rental income/losses are generally considered passive, meaning that you can’t off-set these losses against your W-2 income. Keep in mind that the tax code is complex and there are phase-outs based on income and other exclusions and exceptions, so it is extremely important that you consult with your tax preparer/planner to understand how investment property will affect your taxes.
Finally, consider appreciation. In the short term property values can fluctuate wildly, but over the long term, real estate appreciates at a rate relatively comparable to inflation. You could conservatively expect to earn 1-5% appreciation annually in real estate in the long term. Timing is everything, the goal being to buy low and sell high, but if you are purchasing a property that cash flows or reduces your tax liability than appreciation is just ‘gravy’!
Shane Collins is President of the Chico Association of Realtors, and a Realtor at Century 21 Jeffries Lydon. She welcomes your comments and questions and can be reached at 530-518-1413 or Shane@MovingChico.com.