RENTAL PROPERTY INVESTING: NEED TO DO THE MATH
While all investment decisions carry a certain degree of risk, purchasing and managing rental properties can be far more lucrative and secure than investing in the stock markets or other asset classes. With housing prices still relatively low – and rent prices on the rise – many new investors are choosing rental property ownership over other types of investment options. Before writing that big check, however, it’s important to consider all of the costs associated with purchasing and managing one or more rental properties.
The purchase and sale
For your investment to be worthwhile – and to get a jump on turning a positive cash flow – you need to find a good deal, whether or not you’ll be taking out a mortgage. This seems pretty basic, but it’s also where a lot of new investors make the mistake that ends up damaging their ROI for the entire holding period.
Research the market
You or someone you trust must know the local market. You need to accurately determine the prevailing rents and the expectations for continued rental demand. The local economy, major employers and other factors all influence how many, and what types of renters will be seeking homes.
Get a good deal upfront
Every successful investment begins with a smart purchase. Whether you’re doing your own property-finding and negotiating or using one of the turnkey rental property companies, you must buy below current market value. If you’ll need to rehab the home, make sure you run the numbers and know your total costs for supplies and labor, and factor in the rental income lost during the rehab period.
Account for transaction costs
You can deduct them at tax time, but always consider real estate commissions and other upfront costs of purchasing and transferring ownership. And, remember that these costs don’t just apply to the purchase: When you sell that appreciated asset, there will be a chunk coming out of your take-home for these costs as well.
Costs of ownership
The types of expenses that apply to your rental property may vary, but this list should help you cover most of your bases when budgeting the amount of rent to charge and forecasting your expenses. Expenses are normally deductible, but you first have to pay them! Costs of ownership include:
- Mortgage payment
- Taxes
- Insurance
- Property management
- Marketing/advertising
- Legal fees
- Accounting
- Maintenance
- Repairs
- Budget for major improvements (these may need to be depreciated rather than deducted)
Before you purchase a property, you must take some time to estimate these costs as accurately as possible. Even if you plan to manage the property yourself, you should still consider the cost of management; many landlords find that, at some point, they don’t have the time or motivation to self-manage, so it’s wise to budget for that contingency. If you do self-manage, you should pay yourself for management.
Once you have a handle on all of the costs of ownership, you’ll be in a better position to determine and negotiate a purchase price that will enable you to cover costs and maintain a positive cash flow.
Tax considerations
As I mentioned above, you can normally deduct all costs of ownership and management. You also get a bonus with a depreciation deduction. Although IRS guidelines may change, 29.5 years is the current depreciation lifespan. Depreciation applies only to the structure, not the land; if your structure is valued at $100,000, you divide that amount by 29.5 to come up with a deduction of $3,390/year. This is money you didn’t spend out of pocket, and you get a deduction line item.
Another tax benefit for rental property owners is the 1031 Exchange. This IRS provision allows the investor – with very strict rules and limitations – to sell a property and roll the proceeds into another investment property without paying capital gains taxes (they are deferred until final liquidation). This helps rental property investors build large portfolios over many years, avoiding capital gains taxes along the way.
Rental property ownership can be a profitable investment strategy, but before diving in, do the math. You’ll not only want to make sure your initial numbers are correct, but also account for future variables to ensure a long and prosperous source of cash flow.
Melissa Conrad, P.A.,Realtor ~ Atlantic Shores Realty Executives
(772) 240-2589
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Jensen Beach, Port St Lucie, Stuart, Palm City, Hutchinson Island, Florida
