Think Small: Getting Started As a
Real-Estate Investor
Think Small: Getting Started As a Real-Estate
Investor
By David Crook
From
The Wall Street Journal Online
The
real-estate bubble has burst. Get over it. In areas that saw big
home-price run-ups in the first half of the decade, prices are stagnant,
or worse. New-home inventories are up; new-home builder stocks are down.
A kind of
real-estate weariness has set in. Who's the cocktail-party boor? The guy
still talking about making a killing on Miami Beach condos.
Smells like a
buying opportunity. Probably not right away, because there's still plenty
of froth in the markets that saw the biggest price increases. But soon,
you'll see the real-estate investors -- property vultures who buy when
prices are low and then ride property manias to their crest -- toeing the
market again.
Even in
today's uncertain climate, novice real-estate investors can make money,
especially in smaller properties that are easy to acquire and manage.
Let's explore
some options.
In-Law Units
The most basic
form of property investment is a so-called in-law unit or guesthouse on
the site of your home itself, sometimes attached to the main house,
sometimes not. No one has ever gotten rich renting out such properties,
but they can significantly reduce the cost of homeownership. Renting out
an in-law unit for $400 a month and using that money every month to pay
down principal on a $350,000 30-year mortgage will shave 10 years from the
mortgage term and reduce total payments by more than $165,000. And you
will be able to write off all your costs on your income taxes -- including
depreciation on the unit -- up to your actual rental income.
Weekend or Vacation Homes
Just as with
an in-law unit, renting out your weekend house is not a way to get rich.
Many of the same numbers that applied to in-law units can be applied to
your weekend home, although the tax situation is decidedly different.
First, the IRS
gives second-home landlords a very nice little present in that it allows
two weeks of tax-free rental income a year. Beyond that, however, the
accounting can be irksome. The IRS doesn't want people buying second homes
and disguising them as rental properties. It has two criteria to determine
whether the property is a second home (bad) or a rental (good). It's a
second home if you don't rent it out at all or if you personally use it at
least two weeks a year or 10% of the number of days the place is available
for rental, whichever is longer.
Single-Family Homes
Throughout
much of the country, the market for single-family homes is seriously out
of whack. As prices fall and inventories rise, that's changing. But,
compared with rents, prices are still quite high, outstripping the ability
of such properties to cover their mortgage and operating costs.
Avoid this
segment of the market unless you have a chance to buy a property at a 30%
or 40% discount from its previous price. Don't think this is out of the
question. In the late 1980s and early 1990s, when the government
liquidated the real-estate loan portfolios of bankrupt savings-and-loans,
speculators picked up properties for just dimes on the dollar.
Managing a
house that pays for itself is what it's all about. You can do it in one of
two ways: Renting or "flipping." Renting is a "buy-and-hold" strategy,
while flipping calls for quick turnarounds of fixer-uppers that can be
spruced up and sold quickly.
But in the
current environment renting is probably the more prudent path, although it
can be very difficult to make a house pay for itself at today's prices.
That's because if your house carries an 80% or 90% loan, the renter will
have to pay more per month to rent the house than he would to buy it.
Look at it
this way: There's a handsome three-bedroom, two-bath house in Tampa, Fla.,
for sale at an asking price of $199,900. If you bought it with 10% down
and a 90% loan at 6%, your monthly payment will be about $1,550 (that's
PITI -- principal, interest, taxes and insurance). As a landlord, at a
minimum, you'll want to budget at least $200 a month in additional
expenses. That puts your break-even point at almost $1,800 a month. That's
far more than you can reasonably expect to earn where comparable
properties in the same neighborhood can be rented for less than $1,300.
But it turns
out that there's a similar house available less than a mile away. This
other house is roughly the same size. The difference is this one's being
taken over by its lender, and the house has a mortgage loan of $110,000.
A buyer with
cash can drive a hard bargain and make out very well. And the worse the
market, the better for the buyer. But don't get carried away. If you
simply take over an existing 90% or 95% note, you won't make any money.
Let the lender foreclose and take over the place. Then lowball the lender.
Multiple Units
A housing
market that saw the price of single-family homes skyrocket was not quite
so generous to smaller two-family or multifamily properties. Because the
universe of home buyers expanded so much in the past 10 years, the
universe of renters contracted, and the market for smaller rental
properties contracted with them.
In Memphis,
where two-bedroom apartments in better neighborhoods rent from $500 up to
$800 a month, good two-family properties can still be bought for far less
than a one bedroom condo on either of the coasts. Recent prices for
40-year-old two-family homes near the University of Memphis main campus
ranged from $70,000 to $110,000. Monthly payments, including insurance and
maintenance, on an $88,000 mortgage (20% down on the $110,000 property)
come to only about $750 a month. So renting both units at the low end of
the market would result in a positive after-tax cash flow of more than
$100 a month. Upgrade the units, and you can charge top-of-the-market
rents of $800 a month.
Good deals on
smaller buildings can be found throughout the country, even in some of the
hottest markets. In trendy Pasadena, Calif., where even modest homes can
sell for $400 to $600 a square foot, two-, three- or four-unit rental
buildings can be bought in the $250 to $350 range.
