Over Thanksgiving holidays we met up with a family friend who is a very successful real estate investor. She has millions of dollars of property both here in the U.S. and internationally. We started talking about investing and here are some of the points that I recall:
Get started as soon as possible. When she found out that we were without kids, making a decent income, and still renting, she looked at me like I had three eyes. I think most successful real estate investors are like that. When I explained that we’d be moving in 6 months, she still said that we need to start as soon as possible. Think long-term, but get on that property ladder!
Learn more about taxes. If you want to have rentals, you need to keep great records and take advantage of all the numerous tax breaks. She said she once took H&R Block’s income tax course and it was the best money she ever spent. That way, it forces you to examine all the byzantine forms step-by-step.
Manage a property yourself at least once. Even though she uses property managers now, she believes that it is very important to know what property management entails. That way, you know what to look for in a property manager yourself, and what they should be expected to do and how much things should cost.
It’s good money, but not easy money. We then turned to tenant horror stories. Besides just not paying rent, she had tales of finding someone to fix bullet holes, and tenants covering up blood stains with area rugs. If you don’t have thick skin or work well with others, you will hate being a landlord. It’s definitely not for everyone.
There was more about financing ideas, but overall, the talk really got me buzzed about owning a rental property. I just spent some time looking at 4-plexes, as she says that’s the sweet spot for good rental income and reasonably simple management. It’s also unlikely that all 4 units will be unoccupied at one time. I confirmed this by seeing that the mortgage-to-rent ratios on most 4-plexes were significantly better than that of single family houses. Try searching Craigslist in your area, it’s fun 🙂 Usually the existing rental income would cover the mortgage payment, even before taking into account tax deductions. Adding in insurance, repairs, property taxes, and such would probably tip it into the cashflow-negative column slightly.
I also looked into H&R Block tax classes, but for some reason I only got classes in Kansas City. Tomorrow I’ll try to find a few good books instead.
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What kind of return can one expect to make from real estate?
In other words, once considering your time & effort, does it offer a better return than your stock portfolio?
-Wes
Where does she own internationally?
This blog is really damn good, quite frankly. You give sound, practical advice and info.
I always perk up whenever I hear about the Block course. I took the H&R Block tax course a few years ago in college. I’m a CPA and this was equally as important as college.
I don’t know if I’d want to jump into R/E right now, but it’s an excellent diversifier and gives you cash flow.
Being a landlord is good, but first of all, we gotta have $$$ to support 2 or more mortgages…
I have also heard good things about the H&R Block classes. A co-worker of mine has taken them and plans on doing taxes after he retires. I plan on taking them in the next couple of years as well. Also planning on buying some rental property (single family homes) in TX beginning of next year.
I took a HR Tax Course two years ago. And I also work with them part time for 2 years now. I really learned a lot from them. They have a lot great resources tax experience people.
What kind of return? Well, it depends on how leveraged you are. She used to be both a Realtor, an owner of a Realtor Group, AND a mortgage loan broker.
Say you have a $500,000 house with only $50,000 down and the house appreciates just 5% a year. That’s a $25,000 return on $50,000 of your own money – 50% annually! The rest is the bank’s money. Of course there are expenses, mortgage costs (which ideally are mostly offset by rent), and there is work involved opposed to a mutual fund. But it’s quite apparent that the money is there.
My opinion is that if you are actively interested in managing your investments overall, you could probably do this. You can always eventually hire a property manager to do most of the grunt work (fix toilets, collect rent) if you are willing to forgo some profit (10% of rent?)
I think she owns in parts of Asia.
I took the HRB course about four years ago and I have been doing taxes since then. Now that I am renting my house, I’m glad I took the class. Block keeps me updated with the new tax laws and I get to do my family members taxes for free.
Buying/investing in homes traditionally has not been that simple. The bubble is now over and homes just can’t sustain the 15-20% growth each year 2000-2005.
When you take into account the 3-6% closing costs (state transfer fees/local taxes/etc.) of buying a home (in Maryland where I live it’s about 5% of the total cost) and property taxes, being a landlord should involve at least a 5 year investment.
So if you are in it for the short-term, I’d highly recommend against it and the stock market would have better returns (averages about 10.5% over the past 30 years vs. housing (3.5-4.5%).
Being a landlord is not for everybody. Our condo building is self managed [how we decide on being self managed is another story], because it is very expensive to hire a professional propery managment company in our area.
I find doing the maintenance by yourself is well…not fun. I don’t mind doing it now, because I am living in it, and this is [self management] the most cost effective way. I can’t imagine [even if I have the money] buying a rental property and rent it out. I don’t think all the work and stresss that I have to put into it justify the “potential” profit.
Of course, this is just my opinion. Before I own my condo, I used to think having a rental property is the greatest idea. But actually having to take care of one is another story.
Just keep in mind, if you do want a rental property. I hope you are very handy yourself, otherwise expect the headache and the cost of finding a plumber, contractor, etc. for fixing “things” for your tenants.
But then, you can always hire a professional building management. If you think it’s worth it.
Nice post – should be helpful to newbies. If anyone is looking for a great real estate investing forums, check out ours: http://forums.biggerpockets.com
It is definitely not easy running your real estate business. I’ll add to your list “Write your real estate business plan”. Unless you start to organize yourself as an investor, you can easily lose focus. Lack of focus can drive you to go above your means and has been the downfall of many investors.
Me and a buddy just started an LLC in order to invest in property.
I know of three ways:
1) flip houses : buy foreclosure homes with no down payment…fix it up..and hopefully in less than three months, sell it for a profit.
2) Buy home to rent using section 8: this way, you get a monthly check from the government, hopefully this will cover your mortgage payment, property tax, and insurance…say you do a 20% down, 15 year loan…In 15 years, the house(s) will be your. Then sell or keep renting to make money.
3) Make money on interest: say you got good credit, and you buy a house and do a 30yr loan for 6% interest. Then advertise owner finance to those folks that got bad credit but willing to pay 12% homeowner finance loan. You are making 6% profit each month, and if they default on the loan…the house still belong to you.
What are 4-plexes? I am getting started in real estate. My situation is similar to yours – my wife and I make a decent living, rent and will probably move in the next 6 months to another city. Any books or websites you can direct me to will be greatly appreciated. Thanks.
I took the plunge a little over a year ago. Lied my way into a 500 sq foot studio w/ a current tenant. I say lied because I said I’d be living in it (not something I’d suggest others try) since saying that got me out of the 10% down and 4 months reserve requirement. Obviously that wouldn’t work if you already HAD a mortgage on your credit report… I put nothing down (again, not something I’d suggest to others) because… well… I’m broke. But I refused to let that stop me.
Quick numbers, my mortgage is 340, the HOA is 60, rent is 350 and the property manager takes 10%. Leaves me 85 bucks short a month… but 45 of my mortgage payment goes towards principal (investment) so I ignore that… which leaves me 40 in the hole. Tax wise my “loss” is over 1700 bucks (depreciation, mortgage interest, property taxes, etc…), which at 25% federal and 3.74% state “saves” me 500 bucks on my taxes… since my “loss” is 480 (40 x 12 mths) I more or less break even and end up “investing” 45 bucks a month in real estate. That’s the ideal world…
Real world I get hit constantly with stuff I didn’t think of, but I can afford since I got such a cheap property to start. 2006 alone I’ve been hit with almost 700 bucks worth of bills I wasn’t expecting… advertising for a new tenant, constant calls for maintenance issues, A/C recharging, cleaning, bug spraying, carpet cleaning, etc, etc, etc. But I get to deduct all that on my taxes as well, so I’m really only “paying” 71.26% of whatever that bill ends up being.
Obviously this doesn’t take into account all the $$ I spent on closing costs, inspection, etc… Factor that in and I’ll be at a “loss” for a long time… Unless you factor in appreciation… Jonathan touched on this earlier w/ regards to leverage. Because I put down as little as possible, any “gains” in my property give me a tremendous rate of return. If my 45K condo goes up even 2%, that’s almost a thousand dollars of return for very little investment. Couple of things:
Depreciation is the greatest gift ever. You get a tax deduction for nothing. You don’t pay it back until you sell the property (if you sell!!) and when you do sell, you get a capital gains rate on your property if you held it long enough – meanwhile you deducted the depreciation at your current tax rate. So you “save” 25% on the write off, then only pay back 10% when you sell.. (I *think*… haven’t researched this fully, since I won’t be selling for a while – see your local tax advisor for details…)
I made the mistake of getting PMI because I wanted the “simplicity” of a single loan and no balloon on a 2nd w/ a higher rate. Even if the overall payment would have increased by going with two loans, at least the extra interest would have been tax deductible whereas the PMI is not.
Those who claim that the “return” isn’t anything you can do anything with, consider this… if your property has appreciated, you can pull that money out w/ a new mortgage or HEL and use it to fund a purchase of a new property. So now you get the increased interest write off on your taxes, you have $$ to put down on a new property (or better yet, multiple properties) which will then grow and appreciate, and soon you can pull THAT money back out and go do more stuff with it. It just snowballs…
How does this compare to investing in a REIT?
I also looked into taking H&R Block classes, and I also only got results for classes in Kansas City. Let me know if you find any good books or courses to take. Thanks!
also looked into H&R Block tax classes, but for some reason I only got classes in Kansas City. Tomorrow I?ll try to find a few good books inst
Unrecaptured section 1250 gains, the tax that you pay because of the lowered basis from straight line depreciation, is taxed at your marginal tax bracket up to 25%. It is not taxed at the long term capital gains rate as Chris S. wishfully imagined 🙂
Therefore, if you saved 25% from the depreciate write off, you would pay back the 25% when you sell your rental property assuming your marginal tax bracket is still 25%. You would only pay the 15% long term capital gains on the actual gain of the property, not from the lowered basis from the paper losses of depreciation. This is still a great benefit since you are effective getting an interest free loan from the government. The benefit is greater if the tax bracket when you depreciate is larger than 25%. On the other hand, it can be detrimental if you depreciate at a low tax bracket such as 15%, and then sell at a higher tax bracket such as 25%.
Depreciation recapture is taxed similarly as section 1250, but applies only to accelerated depreciation.
Wow! We’ve got some really good feedback from J’s entry.
Does anyone know of any blogs that more real estate invetor focused in the sprirt that J’s is for all thing personal finance?
The biggerpockets forum is more of a message board and not a blog.
>When she found out that we were without kids, making a decent income, and still renting, she looked at me like I had three eyes.
It is also possible that she — armed only with the hammer of real estate being a good investment for all — is looking at everything as though it were a nail.
Svseller has a good point about checking into REITs. Might be a safe first step while schooling yourself in the methods your friend recommends.
I converted my primary residence into a rental property a little over 1yr ago and I am pretty happy with the results. For the first full year I recognized a 7.72% return not including tax benefits and property appreciation.
Hustlermoneyblog.com isn’t going to fare well if he goes with option #2 “Buy home to rent using section 8” since funding for the Section 8 voucher program has been slashed under Bush and the Republican congress.
Flipping houses is a good way to make fast cash, but I prefer to get rich slowly and delay paying capital gains.
IMHO, the best way to make $ in real estate is to buy a property below market value, make any necessary repairs, get a new appraisal and refinance post-repairs (taking cash out through refinancing is tax free… you pay taxes only when the property is sold), and then get the property rented to a responsible, long-term tenant.
To answer Wes’ question, my rentals yield anywhere from 12-18% on a cash flow basis (not including appreciation of the property itself). My after-tax yield is even better because while each of my properties are cash-flow positive, I take a tax loss on each due to depreciation (a non-cash expense).
[Note: I’d never do the deal Chris S. described because I like investments to generate positive cash flow. He’s losing $ every month–but hey, it’s deductable, right? That the same fuzzy logic as “we’re losing money on each widget we sell, but we’ll make it up on volume.”]
I did the same search for courses for my local zip code and got the same Kansas City results. Detail on the courses state they run from Sept to November–11 weeks…so we are probably too late for the courses this year unless we trek to headquarters Missouri.
I recall seeing ads in local paper for the tax course/workshop around a month or so ago, maybe longer than that, also offering career potential–which might not be a bad thing to consider for next year.
“When I explained that we?d be moving in 6 months, she still said that we need to start as soon as possible.”
So is her advice “get into real estate as soon as possible?” Aren’t there seasons when its more favorable to wait and have house prices drop a little?
She isn’t a flipper, she’s more of a long-term investor. With that view, I think it’s like the stock market. It’s not timing the market, it’s time IN the market. You never know if prices are going up or down, you only know that over the long haul it will go up.
Despite all the predictions, does any of us really know where housing prices and/or interest rates will go?
I am 64 and retired but spent my adult life buying,selling, renting and building houses, with time and patience you can accumulate a lot of wealth, best book for beginners is “Nothing Down” by Robert Allen, gets a little far out but gives you the basis for buying real estate ,you gain four ways, thru appreciation, deductions, pay down of principle by rentors,and hopefully cash flow
DorkyDad,
I’m still new at this…thanks for the info on refinance and taking cash out on the new appraisal..I never thought of that. Anyways, for section 8, I’m thinking since i’m buying the house at undervalue, and that you putting 20% down to avoid the PMI on a 15yr loan, the last time i talk to someone who does this, it will cover the cost of monthly mortgage, tax, and insurance. She even has a positive cash flow. I’m thinking…as long as you got a positive cash flow or come out even, this is worth it because you are gaining equity in the home at no cost using section 8. Now that the Democrats are in control, i’m thinking they might raise the voucher also.
Your point about the gains realized on, say, a $500K house with 5% appreciation and 10% down is correct, but you’re ignoring the downside of, say, a 5% depreciation (which is not out of the question now) wiping out your equity in a year. Keep in mind that leverage cuts both ways.
I suppose real estate is one of the few places where you leverage yourself unreasonably, and that’s one reason a lot of the get-rich-quick gurus focus on it. Equity markets have statutory limits on leverage, which keeps novices from shooting themselves in the foot. In real estate, which such high gearing ratios, you have the chance to blow off your whole leg.
Also, has your real estate investing family friend gone through a down market yet? Apparent successes that started in the mid to late 1980s got ground to dust five years later.
I currently own a duplex in which I live in one of the units. I have owned it for over 2 years. I am a 25 year old single female and this has allowed me to pay less then I would for rent for the same sized place. My tenants pay more then half of my mortgage which includes my taxes and insurance. I plan on keeping the place as long as I still live a resonable distance away from it. My parents have been a great example for me in doing this and have also helped me do a lot of the upgrades to the place. We typically do all of the work ourselves from replacing windows to finishing off one of the basements. The only cost that I have had with repect to renting has been a “for rent” sign that I place at the end of my street when I found out that my first set of tenants were leaving. I think it is a good move if you go about it the right way. It would have cost me more each month to buy a one bedroom condo in my area and my duplex (6 bedrooms total) is on a quiet side street and was in good shape just needed some upgrading(paint, update carpeting) right away.
my aunt invests in real estate. she has 4 mortgages including our own personal home. can you imagine trying to make enough money to cover that much?
it’s a lot of work even though she uses management companies. there are always little repairs to make or issues like the gardener who raises his fees or something. but the returns are growing steadily and she’s making a lot of money but also emptied most of her savings to buy all these houses. that’s a bit crazy!
So little mention of the downside risks here.
I lived through a property slump in the UK in the early 90s and it can be brutal.
That $500k house can fall to $400k and all of a sudden you have lost ALL of your own $50k AND another $50k of the banks.
Property prices are falling, in the UK the slump continued for around 7 years.
Yes, I know people who have invested and made profits in the bubble think that real estate is the best investment ever, but post bubble there is so much downside risk. You can make those annual losses for many years and never get appreciation.
In someways the property market in the US seems to have become a huge Ponzi scheme. This is why so many schemes and existing investors encourage real estate investment, unless there is a flow of new investors the original investors can’t cash out.
Just my 2c worth. It’s not all upside.
All of these arguments are great reality checks, but they could be said also of investing in the stock market. Of course, I think many people have too high a % in stocks vs. bonds myself.
Absolutely great comments thread. I have a taken the path of having a primary residence and am completing construction on a second “vacation” home about 1.2 hours away from my primary residence. I anticipate making a good profit from it if I decide to sell within the next few years only because I bought it right. It is a more stressful existence to have two homes that aren’t being used as investments, and it certainly isn’t the best use of my money, but along with investing heavily in the market, I think it’s okay to have a recreational home that, over the long haul, will go up in value. My hope is that it’s something that we can enjoy for the next 15-20 years and then sell to use the proceeds for retirement.
I have a friend who is a very wealthy conservative invester. He loves REIT stocks. They traditionally gain in value and pay crazy dividends (if you find the right one). He’s cleaning up with JRT as well as others.
If you’re looking for H&R Block tax classes, call a local office and ask. Intro tax classes are usually offered only in the fall (at least in my area), since spring is crazy busy and summers are used for advanced classes. I forget the cost, but if you stay for a season you can get most of it refunded at the end of the season. Also, my area was so desperate for preparers that they were giving us returning preparers coupons to foist on our friends.
I find the tax information really interesting, but I’m a geek that way. And my return is crazy enough that I save $400 doing it through their computers, plus I save my parents and some friends some money. (I wouldn’t think of doing my taxes by hand anymore – depreciation alone would make me tear my hair out.) As a long-time preparer, plus one of the few able to put up with the person I split my mini-office with, I get to work weekends-only, which makes the season pretty unstressful.
As far as rental property, how about starting with a duplex or fourplex – that you live in? Your taxes get weird quickly, but you have a manageable number of units, you’re not paying rent, and you’re right there when something goes wrong so you learn the management ropes quickly. Downside: You’re right there.
The thing about real estate vs. the stock market is that real estate will not ever go down to zero, and stocks can. When I was really active in the stock market I was a stress case every day just with the normal fluctuations within my portfolio. With real estate the percentage of fluctuation in value and the speed of fluctuation is much, much slower. And long term you really can’t go wrong. Everything I have I owe to 10 years of real estate investing. My job just pays the bills, but real estate has helped me accumulate real wealth. Good luck to everyone!
This has been such an insightful blog. I think I need some advice as I have recently inherited some money and would like to invest in real estate. I have enough invested in other arenas and now would like to go this avenue. Any advice or comments?
Great post! It seems like your friend knows what she’s talking about. Another reason why four unit properties are considered the sweet spot is because four units is the maximum number of units for a property that will be considered for traditional residential mortgage loans. A property with five units or more will be considered an investment property, which requires a commercial mortgage loan.
Somebody Help! Wilma tore my home apart in October 2005. Without insurance, my deductible out of pocket expenses for 2006 amounted to about $40k to rebuild. I am wondering if I MUST take the depreciation deductions this year. It seems like I don’t need the deduction now, and shouldn’t take it this year because I’d rather not have the additional capital gains tax from reduced cost basis when I eventually sell. In addition, I wonder if the loss can be spread out over years like can be done with stock market losses.
Nice and interesting post. Theres not much to say though. I enjoyed reading the comment. =)
Hey guys………..I love these comments. I have been looking for advice, and I think now I may find it. My husband and I own a great house that we cannot afford. We also own a duplex. My house it 3200 sq. ft. I want to sell my house, and move into half of our duplex, which is about 1100 sq. ft for one side. This would be a major downgrade for me, but it would allow us to get out of debt and to be able to save money to invest in more rental property. Would you sell the house and move into the duplex? Or would you stay in your great house and endure the debt? Our debt has also greatly decreased our FICO score. If we pay off our debt from the sell of the house, how long would it take for our FICO to recover? Looking forward to a response.
I think part of the problem in finding the right advice is getting the right advisor. If you do not gel with the person that is providing advice, and they don’t understand your needs, then that won’t work. So that is why that I think that there is quite an issue with buyers using banks or price comparison sites looking for financial advice. Face to face in my view is the best method.