Rental Real Estate As Investment
Some investors prefer real estate as a long-term investment, even though the work is difficult and the costs are very high. Even with property management it is hard work. Property management companies are expensive and when they quit you have to do the work until you find the next manager. You have to trust property management to show up, tenants to pay rent, and both to properly maintain the property. Every time a tenant moves out there are repair and replacement costs, sometimes those costs are enormous. You get tax deductions for rental property, but not as much as for owner-occupied property.
Some landlords are surprised to discover that even if they have a mortgage on a rental property, the rentals are considered income and the rental income is taxable. Owners must file a Schedule E (Supplemental Income and Loss for Owners) to get all their deductions associated with renting real estate. To keep track of everything you are encouraged to keep a spreadsheet. You can get one online, free, one is Google Drive if you have a Gmail account.
It takes a special person to own and hold real estate as an investment in the form of rental real estate. Depending on the cost, type and area is what depends on the difficulty of owning and making the property profitable. Since the costs are very high (and if you take out a loan, you are leveraged with debt), it could be a few decades before you see a profit.
The advantages of non-owner-occupied residential rental property as an investment:
- It is possible to have high returns when holding for the long term, if you hit a point in history when real estate is selling and in short supply.
- You can depreciate the property (this is much more advantageous for property purchased before 1987, although the deduction for depreciation is much less after that year).
- You get a maintenance deductionbut it’s much less than the deduction you get for owner-occupied property.
Disadvantages of non-owner-occupied residential rental real estate as an investment:
- Non-owner-occupied mortgage loans have a higher interest rate than owner-occupied loans.
- The down payment required for non-owner-occupied loans is much higher than owner-occupied loans. In many cases, 20% is required, compared to an owner-occupied loan of 3% to 10% down.
- You must pay capital gains tax on the gains when you sell.
- The annual maintenance cost for non-owner-occupied residential real property is typically much higher than the owner-occupied cost. Most people simply don’t properly maintain property that doesn’t belong to them.and some are very destructive.
- The long-term maintenance cost can be phenomenally high.
- It is difficult to find reasonably priced properties in quality neighborhoods.
- Neighborhoods with lots of “four rents” signs are particularly hard to avoid vacancies, it also sends a message.
- Lost rents are not deductible.
- A low-quality neighborhood (one with high unemployment) brings a low-quality tenant, that is, the delinquency rate in rent payments is high.
- The debt that is carried when the rent is leveraged with a mortgage.
- Constant turnover of new tenants is expensive due to repair costs each time a tenant moves out.
- You have to keep your fingers crossed that when it comes time to sell, prices in the area will be high, the type of real estate you own will be in demand, and there will be enough appreciation.
Combining owner-occupied and non-owner-occupied residential real estate may be a viable consideration for those who feel some form of non-owner-occupied rental real estate is a must, as an investment. An example of a mix of owner-occupied and non-owner-occupied residential real estate is a four-unit complex where you live in one unit and rent the other three.
The advantages of mixed owner-occupied/non-owner-occupied investment property:
- You may qualify for the lower interest owner-occupied home loan.
- You may qualify for the lowest 10% down payment allowed with your owner-occupied real estate.
- You can deduct the repairs and keep the part of the rent.
- You are there to monitor repairs and encourage maintenance.
- You can depreciate the rental portion.
You have a better chance of buying a property in a quality community since its initial cost is lower than that of a property that is not owner-occupied. A quality community brings a higher probability of a quality tenant. Attracting quality tenants is probably the most important aspect of non-owner-occupied residential investments. Investment real estate works when there is a high demand for rental real estate in an area. You will then have a plethora of people to choose from.
Disadvantages of mixed owner-occupied/non-owner-occupied investment property:
- Your tenants can know where you live if the property is titled in your name.
- You can only deduct expenses for the maintenance portion of rental real estate, but not your own.
- You will be responsible for normal capital gains taxes on the non-owner-occupied portion when you sell. There is a capital gains exclusion on the owner-occupied portion.
- If you are actively involved in rental activities, you can deduct $12,000 in losses if you are single and $25,000 if you are married on all property you own.
