Rental-Property Profits: A Financial Tool Kit for Landlords
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Rental-Property Profits: A Financial Tool Kit for Landlords
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Overview
This book walks you through every important step, from spotting smart investments to taking advantage of tax breaks and loopholes.
With rental prices climbing, vacancy rates low, and property values rising, real estate investing has become a tempting option for achieving financial security. The fixer upper shows today that make it look so easy—simply buy a property, fix it up, and then rent it until you’re ready to sell for a profit—has the number of real estate investors is growing, but the same can’t be said for all their bank accounts. The reality is that real estate can be confusing, requiring in-depth financial and tax knowledge that most newcomers lack
With clear language and updated forms, worksheets, checklists, and formulas, Rental-Property Profits explains how to:
- Evaluate risks and opportunities in a post-recession market
- Determine if you qualify for an investor loa
- Calculate cash flow and maintain healthy levels
- Establish sound bookkeeping and accounting systems
- Handle rental property depreciation
Real estate investing is not as easy as it looks on TV, but it also doesn’t have to be risky. With this self-guided manual by your side, avoid the costly mistakes that many before you didn’t see coming, and build the nest egg you deserve!
Product Details
| ISBN-13: | 9780814438541 |
|---|---|
| Publisher: | AMACOM |
| Publication date: | 07/20/2017 |
| Sold by: | HarperCollins Publishing |
| Format: | eBook |
| Pages: | 272 |
| File size: | 4 MB |
About the Author
Read an Excerpt
Rental Property Profits
A Financial Tool Kit for Landlords
By Michael C. Thomsett
AMACOM
Copyright © 2017 Michael C. ThomsettAll rights reserved.
ISBN: 978-0-8144-3853-4
CHAPTER 1
THE NATURE OF REAL ESTATE INVESTING
Real estate, over time, has been the most consistently profitable investment choice you can make. As long as you research ahead of time, know your market, and pick specific properties carefully, your investment should grow over time. This is true even in light of the depressed market since 2008. This period of time has been among the worst markets for real estate in many years. However, the market inevitably recovers from its negative cycles and comes back as strongly as ever.
This is why right now is a great time for investors to look seriously at the possibility of becoming a real estate investor. For most investors, the first question to ask is how much risk is appropriate. The answer to this question will help in the decision as to whether to proceed as a real estate investor or to look elsewhere.
Most people start out investing in residential property. A single-family house or small multiunit property (two to four units) is manageable and affordable, and you can always step up from there to buy additional properties or exchange your initial investment for larger ones. To get started, you want to define what you hope to achieve by purchasing real estate. Property is far more expensive than most other investments, so you will be making a commitment in most cases to a mortgage. The majority of investment value will consist of borrowed money, so you will depend on rental income to make your investment affordable. Given the potential affordability of real estate (with tenants essentially covering your mortgage payment for you), the consistent historical growth of real estate values, and the exceptionally good tax advantages, the benefits of real estate investing are significant. However, "affordable" is not restricted to net profits but, much more significantly, extends to the cash flow generated by the investment — that is, the comparison between money coming in and money going out. You need positive cash flow or, at worst, a breakeven form of cash flow in a majority of cases. Most investors cannot — and should not — afford to carry negative cash flow from their investments.
AN OVERVIEW OF THE MARKET
Since residential property is, by far, the most common real estate investment, examples in this book focus on single-family housing. Other choices (such as raw land speculation, commercial, and industrial properties) are much more advanced and beyond the interest of most investors.
The residential housing market can be easily studied in any given area. You can readily find information about the local population, employment, rental occupancy and vacancy rates, and the level of new construction under way. These factors add up to the supply and demand for real estate in your city or town. This, then, is the logical starting point if you are thinking of investing in real estate.
To find specific properties for sale in your area and to judge the market prices in great detail, even down to neighborhood or zip code, check the many online sources for current listings as well as for recent sales of homes similar to those you are targeting as potential investments.
Supply and Demand
The supply and demand for residential property involves three distinct and separate markets. First is the market price trend of housing, the best known and understood market. In this market, buyers want to know, first and foremost, what a house will cost. The second market focuses on supply and demand for rental units. Third is the market for available sources of mortgage financing.
The first market can be evaluated in terms of how prices change over time. Are houses selling for more this year than last year? What is the percentage of growth? Housing prices have beaten inflation over many years, with the recent exception in this market beginning in late 2008. The longer-term trend places housing among the strongest of growth investments. Assuming, of course, that you've selected property on the basis of good research and sound market analysis, you can expect real estate to be less volatile than the stock market, consistent in its growth rate over time, and safer by far than other alternatives. In many regions, prices have remained flat or have declined, so using national averages is not a safe way to pick a market. You need to check the regional trend to ensure that real estate in your town represents a viable investment. In areas where employment is strong and the population is growing, real estate values tend to grow as well. The market value of property is only the first of three important "markets" in real estate.
The second market involves demand for rentals. What is the average vacancy level? A very low vacancy rate is a positive sign, but a fluctuating or high vacancy indicates that there is more supply than demand. If that is the case, then the timing would not be good for investment, at least not right in your city. The trend between 2008 and 2016 has been for housing prices to decline (over most regions), leading to more people renting than buying. This increased rental level has driven market rentals upward. So as housing costs fall and market rents rise, the market for real estate investors is ideal, consisting of low investment prices along with higher rents.
The third market is that for mortgage money. In 2016, rates were lower than they had been for many years, in the range of 3 percent. This is an extraordinary opportunity for investors, with the cost of borrowed money lower than it has been for many years. However, the rate is not the entire story. Qualifying for a mortgage involves a combination of lending rules and standards, your personal credit history, and the level of equity (your down payment) versus the percentage you would like to borrow. If you do not have money for a down payment or if your credit score is poor, you will face difficulties in getting a mortgage at a desirable rate.
The Basic Equation
More details on these essential ideas are covered in later chapters. As an overview, however, a basic equation is an important starting point. The short-term market attributes of rental property are going to affect how well you can afford to invest money now. The whole market is likely to look different in a few years, but you want to make sure you have a reasonable expectation of keeping tenants in the property each month. The equation worth keeping in mind is a balance between how much money you receive (in rent) and how much you have to pay out (in mortgage payments and expenses). For that equation to work, you want to keep the property occupied as consistently as possible. Any time the property is vacant represents lost income, but your mortgage payment continues from month to month.
An Investor's Point of View
The market for residential real estate is not difficult for most people to understand. If you own a home, you know all about mortgage payments and the importance of being able to afford the payment each month. Anyone who has not yet bought a home knows that landlords expect rent to be paid on time. So the basic economics of real estate are familiar to everyone and are not as mysterious as the market forces at work in other markets, such as the stock market.
In evaluating investments, though, you need to look at properties from a different perspective. When you shop for your primary residence, you are interested in the comfort features, condition, and size of the property. As a real estate investor, you might be willing to buy property that would not interest you as a primary residence but that is ideally suited for rental purposes.
In this example, your revaluation of the market would be made with rental income and payments in mind, rather than from the point of view of a homeowner. The investment attributes of your decision are going to be far different from your personal requirements.
The real estate market has grown in value over time, even though recent trends have been negative. This is a national average, of course, and all real estate is local. This means that it is essential to understand the local features of supply and demand before investing. You cannot depend on national averages or even on local trends for the long term. If local property grows in value over fifteen or twenty years in the future, that is a promising feature. At the same time, you need to ensure that rental demand is strong right now, in order to cover your mortgage payments. As you look for potential rental investments, try to locate properties that are affordable, most likely to maintain value (and grow in value), and appealing to likely tenants.
REASONS TO INVEST IN REAL ESTATE
There are many good reasons to buy real estate. Among the most important reasons — assuming the local market conditions make it a viable choice — are the following:
* Diversification and Asset Allocation. Sound investment requires spreading capital over dissimilar investments. You would not want to put all of your capital into a low-yielding savings account, or into a single stock, or into real estate. You are better off diversifying your capital. You may wonder: If real estate is sure to grow over time, why not put all of your money into rentals? Diversification is important because different investments have different attributes. The stock market is volatile and you can make or lose money quickly; however, your money can be invested or taken out quickly. Savings accounts are safe but yield very little. Well-selected real estate is going to increase in value over time, but it is very difficult to get your money out if you need it for an emergency. You need to diversify your capital so that you have some funds available as you need them, some funds in very safe investments, and some in investments likely to grow over time.
A more sophisticated view of diversification is called asset allocation. This is a strategic planning technique in which a portfolio is spread among many different markets or segments. While diversification usually refers to spreading risks within one market (buying many different stocks), asset allocation is broader. For example, you may want to have some money in ready-cash accounts as an emergency reserve fund; other capital invested in stocks, whether owned directly or purchased through a mutual fund; and yet more of your capital invested in real estate. These three markets represent completely different levels of risk and opportunity, and each is going to perform according to very different market forces.
Real estate is a superb market for asset allocation because of its strong historic attributes. Your ability to allocate capital among dissimilar markets protects your capital from cyclical changes. In times when the stock market is weak or falling, real estate may be strong. In fact, it is likely. Offsetting profit and loss effects of stocks and real estate occur time and again.
Diversification within a single market and asset allocation among many different markets are sensible portfolio management techniques. Real estate is a good fit for strategic asset allocation. It is different from the stock market, however. Investors wanting to get out of stocks for the moment but who plan to go back in a few months later have to decide where to place capital, either in other stocks or in different markets. Real estate is a longer-term investment, though. So if you plan to employ real estate in your asset allocation plan, it should be treated as a longer-term decision. You do not want to buy real estate in March and then look to sell it in June in order to put capital back into the stock market. That would be an expensive and, given closing-cost levels, a difficult move to make profitably.
* Cash Flow. With most investments, you place cash in someone else's care, then you receive dividends, interest, or capital gains. You are 100 percent invested, and there is little or no question of cash flow. With real estate, you usually make a down payment and finance the lion's share of the investment; so cash flow becomes critical. Most real estate investors depend on rental income to cover their mortgage payment. The bad news: If you do not keep the property rented every month, you have to make the mortgage payment from your other funds. The good news: If you keep the property occupied, then tenants' rental payments are used to make those mortgage payments. In this situation — and given no unexpected extra expenses — the property pays for itself. When you purchase properties at the right price for your local market and when rents are high enough to cover your mortgage payment, you will have a positive cash flow. When you consider the tax benefits of reporting losses (which are created because you are also allowed to depreciate your rental property), it is possible to have positive cash flow and, at the same time, a net tax loss. This seemingly contradictory situation is quite common. When the tax benefits from net losses with depreciation create monthly tax savings, you can enjoy the best of both worlds: having tax losses to deduct while you collect more cash than you pay out.
* Leverage. Most individuals cannot afford to buy property outright and pay cash, just as most homeowners cannot afford to pay for their own homes all at once. One attribute of real estate investing is the need, in most cases, to finance 70 percent or more of the purchase price. As a strategic approach to investing, leverage is recognized as an important and advantageous method to use. Leverage means employing a limited amount of capital to purchase and control a greater value in investment. You would not be likely to borrow money to buy stocks because the stock market is an uncertain and risky place. However, properly selected and researched real estate is far less likely to lose market value. Not only does real estate tend to grow in value over time when other economic factors are positive; it is also insured through a fire insurance policy, and investors have direct control over the investment. Ownership in stock is uncertain and less tangible, but, given the features of locally owned and managed real estate, leverage makes a lot of sense.
Weighing the Pros and Cons
The overall benefits of investing in real estate — combining growth, safety, and tax features — make it a choice worthy of serious consideration. You cannot expect this beneficial combination from any other investment. While cash invested in real estate is difficult to take out (because it can be removed only through refinancing or selling in most cases), the overall benefits of real estate make it worthwhile, especially if you balance your capital between real estate and other areas.
Even with all of the long-term benefits of real estate investing, however, you should expect to face some problems as a real estate investor. The need to borrow money to buy property is a significant risk, so you must be prepared to live with debt. There can be unanticipated expenses, such as for repairs, property tax hikes, or utility rate increases. Neighborhoods can change for the worse, the local economy can fall apart, or a large employer may close down or move away.
Another potential problem area involves dealing with tenants. The landlord-tenant relationship is usually amiable and fair. It is occasionally emotional or illogical. As a landlord, you accept the risk that some tenants will not be pleasant to work with. This is one feature of real estate that discourages many people from proceeding. If your temperament is inappropriate for dealing with tenants, then you should not buy real estate. At the same time, if the risk of problems can be mitigated by checking references, and if you are willing to go through those steps, then you will increase your chances for a positive, enjoyable, and profitable experience.
THE IMPORTANCE OF TAX PLANNING
The benefits of real estate are difficult to ignore, and they make a strong case in support of including real estate in your portfolio. Equally important, tax planning requires serious thought and continually looking ahead. Anticipating potential tax-related problems in the future is always a necessary move, not only in managing your investments but generally as well. Real estate investors need to plan. The obvious reason — to reduce current-year tax liabilities — is only one part of the larger picture. Of course, you want to time decisions as much as possible to minimize taxes. The second part has to be kept in mind as well: the limitation on annual deductions. This comes in two forms: dollar amount and your income level.
Annual Dollar Limit
The dollar amount is set at $25,000. You can deduct that much per year as long as your family income is at or below $100,000. If you are married but separated, or if you are single, the dollar amount may be lower, or it could even disappear completely. So married couples living apart and contemplating divorce need to plan carefully to minimize the tax consequences of divorce when real estate investments are involved.
(Continues...)
Excerpted from Rental Property Profits by Michael C. Thomsett. Copyright © 2017 Michael C. Thomsett. Excerpted by permission of AMACOM.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of Contents
CONTENTS
Figures vii
Tables ix
Introduction: What This Book Will Do for You xi
1. The Nature of Real Estate Investing 1
2. Getting Started in Rental Property Investing 19
3. Cash Flow: The Essence of Rental Real Estate 51
4. Picking the Best Investment for You 71
5. Bookkeeping Basics for Rental Property 91
6. Keeping Track of Real Estate Transactions 123
7. Creating a Timely and Efficient Accounting System 139
8. Handling Depreciation for Rental Properties 157
9. Understanding the Tax Rules for Real Estate 183
10. Tax Reporting for Annual Income and Expense 197
11. Including Real Estate in Your Portfolio 227
Glossary 241
Notes 245
Index 247