It has been stated many times that more personal wealth has been created with real estate investments than any other commodity. Sure, there are exceptions, but they are “exceptions” and not the general rule. One of the reasons for this is the ability to control an expensive asset, like a single family dwelling, with a relatively small amount of money (leverage). You can then sell it or better yet, refinance it, for a profit, all the while having the government (yep, that’s Uncle Sam) and other people (renters) help you be successful in this endeavor. Space limits an in depth discussion on real estate investing, and yes, as with all investments, there are risks and drawbacks; but overall, owning a real estate investment will reward you with wealth, and with wealth, you can be the beneficiary of peace of mind.
Start With What You’ve Already Got!
If you already own a home, you are on the way to financial freedom and creating real wealth through real estate. You should, if possible, always invest in owning your own home before buying an investment property. The caveat here is that in some parts of the country, it is very expensive to own real estate, and buying a home seems like the “Impossible Dream,” and is therefore out of the question. For this reason, the Austin area, which is a very affordable area by national standards, makes a perfect place to own investment real estate. Many times one can buy an investment home in our area, hold it for a time, cash out, and then use the sales proceeds towards that “starter home” in those expensive parts of the country where prices seem astronomical compared to prices in our area.
For most of us, that home that we currently use as our domicile often times will make a perfect real estate investment, and for several reasons. First, you already are familiar with the property, including the location and demographics. Second, and it should be obvious, you already own it, and this brings you both equity and favorable financing as owner-occupied homes often are financed at a lower interest rate than investment properties, and often the financing is with a lower down payment.
The question then arises, “But I need the money from that house to make the down payment on my new home, don’t I?” The answer to that is maybe, and this comes down to making a personal decision. If you are contemplating buying a new home as your domicile and using your current home as an investment, you might want to consider “refinancing” your current loan, pulling the cash out of the equity, and using that cash “tax free” as the down payment for your new home. Remember, I stated earlier that Uncle Sam would be of help to you. The cash you pulled out of your home is not taxed, and now is a good time to mention that that is true even if the home was already your investment property. There is no income tax on these proceeds, and that makes for a good argument for not selling your real estate investments. You also need to take into consideration that interest paid for your home-domicile is a tax deduction, so in some instances, a larger home mortgage might be the way to go. As always, check with your tax professionals before making any investment or financial decision. As I stated before, we are limited on space so I can’t elaborate.
Getting Started If You Aren’t Using Your Current Home As An Investment
If you are a seasoned real estate investor, you may want to move on because, although there may be some “investment nuggets of knowledge” for you here, you’ve already read the information before somewhere else; and either you have put the information into play or you never will do so.
Folks, just don’t read a book on real estate investing, or view a clip on it, or attend a seminar. Get out and talk to real estate investors in the area where you are considering making your investment. The best sources of information, of course, are the local REALTORS® who also manage rentals similar to the ones you are contemplating buying or already own. Preferably, this person is also a “professional property manager.” So let me state here, “You have found me!”
By professional, I mean someone who devotes the majority of their business life to the Austin property management profession. This person should be a member of several professional organizations so he or she can stay abreast of ever changing laws and who can take advantage of professional business practices that affect the property management industry. A credentialed property manager from the National Association of Property Managers, NARPM®, or from the Institute of Property Management, IREM®, would be a person with the needed skills and knowledge to effectively manage your real estate investment.
Average Austin, Texas Example
This typical Austin rental comes from information and statistics obtained from the Austin Board of REALTORS® in a typical subdivision with typical rentals, which reflect how an average single family rental will perform. In some cases, the figures have been rounded up or down to make the example easier to follow. However, as you will soon see, this rounding doesn’t significantly impact the overall investment performance.
This example uses a single family dwelling of 1,683 square feet (ideal) purchased in 2000 for the average sales price of that subdivision of $132,000. Assuming the down payment was 20%, $26,000, the amount financed would be $106,000. In 2000, a typical interest rate for the year was 7.5%. The monthly principal and interest (P&I) of a 30 year fixed loan is $741.00. The average property taxes on this typical average rental are $181 a month, and let’s assume that the insurance is $70 a month: that totals $992 a month. The average rent in 2000 for this typical average rental was $1,157 a month, and that equates to a gross positive cash flow of $165 a month. For the record, the average rents in the 10 year period had an average yearly low of $1,065 in 2005 and an average yearly high of $1,233 in 2008. In 2009, the last year studied, the average rent was$1,203 a month.
As with any physical asset, there is physical deterioration and maintenance, and because space is limited, a discussion of maintenance expenses cannot be given here. Depending on the condition of the property, one should expect to set aside between 5% to 10% of the gross rent for repairs and maintenance. Professional property management in Austin can have expenses in the range of 10% of the income. Remember Uncle Sam? Since your rental is a “business,” most of your expenses, if not all of them, will be used to off set the income as deductions. This means that the management fee that you are paying is not your “net management fee” after all (very neat!).
God bless Uncle Sam! With real estate investing, the IRS is also your friend! This typical house gets to have a depreciation schedule on the sticks and bricks (not the value of the land) of 27.5 years. For example and simplicity, let’s say that our purchase price of $132,000 had $32,000 valued in the land, meaning that we can depreciate the physical asset of $100,000 over 27.5 years or $2,750 a year. Couple this with the other fees that accompany ownership of investor properties (management fees, insurance, repairs, etc.) and the amount of money that you can use to offset income can be substantial. With these deductions, you are solidly in the black monthly. The picture gets even better. With all of these IRS approved deductions in hand, why not go to your employer and increase the deductions you take so you reap these benefits monthly with each pay check vs. waiting to do it at the end of the year?
Our typical rental in the real life example that was purchased in 2000 for $132,000 with a $26,000 down payment, sold in 2009 for an average sales price of $207,500, a gross profit of $75,000. Now your net profit will depend upon the other expenses associated with the property such as management fees, repairs, improvements, property taxes (they didn’t always increase during the study period), and so forth. However, for our example, you made a profit of $75,000 with a $26,000 investment for a tidy sum of $49,000. And who helped you make this profit? Why it was Uncle Sam, his cousin the IRS, and the renters (yes, they spilled soft drinks on the carpet) who covered the majority of your expenses and covered the P&I payments with their rent.
This is too good to be true. What’s the catch? Why doesn’t everyone own investment real estate?
And so the objections come. The answers are: it’s not too good to be true, there is no catch, and most people are afraid of risk, and therefore, they are equally afraid of success. Yes, there are people who are afraid of success. Our company motto is
“We Manage For Your Success!” We truly want you to be successful!
Using this example, plug in all of your objections, and then ask yourself this question: If the end result was only half as good and if the profit was “only” $24,500, would this still be a good investment for me?
If the answer is yes, and I bet it is, you should contact us today to see how we at Austin Landmark Property Services, Inc. CRMC® can help you reach your real estate investment objectives.
The example used herein was typical for the type of property in the subdivision studied, which was a typical subdivision for the Austin area. There is a saying in real estate that the 3 most important things about real estate are “Location, Location, and Location!” Preferably, your investment will be an “average property in an average neighborhood.” If your investment is too far below or above average, it usually won’t perform as well as a property that is more in line with what is average. This includes the size of the home, the size of the lot, paint colors, carpet colors, parking arrangements, number of trees on the property: everything.
Before making any investment decision, always check with your tax advisor to determine if the investment is keeping with your long-term financial goals and is suitable to meet those needs.
About the Author
Rick Ebert, MPM®, RMP®, is vice president of Austin Landmark Property Services, Inc. CRMC® (ALPS). While working in the insurance industry, he purchased his first real estate investment in 1976 and made a profit in 18 months. He and his family have been buying, selling, and managing residential real estate for over 25 years in the Austin, Texas area. ALPS is a Certified Residential Management Company (CRMC®) and manages hundreds of single family homes in the greater Austin area.