Each week I ask for recommendations for column topics, and this week I received an excellent suggestion from Realty World agent and Ukiah’s rookie agent of the year Tanya Gilmore, who wants to help people of her generation think ahead and make wise investments. She rightly pointed out that many people are waiting until their mid-30’s to have children. This means hard-working people in their 20’s and early 30’s have an opportunity to save some money and invest. Depending on their financial goals, real estate could be a great option.
Before I go any further, I need to point out that all investing comes with a tradeoff between risk and return: the higher the potential return, the more risky the investment (“return” refers to the money you make). Also, real estate investing is a long-term endeavor. It can lead to significant financial benefits, but it is by no means the get-rich-quick option. A word of advice: be suspicious of anyone who offers you a get-rich-quick option.
For a first-time investor who is young and willing to live in a multi-unit housing situation, I’d recommend buying a duplex, triplex or four-plex. Loans for owner-occupied residences generally come with better terms (lower down payments and interest rates, for example), and a four-plex is more likely to provide positive cash flow than a single-family home.
Investing in real estate provides several benefits. Virtually all the money you spend repairing an investment property is tax deductible. That means the IRS reduces your overall income by the amount you spend repairing your investment property, then calculates the taxes you owe on that number. Translation? You pay less in taxes. In addition, depreciation is deducted from your earnings, which means even more money in your pocket.
If you’ve chosen the right investment property, you are also building equity (ownership) over time, and your tenants are helping you do that because their rent payments help you cover upkeep, management, and mortgage payments.
So how much do you need? Let’s say a four-plex sells for $500,000. With an FHA loan, you could qualify for a low down payment if you live in one of the units. Your down payment would be approximately $17,500 for a 30-year, fixed-rate loan. You’ll need a good credit rating (a FICO score of 680 or higher) and proof of income, so the bank knows you can cover the mortgage and other costs. Your monthly payments will be under $3,000.
If we’re talking about 2-bedroom, 1.5-bath units, you can charge $1050 per month for each of the three units you’re not living in: that’s $3150 per month in income. When calculating expenses, I add 40 percent of the income to the monthly payment figure because, having owned investment properties for decades, I know I will need that much to cover management fees, as well as expected (and unexpected) maintenance and repairs. So you’ll need approximately $4500 per month including expenses, which means your monthly “rent” would be $1400.
If you have cash for the down payment and a 3-month cushion for mortgage payments, insurance and expenses, you have enough to buy this property. As rents increase over time, your payments will decrease. And you don’t have to occupy the unit forever. If you live there for a few years and then move, you will have met the owner-occupied terms of most loans.
Because transaction costs are high, you typically want to buy a property and keep it for at least 3-5 years, depending on the housing market. Do not buy a property if you need its value to rise quickly. Instead, build equity in the property you buy, and then down the road consider refinancing and pulling some of your equity out to put a down payment on another investment property.
If you have questions, please contact me at firstname.lastname@example.org or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 40 years.