Q: I have decided that if I am to invest in real estate, it will be single family ranch style houses with the goal of breaking even on a monthly basis. I’ll either hold the property long-term (if it looks like I’ll make money by increasing the rent over time) or sell after I’ve fixed it up.
We have ample investments that will give us retirement any time we want, now or even ten years from now. But my intention with these real estate investments is to make our later years more “flush” as well as provide something for our heirs.
My question is this: How do I determine whether or not investing in single family homes is even necessary given our financial position? I’ve run a “basic” analysis of what a $25,000 investment in an account will be in 20 years at 7 percent vs. buying a $90,000 ranch house with 20 percent down, and $7,000 in other costs up front. I’ve projected just 2 percent average annual appreciation in home value.
The difference between putting the $25,000 in cash into an investment account and buying homes is not huge, but the effort required is with real estate is much larger. I want to be sure that the effort I put toward this venture is rewarded and this whole project is not just something to keep me busy.
I’d really hate it if I found out I barely made more than if I’d stuck my money in a mutual fund.
A: This is a great question, and one that every real estate investor should take the time to ponder over. But, there’s no short answer.
You’ve done your homework and that’s a good thing. But one issue you need to account for in real estate is the possibility that the value of your asset will not only not appreciate but might depreciate. The second item that you need to factor in is whether you have accounted for other expenses in leasing the property and your inability to lease the home from time to time.
These factors may make your decision easier. If you factor in these additional expenses, you may find that your analysis would move you towards not buying real estate.
While residential real property can be a good investment, for most people it’s a home. That home is a place to live in and a way to live in a particular neighborhood and community. For many years, homes appreciated rapidly but were never investments. Now that the residential bubble has burst, we won’t know whether single family homes will appreciate as they did in the past, or if they will stay at roughly the same value for a number of years before rising again.
For now, in many places, single family homes are declining in value. According to several indices, homes in many metropolitan areas have fallen anywhere from 10 to 28 percent in value over the past 18 months.
Another point to consider: the long-term costs of maintaining your properties. The longer you own a home, the more costly it is to own it. Roofs, boilers and air-conditioners need replacing over the years. Homes need exterior work and maintenance. All of those costs need to be factored into your decision. If you’ve already put aside a maintenance and upkeep budget, your decision will be more informed.
All wanna-be landlords have to decide if they’re up to the task of dealing with tenants. Some people just hate the idea that a tenant can call at any time of the day or night (even if the call never comes). If you’re averse to handling tenant calls about problems with your house and decide to hire a manager to take care of these issues, you’ll erode your stream of income.
Finally, there will be costs involved when it comes time to sell your property. You can expect to pay anywhere from 4 to 6 percent commission, plus other closing costs, such as title, taxes, and other fees.
Being a landlord is a lifestyle, not just an investment. Unfortunately, it’s difficult to quantify the cost of your time and effort in retirement. But if you can get your properties to a cash-flow positive level within the first few years of owning them, you’ll likely build a stable source of income for your retirement, and your heirs.
Even if your rate of return is equal to putting your cash into a mutual fund, you might find the tax benefits of owning investment property will tip the scale toward real estate rather than the stock market for portion of your portfolio.
July 31, 2008.