Diversification through rental property?

[Bruceski44]

Going to use up stored depreciation from the early years to avoid paying tax on depreciation recapture and the capital gains.

How does that work?

Thanks,
b

 

[nun]

I have a rental property and I get $19k a year rent which is around $13k after expenses. I have no mortgage on it or my own home and I love the income now that I'm retired.

 

[pb4uski]

.....Evaluating a good vs bad deal can be done on the back of an envelope, and lots of rules of thumbs can be applied.

1 months rent time 100 should be your purchase price or less. This way you have covered taxes and insurance.

10% net. If you paid all cash you should net a 10% return. rents-(taxes+insurance)=1/10 of the cash invested....

Ok, I don't get it. Let's say rent is $1,000/month. You would pay $100,000 for the property and receive $12,000 a year in rent.

Unless your expenses are only $2,000 a year, how do you net 10%? Surely, taxes, insurance, etc will be more than $2,000 a year... in many areas of the country property taxes alone are 2% of value.

 

[Another Reader]

How does that work?

Thanks,
b

According to the CPA, these are carry over losses that can be used against gains and recaptured depreciation. If that's not the case, I need a new CPA.

 

[Bruceski44]

According to the CPA, these are carry over losses that can be used against gains and recaptured depreciation. If that's not the case, I need a new CPA.

OK, that works. I didn't make the connection. Thanks!

 

[Another Reader]

The general rule on SFR's is a minimum of one percent of your all-in number per month in rent. Expenses, including reserves for capital improvements, plus property management and vacancy, run roughly 50 percent. So your minimum net from cash flow before mortgage payments should be six percent. If appreciation is a compounded 3 percent, overall, your return is around 9 percent. If you can increase the rent as a percentage of your cost or shave your expenses, you can hit double digits.

The numbers change if you are in a low or high appreciation market, where the appreciation trend is likely to continue. Low appreciation requires a higher portion of your return from cash flow to reach your target return. Markets where appreciation historically exceeds inflation encourages investors to accept lower returns from the initial cash flow. Rent and value increases are needed and expected to make up for the anemic or non-existent initial cash flow.

ETA: That's unleveraged. If your leverage is positive, your cash on cash return is higher.

 

[Winemaker]

Ok, I don't get it. Let's say rent is $1,000/month. You would pay $100,000 for the property and receive $12,000 a year in rent.

Unless your expenses are only $2,000 a year, how do you net 10%? Surely, taxes, insurance, etc will be more than $2,000 a year... in many areas of the country property taxes alone are 2% of value.

Your down payment for a $100,000 building is $30,000, assuming 70% financing. If you can net $3,000 that's 10%, but I would never accept that low of a cash on cash return considering the risk. The property must have positive cashflow, and you might even have a lower taxable income (or loss) and actually put money in your pocket. Many SFHs do not show a taxable income.

 

[jazz4cash]

Ok, I don't get it. Let's say rent is $1,000/month. You would pay $100,000 for the property and receive $12,000 a year in rent.



Unless your expenses are only $2,000 a year, how do you net 10%? Surely, taxes, insurance, etc will be more than $2,000 a year... in many areas of the country property taxes alone are 2% of value.

I think he's saying if you can only rent a 100k property for 1k a month, don't do the deal.

Around here 100k is the very bottom of the market for a decent townhouse in a stable neighborhood. The rent would be at least 1300 with taxes and insurance about 3500 that's 12% return but will get trimmed by repairs/maintenance. This is consistent with the 10x rule of thumb. It's getting harder to find places that are not condos. If there's a condo fee it's very tough to justify at the lower end of the market. This is my casual observation after looking into the local market.

Three siblings have many rentals among them and they all swear by single family units (detached/duplex) but I think the business case is different for them.

 

[brucethebroker]

Also live in Bay Area. Bought my rentals many years ago. Location, Location,
and Location. Now paid for. Good rents and appreciation. However,real estate is not a straight line. It does go up and down.

Have 2 friends who did the same as your friend. Sold/traded, local Bay
area rentals for out of state. Reasoning. Can buy multiple units, diversify
the rents, used property mangers.

Short version: Big mistake. Paying property managers very expensive.
Repairs, costly. (if local, you could do yourself).
Tenant turnover, high. (if you manage your own rentals
you are more careful). (property manager's have no
incentive, to try and find long term tenants).

One friend, said, never again. The other, I have not talked to recently.

My thoughts also...
Dad tried "out of state management"...he had numerous problems. I like being nearby, and able to talk to repair people, etc.

 

[brucethebroker]

Gain in value is a bonus. Having someone else pay the mortgage until free and clear is the real value. Then the cash really flows.

+1.

In most Midwest (rustbelt) markets, appreciation is a very slow growing bonus (2-3% annually, maybe...).

To answer another post regarding returns....in this same Midwest market, we see about 7% return on appraised values of paid off single family homes. Of course, the tax advantages are not taken into consideration.

BTW, when the housing market crashed, rental incomes remained level. The underlying reduced "appraised value" made no difference to cash flow. IMHO it was very easy to stay "fully invested" and not panic sell when the rents just kept coming!

 

[laurence]

Here in San Diego I had to overpay to get something near me, according to this formula. $345k for $2400/month rent. But with 25% down and super low interest rates the P+I of the mortgage is under $1300 so it's always been a little cash flow positive. We took the chance as we knew the area extremely well, and felt a 1500 sq foot 3 bed 2 bath 2 car garage place zoned for a 10/10 rated school had good appreciation potential, plus the beach and a university were 10 minutes in either direction. But now, almost four years later these homes are pushing $500k while the rents have only budged a bit. Chinese investors have been coming in all cash for years, offshoring their wealth and making the market loopy. I don't see rentals working here right now as an investment.

 

[pb4uski]

According to the CPA, these are carry over losses that can be used against gains and recaptured depreciation. If that's not the case, I need a new CPA.

I prefer investments that do not result in losses, even if you get to carry them forward... if your losses net with gains, how is that a great investment?

 

[pb4uski]

I think he's saying if you can only rent a 100k property for 1k a month, don't do the deal.

Around here 100k is the very bottom of the market for a decent townhouse in a stable neighborhood. The rent would be at least 1300 with taxes and insurance about 3500 that's 12% return but will get trimmed by repairs/maintenance. This is consistent with the 10x rule of thumb. It's getting harder to find places that are not condos. If there's a condo fee it's very tough to justify at the lower end of the market. This is my casual observation after looking into the local market.

Three siblings have many rentals among them and they all swear by single family units (detached/duplex) but I think the business case is different for them.

What he actually said was:

1 months rent time 100 should be your purchase price or less. This way you have covered taxes and insurance.

10% net. If you paid all cash you should net a 10% return. rents-(taxes+insurance)=1/10 of the cash invested.

So for him if a property rented for $1,000/month he would be willing to pay up to $100,000 for it. If that was the case, it would be unlikely that rents-(taxes+insurance) would be $10,000 a year.

I'm curious as to how many properties he actually owns. I suspect the number is closer to zero than to one.

My dad owned several residential rentals and ultimately found they were more of hassle than they were worth and sold them. He had a commercial rental property that is easy peasy, generates incredible returns and he kept and I manage for my mother since his passing.

 

[pjigar]

What he actually said was:







So for him if a property rented for $1,000/month he would be willing to pay up to $100,000 for it. If that was the case, it would be unlikely that rents-(taxes+insurance) would be $10,000 a year.



I'm curious as to how many properties he actually owns. I suspect the number is closer to zero than to one.



My dad owned several residential rentals and ultimately found they were more of hassle than they were worth and sold them. He had a commercial rental property that is easy peasy, generates incredible returns and he kept and I manage for my mother since his passing.

A lot depends on expresses, mainly taxes and interest rate. When I bought my rental SFH properties, home prices were 9-12 times monthly rent, cap rates were 6-8% and leveraged cash-on-cash returns after taxes were 7-10%. Now the home prices are 15-16 times monthly rents in my area, so no deals. As Warren Buffett says, you make money when you buy an investment. It is very true especially for the rental properties.


PS: Due to crazy appreciation on SFH in recent years, my asset allocation is very heavy with real estate. I tendv to focus on cashflow returns for all my investments so I am staying put for now. But if the crazy valuations goes on for one more year then I am going to start unloading my rental properties.

 

[DrBrisket]

I prefer investments that do not result in losses, even if you get to carry them forward... if your losses net with gains, how is that a great investment?

A tax loss does not necessarily translate to bad investment in the rental property world. In fact, it is perfectly normal for a rental property with a positive monthly cash flow to have losses when you file your taxes.

Most of the losses associated with profitable rental properties are non-cash expenses related to depreciation. From a tax accounting perspective, these non-cash expenses shield rental income from taxation; for a rental property purchased with a mortgage, it is not unusual to have a positive cash flow after all cash expenses are paid. Depreciation charges (which are non-cash expenses) can cause a rental property with positive monthly cash flow actually have a loss from a tax perspective. Unless you are full-time real estate person (NOT an investor with another career outside of real estate), these "passive activity losses" may be limited when you file your taxes each year. Any unused passive active losses accrue until you sell the property.

However, there is no free lunch, so when you sell a rental property, IRS rules require to pay up and pay the taxes that were "deferred" due to depreciation. Any accrued passive activity losses can be used to offset the depreciation recapture tax.

 

[Spudd]

Was just speaking to a co-worker (we're in the bay area) who recently sold his local rental property. To avoid capitol gains he bought 2 rental properties in another state.

I know this is besides the point, but does this actually avoid capital gains in the US? In Canada, capital gains would be payable regardless of what he did with the proceeds. I'm just curious!

 

[pjigar]

I know this is besides the point, but does this actually avoid capital gains in the US? In Canada, capital gains would be payable regardless of what he did with the proceeds. I'm just curious!

Yes, gains are deferred if you do section 1031 exchange.

 

[jazz4cash]

Right now it is easier to find cash flow positive properties than any time I can remember. The 100k townhouse I described that rents for 1300/mo might have sold for 180k ten yrs ago. Taxes and mortgage rates have dropped also but not the rent. This won't last.

 

[Curmudgeon]

What do you folks think about college town rentals? I've considered buying a rental in a town where my son attends school, about 2 hours from me. Son could take care of minor management issues. Seems that student rentals would have problems with less-responsible renters and yearly turnover. But, I suppose someone is making money at it?

 

[pb4uski]

I know this is besides the point, but does this actually avoid capital gains in the US? In Canada, capital gains would be payable regardless of what he did with the proceeds. I'm just curious!

It would NOT avoid capital gains the way the OP described it... selling a property and buying another.... in order to avoid capital gains one would have to trade one property for one or more other properties (called a 1031 exchange).

 

[krldrummerboy]

He did a 1031 exchange

 

[calmloki]

What do you folks think about college town rentals? I've considered buying a rental in a town where my son attends school, about 2 hours from me. Son could take care of minor management issues. Seems that student rentals would have problems with less-responsible renters and yearly turnover. But, I suppose someone is making money at it?

Long ago my Mom bought a huge oooollld house for my sister to live in while she went to college. College didn't work out at that time, but Sis had a good time and met some lifetime friends - in fact, one of her roommates ended up being her husband. Worked out well, as they remain married to this day. Seems to be a popular idea in our little college town - meanwhile I make bucks year after year from the kids whose parents prefer the rental route.

Bear in mind, if college at that school doesn't work out you may take a bath on the resale - you need about 8-10% appreciation just to cover cost of sale. Also consider whose name the house will be in - capital gains can eat you up but primary residence exclusion can be really sweet.

 

[jazz4cash]

What do you folks think about college town rentals? I've considered buying a rental in a town where my son attends school, about 2 hours from me. Son could take care of minor management issues. Seems that student rentals would have problems with less-responsible renters and yearly turnover. But, I suppose someone is making money at it?

I think it's a very good idea but we aren't the first to think of this. It's probably a lot more work (turnover) for a bit more profit.

 

[Winemaker]

What do you folks think about college town rentals? I've considered buying a rental in a town where my son attends school, about 2 hours from me. Son could take care of minor management issues. Seems that student rentals would have problems with less-responsible renters and yearly turnover. But, I suppose someone is making money at it?

While in college, a lot of kids, yes, kids, are rebellious, anti-social, non-conforming and have competitions to see who can be the piggiest, grossest, reeking tenants ever. While the numbers can be staggering in your favor, your main job is not landlording, it damage control. I witnessed this market when my son was in college, and I gave the landlord all kinds of hell when showing his 6 unit building. He promptly showed me another unit in the building where he was to do some maintenance work after our showing. Never in my life......

Not my cup of tea, or unit of swill.....

 

[Luck_Club]

I prefer investments that do not result in losses, even if you get to carry them forward... if your losses net with gains, how is that a great investment?

These loses are only on paper. Go figure. A loss on paper of 20K but cash in pocket is $6K tax free The $14K left can further reduce your taxes if you don't earn too much money.

Cary the property to death heirs get step up in basis.

Wash and repeat!