Buy a House For Investment?
I was asked "I bought my first home to live in, should I buy a second one for investment?" While there are many different aspects to this question, the number one rule is to speak to your tax advisor first to determine if real estate investment works in your financial picture. Interest and expenses that are tax deductible can be limited by your annual income, and the amount that can be written off, which will affect your return on investment.
An example of an owner-occupied home, which due to the leverage of real estate ownership, shows a return of 20 times more than a savings account:
$20,000.00 into bank @ 2% interest = $400.00
$20,000.00 used as a down payment on a $400,000.00 home or condo = $8,000.00 in equity*
*This assumes an appreciation in real estate values of 2% annually
Using the same example, some of the considerations in buying the home as an investment property are:
- The first issue is that unlike owner-occupied property, lenders do not usually make 95% loans on investment property. It may be necessary to put more cash down (a 20% down payment on the $400,000 example above is $80,000.00). The downside of putting more cash down, is that it reduces the percent of return (although in the example above, this still equals a 10% return, or 5 times the return of money placed in the bank)
- Other options that may have higher carrying costs, but take less cash out of pocket, are:
- Get a first loan of 80% of the property value, and a second loan for as much of the difference as possible, or
- Borrow against another piece of real estate that you own for the down payment and/or secondary financing.
Your choice between these options is a balance between your available cash and your comfort level. Less leverage generally equates to the less return and less risk. If you have secure, discretionary income, the more leverage provides you the better return. If you work in an unstable job market or have fluctuating income, a more conservative approach is appropriate.
In addition to the return on your initial investment, the other great advantage of investing in real estate is the ability to depreciate the improvements (land cannot be depreciated, so in tax and assessment language "improvements" are everything except the land or lot). For this example, I will assume improvements equal 70 percent of the value and lot value equals 30 percent. Using the example above, 70% of $400,000.00 equals $280,000. Divide this by 30 years (the life of the loan). The result is $9,333 that may be able to be written off each year for depreciation in addition to other operating expenses. If you are eligible for the full depreciation, you rent the property for $777 less than your hard costs and still break even with the depreciation deduction.
While I have often said I don't like to buy anything I would not want to live in myself, there are slightly different parameters for getting the most out of buying an investment home. House for house the more bedrooms, the more rent, and the more improvements (house size and value) to lot size, the more that can be depreciation deductions for you as an investment owner. This points out why condominiums and apartment houses work for the investor. However, I recommend starting with a single family home or condominium as a good way to ease into real estate investment. There are more "takers" when you wish to sell it, and you can see how it works for you financially. There are learning curves in the process and decisions like whether you want professional property management, or you wish to manage it yourself. Single family homes are usually more comfortable, familiar, and easier for you to judge value when starting out.