Why rental property can be a great investment
- Thread starter Gody
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MilesAbound
Level 2 Member
Usually residency requirements are 12 months. THAT is what gap years are for!!!
Yes kids are dual. Come March 2015 they will be triple with US as well
Lindyhopper
Level 2 Member
IDK if this is the real estate thread or if I should have created another thread, but what do you guys think of www.BiggerPockets.com? I can't decide if it is the FlyerTalk of real estate, or the BowTie (may not be a perfect analogy). It seems like it is going to promise great things, but many of the articles seem to me to fall a bit short, and just seem to self promote other things.
It's not really the real estate thread, but I think its OK here. Self promotion is the main purpose of any blog/website.
In short, to understand the benefit of the LLC (and what it can't do for you), you need to consider the difference between the sources of liability as a landlord - contract liability vs. tort liability. Contract liability, such as the obligation to pay the note secured by the property ends with the separate legal entity, subject to the doctrine of piercing the corporate veil. This means that if the LLC landlord doesn't pay a vendor or otherwise simply breaches a lease or other agreement, the owner of the LLC landlord isn't generally liable (again subject to veil piercing, which is very difficult). Contrast that with an action that was personally done by the owner of the LLC. For instance, if the owner of the LLC is an amateur electrician and rewires the house and then place burns down, the owner (not just the LLC) would likely be liable because he personally did the act. The LLC does nothing to insulate the owner from his or her actions. In this situation, liability insurance (in addition to property insurance that your lender will require anyways) is your friend.
There was some mention of forming the entity in Delaware because it is "business friendly." I wouldn't do that for two reasons. First, the limitations on liability are fairly consistent among the states (not identical, but don't assume that a business friendly jurisdiction is out there to protect the member or shareholder). Second, if you organize in Delaware and own property in your home state, you are going to have to file annual reports in both Delaware and your home state.
Matt had asked about having to deal with probate if you buy property across state lines. I'm not an estate lawyer, but I would think that you can deal with this issue by putting the property in the LLC's name and then convey the LLC interests by will or put into a trust.
LLCs and other limited liability vehicles absolutely have their place. I wouldn't own investment property outside of a limited liability vehicle.
El Ingeniero
Level 2 Member
I have a question. Most of you seem to be investing in 1 and 2 unit properties. What about 4 to 10 unit properties? I am thinking there might be a decent sweet spot in pricing there as the much smaller number of properties implies that large investors can't bring economy of scale advantages to bear.
I think the biggest difference is that loans change at 5 unit and above. From what I know it becomes a commercial loan that is then focuses more on cash flow from the rent rolls of the property.
BTW, funny you bump the investment property thread as I was just searching Trulia for them.. really keen to get in on this and get my first investment property, though I probably should wait another 6-12 months for life to slow down a bit first.
Lindyhopper
Level 2 Member
Matt is right. 1-4 unit is a mortgage to a person, 5 and above is a commercial loan.
El Ingeniero
Level 2 Member
Quads might be just the thing then.
I'm all for it, but I was just pointing out that shift from personal to commercial as it is where @El Ingeniero mentioned there seemed to be a discrepancy.
Here's my list of pros and cons of buying larger multi-unit properties:
PROS:
-Multi-unit properties can be great for cash flow as you are getting more units for one overall cost. Generally people rate these properties by the "Cap Rate" or cash on cash return you would get. Generally the cap rate for these types of properties can be in the 7-12% range.
-If you have other rental properties you can possibly benefit by getting cheaper costs for maintenance, labor, and property management if they are all in the same area.
-Buying a multi-unit property with greater than 4 units allows you to use a commercial loans. Commercial loans look more at the financials of the property instead of the individual investor. Commercial loans are also nice because if you carry a lot of conventional loans as an investor they won't count towards your 4 loan limit that Fannie Mae has for carrying loans.
CONS:
-Multi-unit properties are mainly used for the cash flow they produce, so they are not a great for tax sheltered income or growth of initial capital through property appreciation or equity building. Property values don't increase as quickly for these larger properties as an increase in property value often hurts the cap rate. So its usually the income produced by the property that drives the value of the property.
-The bigger the property the more costs associated with it. Larger properties require landscapers, possibly a resident manager, parking lots to maintain, and more routine repairs to deal with. While you might be receiving a lot of cash flow there will be years where you have to paint the complex or redo the roofs and those major expenses can cut into your cash flow. Larger properties require a certain amount of reserve money available so that you can handle those major repairs or costs when they come around.
- A commercial loan is usually at a slightly higher interest rate than most individual conventional loans. In addition it should be noted that there are a good deal of commercial loans that come with prepayment penalties. I have a commercial loan for an apartment complex and it comes with a prepayment penalty where I have to pay a % of the remaining balance if I choose to pay off the loan within the first 10 years. So using a commercial loan doesn't always offer you the flexibility of quick exits if that is what you are looking for.
- The market for multi-unit properties is much smaller than individual properties, obviously. When its time to sell you multi-unit properties it can take a while for the right investor to come around depending on if you're property has any stellar qualities. In comparison to single family homes or duplexes, you would always have the benefit of selling not only to other investors but regular homeowners as well, so with that increase in demand it makes for an easier and possibly more profitable exit.
I've dealt with both apartment complexes and multiple single unit rentals now and my personal preference is to deal with multiple single family homes instead of apartment complexes. I feel there is more upside and flavors of investments you can do with single family rentals while apartments and multi-unit properties tend to be more 1-dimensional cash flow only vehicles.
Maggie66
Level 2 Member
Just watch out for the streaking
Great points.
One thing that I was thinking last night is that the other block that a Commercial Loan could create is that if they are looking for a CF history you are restricted in terms of what you could buy. IE would there be a problem buying a place that you renovate and then rent out, as it has no CF history?
Or would they perhaps just use nearby comps?
Brother in Law is a commercial lender, so he probably knows all this. We did consider a commercial loan for our recent move, talked with him about buying a large unit and living in one of the apartments for a period of time.
If you are trying to buy a commercial property that has a a more volatile or unpredictable cash flow, lenders usually compensate for that risk by offering a shorter amortization period or higher interest rate. They would use comps of similar type properties to help assess their risk. I'm not personally familiar with these types of situations but this is what I've seen and heard from other people's experiences.
Buying a large apartment complex and living in it as the resident manager could be quite a profitable venture. I know managerial costs for apartment complexes tend to be a good chunk of your expenses so to be able to cross those off could make a purchase very favorable if you're willing to live on the property and handle a lot of the management duties yourself. I've never seen it done but in theory it would be a nice venture.
I just want to suggest that people look into the landlord/tenant laws in their area before engaging in this type of endeavor. For example, folks who live in SF/LA/NY should understand that landlord/tenant laws favor the tenants. I'm not trying to dissuade folks from doing this, but please go into it knowing the worst case scenario.
SC Trojan
Level 2 Member
If you're reading this thread and thinking about making the jump to being rental property owner I'll give my 2 cents.
First, the #1 thing is to get a good tenant. A bad tenant will cost you thousands of dollars in damage and if you have to evict them it is a long and costly process. While you can never know for sure, this means screen your tenants thoroughly and don't be afraid to reject people that are questionable. Also, there is the rule that the nicer the neighborhood the nicer the tenants. Most people that live in nicer neighborhoods aren't the type that are living paycheck to paycheck or are going to trash your place. It's a generalization but if you rent in a low class neighborhood expect people that act low class and will treat your property with little to no class. I'm sure there are people that have made tons of money by renting properties in low class neighborhoods, but it's definitely more effort and you're more likely to get someone that trashes the place.
The second thing I would consider is to buy a place when it's "on sale". Right now real estate prices are somewhat high, so I would say just wait a few years for another crash and then jump in. Obviously you can still make money in the right situation now, but there will probably be more opportunities when prices drop a bit.
There was some discussion on insurance, my experience was it was absurdly cheap to get a lot of liability insurance. I think it cost me like $15 / year for $1 million in liability insurance on the homeowners policy. I would say just don't go cheap here and get an appropriate amount.
One thing I lucked into was buying a rental property in a tax with no state income tax. This just simplifies things a bit, because you might have to file taxes in another state if you have properties in that state. Florida, Texas and Nevada all have no income tax and relatively low property values.
First, the #1 thing is to get a good tenant. A bad tenant will cost you thousands of dollars in damage and if you have to evict them it is a long and costly process. While you can never know for sure, this means screen your tenants thoroughly and don't be afraid to reject people that are questionable. Also, there is the rule that the nicer the neighborhood the nicer the tenants. Most people that live in nicer neighborhoods aren't the type that are living paycheck to paycheck or are going to trash your place. It's a generalization but if you rent in a low class neighborhood expect people that act low class and will treat your property with little to no class. I'm sure there are people that have made tons of money by renting properties in low class neighborhoods, but it's definitely more effort and you're more likely to get someone that trashes the place.
The second thing I would consider is to buy a place when it's "on sale". Right now real estate prices are somewhat high, so I would say just wait a few years for another crash and then jump in. Obviously you can still make money in the right situation now, but there will probably be more opportunities when prices drop a bit.
There was some discussion on insurance, my experience was it was absurdly cheap to get a lot of liability insurance. I think it cost me like $15 / year for $1 million in liability insurance on the homeowners policy. I would say just don't go cheap here and get an appropriate amount.
One thing I lucked into was buying a rental property in a tax with no state income tax. This just simplifies things a bit, because you might have to file taxes in another state if you have properties in that state. Florida, Texas and Nevada all have no income tax and relatively low property values.
El Ingeniero
Level 2 Member
What is your opinion of using credit score, say above 650, as a screening tool for tenants?
SC Trojan
Level 2 Member
Credit score is definitely part of the equation, as is any criminal record. Definitely look at WHY they had demerits. If they were foreclosed on, it actually might be they were honest but in over their head, if they can't make a car payment then I'd be worried. I'd look for someone with a steady job, not one based on commissions or tips if you can (though I had to break that rule in Vegas because most people are in the service industry). In my opinion the best thing is to interview prior landlords.
My grandfather had a story about a prospective tenant that looked very upscale, had a Mercedes and gave him like 4 references. When he called them, the landlords said the prospective tenant was a horrible tenant and trashed her last place. He rejected her and told her why and she said "oh I didn't think you'd actually call them".
In the Bay Area I hear you have to have "rent resumes" to apply for places as they are so competitive.
My grandfather had a story about a prospective tenant that looked very upscale, had a Mercedes and gave him like 4 references. When he called them, the landlords said the prospective tenant was a horrible tenant and trashed her last place. He rejected her and told her why and she said "oh I didn't think you'd actually call them".
In the Bay Area I hear you have to have "rent resumes" to apply for places as they are so competitive.