I recently wrote some advice for person who is in the initial stages of considering a purchase of some rental property in Austin.
I realized what I wrote was a very abridged version of an update of current lending and purchasing conditions for investment property in the Austin area.
Here we go:
I have lots of
practical information for you and a few suggestions. Purchasing investment
property is a different mindset because it’s about the return on investment,
versus all the emotional considerations involved when it comes to buying your
primary residence. Because the risk is higher with investment property, I think
it’s important to approach each investment property with a “guilty until proven
innocent” assumption. “What are all the ways that things could go wrong at this
property?” is the question we need to ask ourselves every time we look at a new
listing.
So now that we’re in
skeptical-negative mode, let’s talk about the tough parts of buying and
owning investment property:
1)
Money down: Investment property
generally requires 20% down thanks to the mortgage crisis. Lots of people
purchased investment property and when things got tough, they let those
investments foreclose while saving their own primary residences from the same
fate, so the investment foreclosure rate is higher than homesteads.
Consequently, the mortgage insurance companies stopped writing policies on
investment property. (Remember that for most mortgages, you have to have private
mortgage insurance until you have 20% equity in the property.) So that means
that the lenders won’t lend without the 20% down. (Note: there are always
exceptions. I know of some 10% and 15%-down financing, but because of lack of
mortgage insurers at that level, they really stick it to you on the rate.
They’re called “self-insuring.”)
2)
Property taxes: If you own your
primary residence there in Houston, you should have what’s called a
Homestead Exemption on your property taxes. It serves two functions: it gives
you a rather minor baseline discount on your property tax amount every year, but
it’s real value is in the cap it places on annual increases in home valuations.
So when the market normalizes and your neighborhood becomes a highly desired
area, your tax appraisal amount can only increase by 10% per year. With
investment property, there’s no such cap. So if you buy a condo in central
Austin and the
valuation goes up 20% in a year, you could see a substantial increase in
payment.
3)
Landlord headaches: Things happen when
you’re a landlord. Tenants lose jobs and stop paying rent, appliances break,
roofs leaks, etc. There will also be some time between one tenant moving out
and another moving into a unit where you are not receiving rental on the
property.
4)
Condo associations: These guys charge a
monthly fee, usually between $150 and $300, depending on whether there is pool.
There’s value in it: they take care of common area maintenance, landscaping,
exterior insurance and maintenance, and they sometimes cover the more minor
utility bills, like gas/water/trash. Each one is different. But in a condo
association, at some point, you will likely receive a “special assessment”
notice. If the building needs to have its siding replaced, and let’s say that
in keeping the monthly dues low, the condo association did not build up a cash
reserve to handle major repairs. So now there’s $50,000 in work that needs to
be done, and there are 25 equally sized units. You will get a bill for $2000
and if you don’t pay it, they will foreclose on you. (If you’ve ever had anyone
tell you emphatically that you should never buy a condo, this is usually the
scenario to which they are referring.)
We can’t circumvent
these issues but we can mitigate the risks. I can help you prepare a tax
valuation appeal, where we basically use information from different sources to
prove to the county that their appraised value of our property is too high. My
success rate on that is very high so far. We can contract with a property
management company for a very reasonable fee if you don’t want to handle tenant
issues directly; they will handle repair requests and rent collection problems,
evictions, etc. When it comes to condo associations, it’s all about choosing
the right complex. If an investment looks appealing, then we start talking to
the management company and requesting documentation about their history of
assessments and the health of their financials.
Now it’s time to think
about what your real goals are here: Are we looking for a property that has a
positive cash flow every month, or something that may have little or no cash
flow every month but the opportunity for fast and great appreciation in value?
The latter would be the way to go if you are looking for an investment to cash
out of and walk away with a large sum after 10 years or so of ownership. We may
be able to strike a nice balance of both.
You mentioned a condo
or a house. I would propose a third option. A duplex, if the location is good
and it’s in good shape, can often cash flow much more than a house or a condo.
The rents from each side often bear about 70-80% of what a single-family home in
the same neighborhood would lease for, and of course you multiply that by the
two units. There are lots of them available with existing tenants in them, so
the property is generating rental income from the day you close the deal. They
most often will only have one side vacant at any given time. They tend to have
more long-term tenants than condos do. There are also occasional short sale
opportunities (that’s a pre-foreclosure situation where the property is sold for
less than the loan amount, rather than let it go to
foreclosure.)
I have lots of
practical information for you and a few suggestions. Purchasing investment
property is a different mindset because it’s about the return on investment,
versus all the emotional considerations involved when it comes to buying your
primary residence. Because the risk is higher with investment property, I think
it’s important to approach each investment property with a “guilty until proven
innocent” assumption. “What are all the ways that things could go wrong at this
property?” is the question we need to ask ourselves every time we look at a new
listing.
So now that we’re in
skeptical-negative mode, let’s talk about the other tough parts of buying and
owning investment property:
1)
Money down: Investment property
generally requires 20% down thanks to the mortgage crisis. Lots of people
purchased investment property and when things got tough, they let those
investments foreclose while saving their own primary residences from the same
fate, so the investment foreclosure rate is higher than homesteads.
Consequently, the mortgage insurance companies stopped writing policies on
investment property. (Remember that for most mortgages, you have to have private
mortgage insurance until you have 20% equity in the property.) So that means
that the lenders won’t lend without the 20% down. (Note: there are always
exceptions. I know of some 10% and 15%-down financing, but because of lack of
mortgage insurers at that level, they really stick it to you on the rate.
They’re called “self-insuring.”)
2)
Property taxes: If you own your
primary residence there in Houston, you should have what’s called a
Homestead Exemption on your property taxes. It serves two functions: it gives
you a rather minor baseline discount on your property tax amount every year, but
it’s real value is in the cap it places on annual increases in home valuations.
So when the market normalizes and your neighborhood becomes a highly desired
area, your tax appraisal amount can only increase by 10% per year. With
investment property, there’s no such cap. So if you buy a condo in central
Austin and the
valuation goes up 20% in a year, you could see a substantial increase in
payment.
3)
Landlord headaches: Things happen when
you’re a landlord. Tenants lose jobs and stop paying rent, appliances break,
roofs leaks, etc. There will also be some time between one tenant moving out
and another moving into a unit where you are not receiving rental on the
property.
4)
Condo associations: These guys charge a
monthly fee, usually between $150 and $300, depending on whether there is pool.
There’s value in it: they take care of common area maintenance, landscaping,
exterior insurance and maintenance, and they sometimes cover the more minor
utility bills, like gas/water/trash. Each one is different. But in a condo
association, at some point, you will likely receive a “special assessment”
notice. If the building needs to have its siding replaced, and let’s say that
in keeping the monthly dues low, the condo association did not build up a cash
reserve to handle major repairs. So now there’s $50,000 in work that needs to
be done, and there are 25 equally sized units. You will get a bill for $2000
and if you don’t pay it, they will foreclose on you. (If you’ve ever had anyone
tell you emphatically that you should never buy a condo, this is usually the
scenario to which they are referring.)
We can’t circumvent
these issues but we can mitigate the risks. I can help you prepare a tax
valuation appeal, where we basically use information from different sources to
prove to the county that their appraised value of our property is too high. My
success rate on that is very high so far. We can contract with a property
management company for a very reasonable fee if you don’t want to handle tenant
issues directly; they will handle repair requests and rent collection problems,
evictions, etc. When it comes to condo associations, it’s all about choosing
the right complex. If an investment looks appealing, then we start talking to
the management company and requesting documentation about their history of
assessments and the health of their financials.
Now it’s time to think
about what your real goals are here: Are we looking for a property that has a
positive cash flow every month, or something that may have little or no cash
flow every month but the opportunity for fast and great appreciation in value?
The latter would be the way to go if you are looking for an investment to cash
out of and walk away with a large sum after 10 years or so of ownership. We may
be able to strike a nice balance of both.
You mentioned a condo
or a house. I would propose a third option. A duplex, if the location is good
and it’s in good shape, can often cash flow much more than a house or a condo.
The rents from each side often bear about 70-80% of what a single-family home in
the same neighborhood would lease for, and of course you multiply that by the
two units. There are lots of them available with existing tenants in them, so
the property is generating rental income from the day you close the deal. They
most often will only have one side vacant at any given time. They tend to have
more long-term tenants than condos do. There are also occasional short sale
opportunities (that’s a pre-foreclosure situation where the property is sold for
less than the loan amount, rather than let it go to
foreclosure.)
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