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Kevin J. Daum
Myth #1 - Paying off my rental property is good.
Culturally, we are taught that we should strive for owning
our real estate free and clear. With rental properties there
is also the appeal of positive cash flow and not having
payments to make. (See Myth #4). This is a very simplified
approach to investing in real estate. However, by not carrying
mortgages on rental property, you sacrifice tax savings
and investment returns, which could add up to tens of thousands
of dollars. In addition you tie up cash in poor returning
investments that could be making you more money elsewhere.
The point of investing money is to gain a solid return on
your investment. One hopes to get the highest yield (or
best return) possible on an investment while minimizing
their risk. There is no advantage when investing in real
estate to leaving any money on the table.
There are more significant ways to earn money on a rental
property besides just rent, the most important one being
through the increase in property value or what is called
appreciation. Ironically appreciation occurs regardless
of the amount you owe on the house. Therefore a higher return
on your investment dollars happens when you have less equity
in the property. Exploring all aspects of making returns
on investment property should be the number one priority
for any rental property owner.
The experts at Stratford Financial can explain the
different options available for making the most money on
your rentals and help prescribe methods for achieving those
returns.
Myth #2 – Apartments/Rental Units are better
Investments than Single Family Residences (SFRs)
There is a curious attraction to owning apartment buildings.
At first glance, multiple units have the promise of steady
rental income and seem like the best of real estate investments.
However, since units are valued strictly on the amount of
rental income they can generate, their appreciation tends
to be limited to the increase in monthly rent amounts. Since
inflation has been relatively low and rents are generally
tied to the Consumer Price Index (CPI), appreciation on
units has held to modest appreciation.
On the other hand, a Single Family Residence (SFR) is valued
not by the amount of rental income it will generate, but
by what someone is willing to pay for it. There are other
emotional factors that will affect the value of an SFR such
as location, design, size, landscape, etc. None of these
have anything to do with the rental income it will generate.
Higher vacancy rates can be a problem factor for apartments
and commercial buildings, especially in poor economic times.
Also the maintenance and upkeep can be more time consuming
and expensive to deal with. Now that we know the biggest
moneymaker in Real Estate is appreciation, which would you
choose?
The experts at Stratford Financial can help you analyze
which properties will yield the best returns and help you
make educated decisions.
Myth #3 - Managing houses is more difficult than
managing apartments/units.
One house, one tenant. Four units, four tenants. Four times
the trouble. Four times the repairs. Your phone will be
ringing off the hook from tenants when you manage apartments
or commercial units. People will be calling you at all hours
screaming about clogged sinks, overflowing toilets and complaining
about the neighbors’ noise levels whom they share
walls with. For the same amount of investment dollars a
house creates fewer problems and fewer complaints compared
to units.
Single Family Residences (SFRs) are also likely to attract
a more affluent tenant than an apartment. SFR renters typically
demonstrate a greater pride of ownership taking better care
of the home, and they tend to lease for longer periods of
time than apartment dwellers. If you still think managing
a home is difficult, you might consider purchasing a home
warranty. A home warranty is only available on SFRs and
not on apartment units. This is an insurance policy that
will generally cover all appliances and systems for the
house for around $200 annually. You have to pay a $60 deductible
if they come out to the home, but they can replace water
heaters and solve plumbing problems – without you
having to go see the tenant in a rainstorm.
The experts at Stratford Financial can explain the
different options available for maintaining rentals efficiently
and educate you as to the most efficient choices.
Myth #4 - Financing rental property is difficult
and expensive.
In the past it was more difficult to obtain financing on
investment properties. However, in recent years lenders
have introduced competitive rates and programs for Non-Owner
Occupied Single Family Residences. However, once you get
up over 4 units on a property, it is no longer considered
residential. Instead, it is considered a commercial property
subjecting you to commercial financing.
Compared to residential financing commercial financing
is typically shorter-term, with greater restrictions on
what you can borrow against the property and of course the
interest rates are higher. Qualifying for commercial financing
is also more difficult as the guidelines are more rigid.
Financing on residential homes is far more affordable, offering
longer terms and better rates. On rental homes, there are
programs offering as much as 90% of value and there are
also programs that don’t require income verification
called No Income Qualifiers.
The experts at Stratford Financial can explain the
different options available for financing your rentals and
help obtain you the best program for your situation.
Myth #5 - I should buy rentals near my home.
Do you really want to have your tenants as neighbors? If
being disturbed by your tenants is a concern then living
nearby is probably not for you. There is some appeal to
being close to your rental so that you could handle repairs,
keep an eye on the maintenance and upkeep, and be available
for emergencies. However, there are affordable alternatives
such as property management companies. For about 10% of
the rental income, a property manager will handle any repair
or maintenance calls, collect rent, perform accounting services
as well as fill vacancies when they arise. Hiring property
managers is also a great idea for managing long distance
rentals, or if you own multiple properties.
This gives you the opportunity to buy rentals where the
investment dollars make the most sense. Starter home neighborhoods
are the most likely to appreciate because they have the
most buyer demand. Expand your thoughts to locations that
are just now starting to develop where exponential appreciation
is possible. If you live in a mature neighborhood with high
values, you will likely see a poorer return on your investment
from rent.
The experts at Stratford Financial can explain the
different options available for managing your rentals and
help you make educated decisions.
Myth #6 - I should never sell my rental houses.
The amount of rent you earn compared to the value of the
property is what is called ‘Rent to Value or RTV.
Over time as a home grows in value, the less rent you will
be able to get for the home, lowering your RTV. Over time
your return on investment will decrease as a property’s
value increases. Also, without a mortgage on a property,
there is less tax deduction available. The longer you own
a property, the lower your principle on the loan balance
therefore the less interest you pay. These are a few considerations
when thinking of selling a rental home.
The reason most people hang on to their rental properties
is because they do not want to face the taxes on their gain,
if they sell the home. What most people don’t know
is that the more you pay down your mortgage, the more you
reduce the available deductibility of interest on that property
for good. The only way to reset the clock on the tax deduction
is to sell the property because you are limited on the interest
deduction based on the current loan up to the original loan
amount. By using a 1031 Exchange process to sell the property,
you can defer the taxes on the gain by rolling the proceeds
into another rental property and restart your interest tax
deduction.
The experts at Stratford Financial can explain the
different options available for maximizing your tax deductions
on your rentals and give you the questions to discuss with
your CPA.
Myth #7 - I should always strive for positive cash
flow.
When playing the lottery, what is it more often desired:
to take the cash option or the payments over time? Cash
now, right? Appreciation in a property is just like winning
the lottery – it’s free money, and the same
principle applies here. Why leave money tied up in your
investment versus in your pocket right now? Remember, income
you earn on your rental unit (positive cash flow) is taxable.
The best bet is to break even and make money from the appreciation.
To do this, you must leverage your liquidity balancing your
tax deductions with your rental income. If you are breaking
even then you are leveraging your investment wisely.
The experts at Stratford Financial can explain the
different options available for making the most money on
your rentals and help prescribe methods for achieving those
returns.
Myth # 8 - There is no way to get my money out of
rental property without paying taxes.
A 1031 Exchange allows you to defer taxes on the gain from
a rental property by selling the home and moving all of
the cash into “Like Properties.” Taking cash
out of a home through a refinance is not a taxable event.
The IRS will allow you to take cash out of a property, provided
that the refinance happens within a “reasonable time”
prior to the sale and exchange of the property through a
1031 Exchange. While the IRS does not specifically define
“reasonable time,” most CPAs and Tax Attorneys
agree that 6 months is considered to be a “reasonable
time” by IRS standards. By adhering to these guidelines,
you can extract cash without creating a taxable event allowing
you to pull money out of your rental property.
The experts at Stratford Financial can explain the
different options available for taking cash out of your
rentals and help you achieve that goal.
Myth #9 - 1031 Exchanges into limited partnerships
are a great return for little effort.
There is a trend for many people today to 1031 exchange
their rentals into limited partnerships that return 10%
annually on their investment. This seems to make sense if
your rental properties are all paid off (See Myth # 1) and
the rent you are receiving is low relative to the money
you have tied up in the property (See Myth # 6). However,
with a little bit of financial restructuring using leverage
and tax benefits, rental properties can continue to yield
50% to 100% annually on your investment with minimal work
and maintenance. So if you are sitting on $250,000 or more
in equity in a property, you could be earning a six-figure
income that could make retirement come a little sooner.
The experts at Stratford Financial can explain the
different options available for making the most money on
your rentals and help prescribe methods for achieving those
returns.
Myth #10 - There is no single resource to answer
my questions regarding Real Estate Investment and Finance.
Many people want to invest in Real Estate but don't have
enough information to maximize their investments. Choosing
a financing strategy without asking all the right questions
can cost you thousands of dollars, or even your dreams.
Stratford Financial - an INC 500 company in business since
1989, is dedicated to helping our clients make real estate
decisions based on knowledge rather than ignorance or emotion.
We educate and advise you so that you make informed decisions,
which you can profit from both emotionally and
fiscally.
Stratford provides information and products to help you:
- Understand the Single Family rental market
- Assess your ability to invest
- Buy the right property
- Structure your financing for maximum liquidity and tax
benefit
- Harvest your gains tax free through 1031 Exchange
Stratford has financed millions of dollars in rental properties.
We give you the questions you need to ask and point you
to the right people for the answers.
Click here to contact
us so we can help you maximize your rental investments.
Kevin Daum is the Founder and CEO of Stratford Financial
Services, a Real Estate finance and education company, founded
in 1989. Stratford specializes in Purchase loans, Refinance
loans and Custom Home Construction finance for California
and has successfully financed thousands of clients. Mr. Daum
was an Underwriter for Plaza Savings and Loan and Key Bank
of New York. He is an INC 500 CEO and has been listed as one
the 40 Most Influential People Under 40 in the San Francisco
Bay Area. He is the Global Chair for the Edison Innovation
Program with the Young Entrepreneurs' Organization (YEO) and
is a founding Board member of the Bay Area Chapter of YEO.
Mr. Daum is a frequent contributor to numerous business publications
on the subjects of Real Estate and Small Business leadership
and speaks regularly on both subjects. He can be contacted
at kevin@stratfordfinancial.com.
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