Only real estate offers the benefit of leverage.
As investments go, residential rental properties have plenty of pitfalls, from bad tenants to costly repairs. Uneducated investors “can easily lose all of their equity in a property if they overpay,” says Daniel Beckerman, founder and CEO of Beckerman Institutional, a wealth management company. But experts say savvy investors shouldn’t ignore the potential. No other investment lets an investor control a large asset while putting down only a fraction of the price, such as 20 percent. That relatively small cash investment could produce more than a 20 percent annual cash-on-cash return — and that’s before tax incentives and any price appreciation. Seasoned real estate investors have these tips for making money even in a sellers’ market.
Look in smaller, more affordable markets.
“Although residential real estate has appreciated over the past few years, it is far from overheated,” says Beckerman. While cash flow rental properties are hard to find in markets like Silicon Valley or New York, real estate is incredibly local. Many smaller markets aren’t overheated and have strong industries, like Cleveland, where there are world class medical facilities; Huntsville, Alabama, for its “rocket scientist” community; and Pittsburgh for its tech and film industry. All offer good rental cash flow and growth potential, says Katherine Fettke, co-founder and co-CEO of Real Wealth Network, a real estate investment club.
Build new rather than buy used.
Larger, primary markets require a different strategy. “In those areas we are building [new] and providing much needed inventory to a housing-starved market,” Fettke says. Her company bought an apartment building in Mountain View, California, across from Google. “Our business plan is to increase density from 250 units to 800,” she says. Real Wealth Network also is building single-family homes in Reno, Nevada, where there is massive tech migration from Silicon Valley, and in Tampa, where the company bought 4,200 lots during the crash when land was going for a song.
Take advantage of tax breaks.
The depreciation or paper loss that can be triggered by the investment is another advantage of buying rental properties, even in hot markets, says Thomas J. Williams, an enrolled agent and tax accountant who operates Your Small Biz Accountant. If the taxpayer is earning W2 wages, the depreciation could potentially trigger a partial refund of federal income taxes paid on those wages. But Williams doesn’t recommend buying residential real estate for tax purposes only: “To be clear, investors should not get into the business to lose money, but if their tax situation is structured correctly, it can be a favorable opportunity,” he says.
Try short-term, furnished housing.
In popular vacation rental markets where real estate is expensive to buy, investors can improve their cash flow by renting furnished homes to short-term tenants, says Flavia Berys, a San Diego-based real estate broker and attorney. “In San Diego, short-term vacation rentals typically net much higher rents than traditional 12-month unfurnished unit leases,” she says. The challenge is finding properties that are zoned for short-term vacation use. Some communities and properties, like condominiums, also may prohibit or have restrictions for short-term rentals.
Buy in working-class neighborhoods.
“There are approximately 41 million renters today. Based on their debt levels, low credit and lack of down payment, it is estimated that only 3 percent could qualify for a loan today,” Fettke says. “If that’s the case, landlords will be in business for a while.” That makes working-class housing a good, recession-proof bet. Alex F. Cohen, chief commercial specialist at Compass, a New York City real estate agency, personally invested in workforce-oriented, small, single-family rental housing in Miami’s Buena Vista neighborhood three years ago. “I targeted gentrifying locations with proximity to employment and amenities, and I have seen very good returns and dramatic appreciation,” Cohen says.
Stick to areas popular with investors.
“Inflated rental home prices typically occur when investors begin to compete with homeowners,” says Jeff Miller, co-founder of real estate agency AE Home Group. “To make rental numbers work, we advise clients to focus on neighborhoods that cater to lower-income renters.” Most of these homes, he says, are bought and sold by investors, and therefore the valuation is strongly based on the area’s rental potential. Instead of competing with homeowners who are willing to pay a premium to live in a neighborhood, you’ll be competing with other investors who have the same cash flow concerns that you do.
Get creative with units.
Adding units where they didn’t exist before may make sense in certain markets. For example, California’s new statewide legislation lets any single-family homeowner build an accessory dwelling on their property. “This adds a whole new potential return,” says Seth Philips, president of SP3 Realty in Los Angeles. “The land for the second unit is basically free because it’s already been paid for with the single-family home purchase.” In Washington, D.C., where housing is expensive, owners get a certificate of occupancy for the basement, separately meter it, then rent the basement apartment and stay upstairs or split the home into two rentals. “This is a highly lucrative trend,” says Cedric Stewart, founder of Entourage Residential Group.
Buy and flip.
Rental income isn’t everything. If the investor has a reasonable expectation of selling the property for much more than the original purchase price, it may be a sound investment even if cash flow is tight, Williams says. But don’t invest blindly or on faith alone. “I, like many seasoned investors, am sitting on a lot of dry powder while selling at what feels like top-of-the-market prices,” says Bruce Ailion, a realtor and attorney with RE/MAX Greater Atlanta. “Still there are buys to be had that require hard work, diligence, and skill to unearth. Like the truffle hog specially equipped to sniff out a truffle as much as three feet underground, hard work and special skills must be employed.”
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