Can family investors make the numbers work?
You might think that the rental market is controlled by gigantic real estate companies. But statistics show that the smallest range of ownership between one and four units is still largely the domain of family owners.
Of the country’s 48.3 million rental units in 2017, nearly half are made up of small clusters of up to four units, according to the Ministry of Housing and Urban Development’s 2018 Rental Housing Finance Survey. And of those, 72.5% belong to individuals like Sam Stoia.
The first step in every owner’s dream is to find a situation where the numbers make sense. If the projected mortgage and maintenance costs don’t cover the potential rental income, then you’re going through a lot of extra stress for little return (although that might still make sense if you expect the home’s value to rise considerably over time).
This is largely a local equation, since real estate markets vary enormously across the country. But in terms of national averages, monthly operating and capital expenses per unit were $830 in 2020 dollars, according to the Rental Housing Finance Survey.
Perhaps you have the advantage of already owning the property, having purchased at a lower price. For example, maybe your kids have grown up and moved out, and you suddenly have more space than you need. Your monthly rental expenses might be lower than average, especially if you live in one of the quieter markets in the country.
But if you’re buying a rental property now, the math becomes more difficult. The real estate market has been booming in recent years: the US national S&P CoreLogic Case-Shiller home price index, for example, has risen 20.55% over the past 12 months.
Meanwhile, interest rates have risen to over 5.5% for a 30-year fixed mortgage. If you take on debt to close the deal – 59% of rental properties have a mortgage on them – that means more shipping costs for you as the landlord. And interest rates for mortgages on rental properties are almost always higher than those for mortgages on owner-occupied housing.
If these initial costs are satisfied, do not forget the many costs to come. That means property taxes, maintenance and repairs, necessary upgrades, and all the other bills that drive homeowners up the freshly painted wall.
“Home prices have skyrocketed over the past few years, so the purchase price could take more of your retirement savings than you’re willing to spend,” says Glink. “If you have the money, remember that you will need to cover your property taxes, insurance, condo or homeowners association fees, and property maintenance. In the first few years of ownership, these expenses could eat up most, if not all, of the monthly rent you receive.
Good news is the often favorable tax treatment for landlords. For example, if the rental property is also your principal residence, you are exempt from capital gains tax on a sale of $250,000 in profit if you are single, or $500,000 if you are married and file jointly. (Ask your tax advisor about the tax ramifications if you live in part of the building you rent.)
Also, keep in mind that “generally, qualifying rental expenses (like property taxes, mortgage interest, operating expenses, and repair costs) are tax deductible,” says Pinnegar. Depreciation is another key tax benefit: since apartments deteriorate over time, you can spread this depreciation over several years and benefit from the deductions.
With any sale, you can also consider what’s called a 1031 exchange, whereby you defer taxes by buying another property. For all of these issues – including estate taxes, passing assets to your heirs – consulting an experienced CPA is always a good idea.
room for error
As an owner, you have options that can help things run smoothly. For example, many companies offer tenant screening, to ensure creditworthiness and weed out applicants with red flags like criminal backgrounds. You can also hire professional management to handle day-to-day affairs. This will obviously come at a cost and cut into your profit margins, but at least you won’t have to deal with plumbing issues at 2am.
As for Stoia, he likes the idea of his retirement plan being the four walls around him, instead of just abstract numbers in an investment account. That way, he won’t be a burden on anyone in retirement, and he builds equity and creates a legacy to pass on. “Ideally, you want your rental property to be where you live, allowing people to retire in their forever home,” he says. “I think it’s a great way to subsidize retirement.”
Chris Taylor is a senior correspondent for Reuters, covering personal finance and labor issues. He is a frequent contributor to Fortune magazine and has won journalism awards from the National Press Club, Deadline Club and the National Association of Real Estate Editors.