You May Want to Think Carefully Before Deciding on Residential Real Estate As An Investment
Owner-occupied real estate is one of the best long-term investments one can make. History has shown owner-occupied real estate has produced tremendous long-term returns. In a few areas of the country the tremendous returns have even been short-term. In some cases homeowners have sold homes held 30 or 40 years, for 30 to 40 times their original cost. Other types of real estate investments, are the non-owner occupied rentals, and a combination of the owner-occupied/non owner-occupied rentals. The least expensive for maintenance cost is the owner-occupied real estate investment. The most costly is the non owner-occupied rental. The hardest part of real estate investing is to know when prices are inflated or down. To understand this you must do a lot of research or endure a lot of pain until prices stabilize. Residential real estate as an investment requires, skill, intelligence, research, intuition, a lot of time, very hard work, and luck.
The advantages and disadvantages for all three types of residential real estate as an investment is listed below.
Advantages of owner-occupied real estate are:
- You can qualify for the lowest interest real estate loans available
- You can qualify for low down payment consideration, of 5%-10%. There are also extra low-down payment loans for first time buyers who qualify, as low as 3% down.
- You qualify for a full array of owner-occupied tax deductions.
- Most owner occupied homeowners take pride and joy in maintaining their own home, so the long-term maintenance is usually reasonable.
- Owner-occupied real-estate profits have been tremendous when held long-term.
- There is a capital gain exclusion for taxes up to $250,000 if you have lived in the house for 2 of 5 years.
Disadvantages of owner-occupied real estate:
- The debt carried when a home is leveraged with a mortgage loan.
- The responsibility of up-keep, for some this is an advantage, since they enjoy the up-keep.
The next possibility for real estate as an investment is residential real estate rental property or 100% non owner-occupied property. A few investors have very good luck with rental real estate as an investment, while most find it very costly and highly stressful to deal with tenants, even when a management company is hired to collect rents and maintain the property.
The advantages of residential non owner-occupied real estate as an investment (rental property):
- It is possible to have high returns when held long-term.
- You can depreciate the property (this is far more advantages for property purchased prior to 1987 though, the depreciation deduction is much less after that year).
- You get a deduction for up-keep.
Disadvantages of residential non-owner occupied real estate as an investment (rental property):
- Non owner-occupied mortgage loans carry a higher interest rate than owner-occupied loans.
- Required down payment for non owner-occupied loans is much higher than owner-occupied loans. In many cases requiring 20%, compared to an owner-occupied loan of 3%-10% down.
- You must pay capital gains tax on profits, when you sell.
- Yearly maintenance cost for residential non owner-occupied real estate is usually much higher than owner-occupied cost. Most people simply do not properly maintain property that does not belong to them.
- Long-term maintenance cost can be phenomenally high.
- Is difficult to find reasonably priced properties in quality neighborhoods.
- Neighborhoods with a lot of “four rent” signs are particularly difficult to avoid vacancies.
- Lost rents are not deductible.
- A low quality neighborhood (that with high unemployment), brings a low quality tenant, i.e. the default rate on rent payment is high.
- The debt carried when the rental is leveraged with a mortgage.
The combination of an owner-occupied/non owner-occupied residential real estate can be a viable consideration for those who feel some form of non owner-occupied rental real estate is a must, as an investment. An example of a combination of residential owner-occupied and non-owner occupied real estate is a four-plex where you live in one unit, and rent the other three.
The advantages of the combination owner-occupied/non-owner occupied real estate investment:
- You can qualify for the lower interest owner-occupied mortgage loan.
- You can qualify for the lower down payment of 10% allowed with your owner-occupied real estate.
- You can deduct the repairs and up keep on the rental portion.
- You are present to monitor the repairs and encourage maintenance.
- You can depreciate the rental portion.
You have a better probability of purchasing a property in a quality community since your initial cost are lower than a non-owner occupied property. A quality community brings a higher probability of a quality tenant. Attracting quality tenants is probably the most important aspect of residential non-owner occupied investments.
Disadvantages of the combination owner-occupied/non-owner occupied real estate investment:
- Your tenants may know where you live.
- You can only deduct expenses for the rental real estate portion of upkeep, but not your own.
- You will be liable for normal capital gains taxes on the non-owner occupied portion when you sell. There is a capital gain exclusion on the owner-occupied portion.
- In our example, it would be 25% of the profit up to $250,000. This is current as of 2004.
Laws change on just about everything, yearly. Consult directly with current Internal Revenue publications for the latest changes.
See IRS publication 527 at www.irs.gov: Residential Real Estate Property
See IRS publication 523 at www.irs.gov: Selling Your Home