Will 2021 be the year you take advantage of these incredible interest rates and purchase a rental property? A few things to consider before you do. First, we are not accountants or attorneys, please seek guidance from those professionals regarding any strategies mentioned in this post that you would like to pursue further.
What is Your Strategy
What would you like to accomplish as a real estate investor? Are you looking to create more income, or generate losses and tax deductions against your current income? Depreciation is a powerful tool, and buying rental properties can be a great way to generate income and great tax deductions at the same time. Flipping houses presents an opportunity to create more earned income, but that comes at a price as you are taxed not only on your profits at your tax bracket, you also are subject to capital gains tax. If you are looking to generate more income for whatever reason, flipping houses is still a great strategy to consider. Maybe you want to qualify for larger loans and need to show more borrowing power, maybe you have watched your fair share of HGTV and you’re ready to design a dream house, or maybe you are looking to diversify and create additional sources of income. If so, flipping could be for you! Keep in mind, in our market, the good deals are getting harder and harder to find and the margins are getting smaller for flippers as there has been an unbelievable demand for Monterey Peninsula fixer uppers this year. Rental properties, on the other hand, offer several long term benefits worth considering.
Owning rental property has four main benefits, and some markets make it much easier to achieve these benefits than others. Ours is particularly difficult for rental property investors due to the price to rent ratios local investors experience. A price to rent ratio is the ratio of the price of the home in relation to the rent the property generates. Many investors across the country look for at least a 1% price to rent ratio, so if the price of the home is $200,000, they would like to see $2,000 in monthly rent in order to have their mortgage and expenses paid and make a little bit of cash flow every month. In our market, a 1% price to rent ratio is almost unheard of, but cash flow is not necessarily the most important thing to real estate investors on the California coast. If they can put a large chunk down to break even or get close to breaking even, many local investors are satisfied and will focus more on the long term appreciation, which historically has been much stronger than other markets such as Florida or the midwest that offer 1% price to rent ratios generating better cash flow but less appreciation. So, what are the four main benefits of owning rentals?
Benefits of Owning Rental Real Estate
Principal Paydown – Ideally, your tenant will cover your mortgage or at least close to it, building your net worth and paying down your debt every month.
Cash Flow – As we discussed, some markets generate more cash flow than others. The Monterey Peninsula is not a winner in that regard, but you might be able to find something with a guest unit or opportunity to convert a garage to an accessory dwelling unit(ADU) to generate more income from that particular property. What can you do to get your property performing at its highest and best use?
Appreciation – We have all watched real estate increase over the years despite some significant downturns, but many investors put their money into real estate in hopes that the market will continue to weather recessions and increase their property values.
Tax Benefits – As the owner, you would depreciate the property over its usable life, which is 28.5 years. So, if you purchased a property for $1,000,000, you would divide that $1,000,000 by 28.5 years, creating roughly $35,000 in depreciation per year. There are advanced strategies known as bonus depreciation and cost segregation studies that can allow you to accelerate the depreciation on your rental property that many investors utilize to offset their income. There are some great books and online content on both of these strategies. The real magic is the combination of all of these benefits. Ideally, your investment property would be appreciating in value while depreciating to create losses. Your net worth increases as your tenants pay down your note, and maybe – just maybe – you generate a little bit of cash flow.
What are your questions on real estate investing on the Monterey Peninsula?