So you want to be a slum--er--landlord, eh?Aug 22, 2000 Write an essay on this topic.
Is real estate investment for you? Here are some advantages and disadvantages to help you decide.
Let's assume you're renting out some property other than the one you're living in. There are a few scenarios where it makes sense to rent your house while you're renting somewhere else, e.g. if you are on temporary relocation assignment, but for most people, the tax advantages of home ownership start by owning your own residence.
Let's also assume we're talking about renting a single family residence, such as house, townhouse or condo, rather than a commercial building or multifamily unit (other than e.g. a duplex).
The potential advantages of real estate for investment purposes are current income, capital gains and tax advantages.
Current income: You can charge the going rate for your property on either a month-to-month or lease basis. This comes to you as direct income, without any social security or other payroll tax. You will owe income taxes on your net rental income, but this will be reduced by expenses (see below), so the taxes can be reduced. Rents will generally increase over time as the cost of living increases.
Capital gains: Most real property appreciates in value over time. This is not guaranteed, and may fluctuate due to national and local economic reasons, but the right property has the potential to appreciate at a rate comparable to fixed rate investments over time, and higher in some cases. At the same time it is paying current income! Capital gains are taxed, though under certain circumstances you may be able to convert your rental property into a residence for two years and take advantage of the capital gains tax exemption of up to $500,000 per couple on real estate sales.
Tax advantages: This is beyond the scope of an epinion, but in general you can deduct depreciation, interst, expenses and taxes associated with a rental property provided you meet tests for number of days the property is rented. Depreciation is taken over 27 years for the dwelling. In the right combination of economic circumstances, rental income will equal the mortgages, taxes, expenses and depreciation, meaning you will owe no taxes, yet receive cash in the amount of depreciation each year. The depreciation will decrease your basis over time, increasing your capital gain at time of sale.
Sounds great. But of course there's a catch! There are a number of factors that make real estate investing higher risk than financial investments such as stocks and bonds. The primary ones include poor liquidity, property issues and tenant issues.
Poor liquidity: there is no exchange for homes. You might not be able to sell the property when you no longer want to own it, or may not get the price you would like. This can be problematic in the event that you need to move to another area, or have a sudden change in personal finances. Don't invest money that you will need within five years.
Property issues: As with any dwelling you own, the property won't take care of itself. Maintenance and repairs will be needed on an ongoing basis, moreso with older properties. You can handle this yourself, or you can contract with a management company to coordinate repairs so that you don't need to spend your vacation overseeing a roof replacement.
Tenant issues: Income is dependent on tenants. When tenants turn over, you may have periods of no rental income. Tenants may also refuse to pay rent, forcing you to evict them, often with associated damage to your property. It is very important to check out all tenants prior to renting to them. Again, management companies can provide marketing, lease administration and rent collection service, at a cost of perhaps 8% of rent (including property maintenance).
Real estate investing is more complicated than financial investment, but it can be a part of a well balanced portfolio. In times of inflation, such as the 1970's, real estate did better as an investment than the stock market, since rents and prices increased. Conversely, in a deflationary economy like the early 1990's, you may suffer through periods where units cannot be easily rented or sold for your cost.
In the end, you make the choice by how much you look forward to the challenge of owning additional property. In the most common case, you might find that owning a vacation home in a resort area provides you a ready-made vacation for up to two weeks per year, combined with an active rental market for at least part of the year.
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