STEP 1 HAVE AN EFFECTIVE INVESTMENT STRATEGY
Successful investing rests squarely on building a strategy based on business goals which help to choose the best investment property's location and type. Understanding the investment property market takes time to learn and understand, so the fourth part of a successful strategy (besides goal, location, and type) is to make the best use of best advice. We discuss investment goals in "A Proven Strategy for Buying Your First Rental Property" and "Don't Chase Yield when Buying an Investment Property." Successful investors continually ask themselves, "Is this the best advice I can get, and am I making the best use of that advice?
Answering that question is what this article is all about.
STEP 2 WHERE TO INVEST IN REAL ESTATE
Real estate is global. Many factors, from global to local, affect current prices, future capital value, and current rental income. As well as global and regional factors to consider, each country has its own income, real estate, and capital gains tax regulations. They also have their own purchase, financing, and sales costs. These costs have a direct effect on cap rate, net cash flow, leverage, and future profits.
Within each country there are cities. Each city has benefits and disadvantages for the real estate investor (both domestic and overseas investors.) By taking regional and national factors into account, and then drilling down to the city level, investors are more able to make wise decisions and the best choices, so they maximize the results that deliver on the seven reasons listed above.
STEP 3 CHOOSE A GOOD LOCATION
The right location is critical to ultimate success. In our article "An Analysis of the Best Cities to Invest in Rental Properties in 2019" you will see a detailed analysis of the subject. In summary, the International Monetary Fund studied 57 economies and divided them into three categories as far as real estate investment is concerned. We linked this study to UBS Wealth Management's most recent report on 20 individual cities. It is clear that some of the world's cities, such as Hong Kong, Toronto, and London are in what UBS calls "bubble-risk" territory. Others are listed as over-valued, fairly-valued, and undervalued.
Our focus is on New York City, particularly Manhattan and its neighborhoods, and on Miami. We have additional information on Downtown Miami as well as general tips for investing in, and getting advice on, Miami luxury real estate and New York real estate.
Location matters. The right location for the investment property plus choosing the right property itself will deliver on all seven reasons listed above. Each city has neighborhoods, and those neighborhoods will deliver price appreciation to a larger or smaller extent. Each neighborhood will also appeal to specific rental market types. Such types include, for example:
STEP 4 CHOOSE THE RIGHT PROPERTY
Different property types attract different types of tenant. When investors choose the right type of real estate they can then look more closely and choose the right building. There are several types of good rental property.
Multifamily homes make excellent rental properties. A multi-family property is, basically, a building in which there is more than self-contained home. The building may be a duplex (two homes,) a triplex (three homes,) a quadplex or fourplex (four homes,) or an apartment building (condo or cooperative development.)
There are several advantages to investing in a multifamily home. Choosing a property which specifically meets an investor's immediate and longer-term goals is straightforward. Many renters almost automatically choose a multi-family unit, so the market is strong. They go down this route because they are the types of property most available, so it is easy for them to choose the specific property that is right for them. They will find neighbors "just like them" so social and family life will be enjoyable.
The building will have a professional property manager to both maintain the amenities, and to handle problems.
Multifamily investment properties maximize or, at the minimum, smooth yield rates. If a single-family investment property is empty for a month, the yield is reduced by 100%. If one unit of a fourplex is unoccupied for
If a family member lives in one unit and is the property manager for the others - to learn the basics of managing and running a business - then the income from the other units pays for, or contributes to, the costs of the family member's home and generates profit to invest in the next property purchase. Those two factors are an incentive to ensure the rental property business is successful.
STEP 5 CHOOSE THE RIGHT BUILDING
Once investors choose the property's location and the property type, the next decision is about the choosing the right building. There are two sides to this decision; the investor's side and the tenant's side. Get them both right, and the result is investment success.
Again, the decisions incorporate the underlying goals. In simple, practical terms the decisions are based on such things as:
Tenants tend to choose a home based on five criteria. They boil down to prestige, privacy, space, view, and convenience. "The PPSVC of renting." These factors are not in any order of importance since some tenants prize one or more over the others. Let us discuss them:
A less impressive view may not deliver a high enough yield to cover the purchase cost premium, but by leveraging the investment that issue is mitigated, and the prize comes on the sale price. Units with better views, especially if there is little to choose in rent payments, will always see higher occupancy rates than units with poor views.
When both the owner's and the tenant's sides get taken into account, it is easier to choose the right building, and then to maximize cash flow and profit.
STEP 6 THE COST COMPONENTS OF A REAL ESTATE INVESTMENT
Wise investors understand the costs of buying and owning an investment property. Cost components fall into three main categories:
Acquisition costs include the price paid for the property plus purchase of items needed to rent it out. In Manhattan and Miami, kitchen appliances are usually included in the purchase. In Manhattan flooring in a new apartment will be but in
Buyers pay for their inspections, title insurance, title agent fees, and closing attorney fees, plus prorated costs such as taxes or management fees the seller has prepaid. Operating costs include such items as property management fees, insurance, taxes, utilities, and mortgage costs, etc. These should be covered by occupying tenants' rents. Owners may also responsible for their own marketing costs when looking for tenants.
When owners sell their investment property they will pay the broker's fees to market the property and to find a ready, willing, and able buyer. They may also hire their own legal advisor, as well as being responsible for any repairs to make the property safe and functional.
STEP 7 THE OTHER SIDE OF THE COIN
While there are costs, there are also valuable tax benefits that investors use to minimize their costs. It pays investors to understand property tax rules and regulations because the purchase and management of the property is a business transaction, so all valid costs are tax deductible.
The IRS rules are very pro-investor unlike in many countries. As well as direct costs of purchase and ownership being tax deductible, an owner can depreciate the property's value over 27.5 years. So, even though, the property gains in market value, it can still be depreciated for tax purposes. When it is time to sell, by using a 1031 Exchange (see below) the potential tax can be deferred as long as the sales proceeds are invested in another "like-kind" item. "Like-kind" does not, for tax purposes, necessarily mean another piece of real estate.
New York city offers tax abatement opportunities, and Florida does not have a state income tax. Foreign investors should seek advice on establishing a corporate entity and other tax matters, so they avoid or minimize US tax liability.For US business entities, if the rental business's taxable income is less than $315,000 (and it is not a C Corporation) then a "pass-through" deduction equal to 20% of the qualifying business income may be deducted from the tax bill. US tax laws are very pro-business, and the recent tax law changes for investors and homeowners deserve special attention.
STEP 8 WHAT IS A 1031 TAX DEFERRED EXCHANGE?
The 1031 Tax Deferred Exchange (named for Section 1031 of the US Internal Revenue Code) enables an investor to sell a property and to use all the sale proceeds to buy one or more "like-kind" properties of equal or greater value, within an approved timescale, without paying any capital gains tax on the property being sold. The tax is deferred until there is a final liquidation without further investment.
The 1031 rule, therefore, is an excellent way of maximizing return on an investment because all the profit can be used to buy the next property (or properties) without passing any of the profit to the government.
Investors can use this benefit to consolidate or diversify current investments, make the most of an emerging market, make better returns elsewhere, or reset the depreciation clock. Brownstones held in New York can be "exchanged" for new apartments in Miami, for example. Vacant land or a commercial building held in Miami can be "exchanged" for other investment real estate in New York. The options are many, the rules governing exchanges are tight, and the transactions must be handled by an approved intermediary.
By relying on sound advice from the real estate agent or property manager, investors can maximize their returns. This brings us to the next section.
STEP 9 GETTING THE RETURN ON YOUR INVESTMENT
Obviously, there are three major components to getting the biggest return on your investment. The first is the price you pay. Considering the eventual resale during the purchase process is a sign of a successful investor. The article in the link focuses on Miami, but the principles discussed are components of any investment property purchase/resale thought process.
The costs of, and the income from, ownership are critically important to the ultimate return. A question our clients often ask is how to get the most bang for their buck – besides negotiating a great purchase price on the right property in the right location. A powerful way to ensure that is to leverage the purchase.
The first, and obvious, is to take out a mortgage loan on the property. Foreign investors learn there are well-established and willing American lenders when looking for real estate loans. Domestic investors often put down 20% and borrow the rest. Overseas investors often make a 50% down payment.
The down payment may come from stock market profit-taking, or the sale of an existing property to make the most of price appreciation and the 1031 Exchange benefits. The cost of amortization is tax deductible, of course, and the tenant is there to cover the loan costs via their rent.
The second most common way is to use the equity in a current property to use as the down payment. The two ways of doing this is to take out a mortgage loan using the property's equity for security. The second way is to use a home equity line of credit (HELOC.) The main difference is that the line of credit can be used for anything and interest is only paid on credit used. It, therefore, enables a more subtle approach to looking for the right investment property, and to cover the purchase costs and those of any renovation, etc.
An obvious benefit of financing the purchase is that price appreciation of the property is being funded by the down payment and the rental income. A $600,000 down payment on a $3 million property which sees a price appreciation of 5% ($150,000) means the appreciation represents a 25% return on the down payment amount.
Financing for accredited investors makes good business sense.
Using the right property manager will maximize occupancy because the management company will market the property to potential tenants, vet them, and manage the rental contract while it is active. The decision to contract out that activity often produces better tenants and higher occupancy rates. Both result in a higher yield.
The third element of getting the right return is to put the sale in the hands of a skilled and successful real estate agent who will market it correctly. The agent will help to negotiate the best price the market will bear, on the best terms for the current owner, and within the owner's preferred timescale.
Put those three elements together, include a 1031 Exchange if appropriate, and the property will generate the highest return on the investment.
STEP 10 PROPERTY MANAGEMENT FOR INVESTORS
Managing investment properties effectively takes time, skill, and experience. There are two kinds of property management, "light property management" and "full property management." Light property management is a route many clients take because it takes care of the initial, critical elements, and can begin as soon as the chosen investment property is under contract.
This service manages all the steps beginning with finding the right tenant. The investment property is marketed to prospective tenants, the tenant is screened, the lease prepared, applications to condo boards are supported, and any necessary repairs, etc. are arranged. Light property management excludes handling tenant or landlord monies but does include terminating and renewing leases.
This service includes handling rents and paying bills, etc. with full accounting services and financial reporting. It also takes care of tenant evictions should that ever be necessary.
STEP 11 FINAL REMARKS
Buying and owning investment properties is a profitable business model, and a well-proven way to build and protect wealth. By leveraging investments, taking advantage of all the potential tax allowances and deferments, and installing the right tenants maximizes yield and price appreciation.
Choosing an experienced property management company to market the investment property, select tenants, and arrange landlord-protective lease documents is another sensible element of becoming a successful investment property owner. Investment properties prove themselves to be a solid way to achieve many goals.