Is Real Estate Investing for You?

by Michael Licamele

Many people develop a substantial income and net worth by investingin real estate. At the same time, many investors walk away from real estatebitterly disappointed. Is real estate investing for you? Take the self-testbelow, and if you feel strongly about investing in real estate, take a lookat the exciting programs that Residential Finance Network has available.

Many first time home buyers wonder if they should consider purchasinga multi-family property to help defray the cost of home ownership. Rentalincome tempts many buyers to start out with a multi-family home that canbe retained as an investment property in future years.

A multi-family property is defined as a two, three or four unit property.Properties with five or more units are considered commercial properties,and as such require commercial mortgages. Single family homes with in-lawapartments usually are not considered two family properties, but may bedepending on the size of the unit in relation to the entire home.

Before jumping into a multi-family property, a home buyer must considerboth the financial and lifestyle ramifications. Many inexperienced homebuyers think that being a landlord means depositing a rent check. When abuyer becomes a landlord, he or she essentially takes over a small business.The asset of the business is the property, and the tenants are the customers.The landlord must maintain the physical asset, provide customer serviceto tenants and hopefully earn a profit on the operations.

Most multi-family home buyers make two financial mistakes when planningfor a purchase. The first is to assign the maximum possible market rentas the rent that they will receive from their tenants. There is a directcorrelation between rent prices in relation to competing apartments andthe amount of turnover among tenants. In other words, the higher the rent,the more likely that a tenant will move within a short period of time. Thisis due to the basic laws of supply and demand: tenant consumers will constantlyseek out the best value for the lowest price. In addition, the higher therent, the more incentive a tenant has to attempt to purchase their own home.Landlords should consider pricing their rentals competitively to reduceturnover, marketing expense and time taken to rent units.

Potential landlords also fail to make adequate provisions for rent lossesdue to vacancies and repair expenses on the rental units. If an apartmentnormally rents for $1,000 per month, most buyers will simply figure theirmonthly payment and subtract the $1,000. No apartment anywhere has everstayed 100% rented forever. Even the normal process of tenant turnover willoften cause the loss of one month's rent. Prudent landlords should budgetat least one month of vacancy per year in good rental markets, and two tothree months of vacancy per year in softer markets. This means that in agood market, the property in the example above would generate $917 per monthon average instead of the ideal $1,000.

Repair expenses are also vastly underestimated. If a new landlord isable to make most simple repairs, then costs should be limited to materialsonly. A landlord who must hire out all repair work however, will quicklyfind bills mounting. Holiday weekend midnight calls to plumbers for brokenpipes can inflict major casualties on a property's cash flow. Landlordsmust set aside a portion of rent revenues each month to prepare for theseexpenses.

Tenant relations is another vital function of property management, especiallywhen the tenant is directly above or below the landlord. Issues such asnoise, parking and garbage are hard enough for one family to manage, butthe landlord must help between two and four families manage these issueswithout driving each other crazy. Landlords can issue rules to tenants,but there is little recourse against non-compliant tenants except eviction.

Owners of multi-families must also understand that their property willtake longer to sell and will probably not appreciate in value as fast asa single family property. Multi-families suffer faster physical deteriorationdue to tenant wear and tear that is much heavier than owner-occupied dwellings.Moreover, less than five percent of the general home buying public actuallypurchase multi-family properties as their primary residence.

Multi-family homes have often had additional apartment units createdwithout proper zoning approvals. For example, many landlords convert thelarge attic of a two-family into a small studio or one-bedroom apartment.Owners avoid obtaining approvals either because zoning would not allow thechange or because they fear higher tax assessments with an additional incomeunit.

No buyer should attempt to purchase a property that does not have properzoning approvals, building code compliance and certificate of occupancies.Lenders will not permit a buyer to obtain a mortgage that is missing anyof these vital elements. More importantly, insurance companies will denyany claim by a property owner for a loss on a property that did not haveall approvals in place. The last problem a new owner wants is to have townofficials knocking on your door the day after you move telling you thatyou are going to be fined for a zoning or building code violation.

Finally, multi-families are treated differently by the IRS for federalincome tax purposes than a single family home. Specifically, the home mortgagededuction is only available for the portion of your home that is used asyour residence. A home owner who lives on the first floor of a three familyhome may only deduct one third of the mortgage interest for the property.

While many parts of being a landlord can be overwhelming, owning an incomeproducing property can be an excellent long-term project if managed properly.

Michael Licamele is President of Residential Finance Network.