| Many Investors Lose Money On Their Rental | | | | Well, that feels a little better doesn't it? |
| Properties. Sometimes Without Realizing | | | | |
| It.Here is a typical rental scenario:Mortgage | | | | That may feel good, but here is the gotcha: |
| payment going out: $1,100 per month. Rent | | | | Your minimum payment is less than your |
| coming in: $1,200 per month. This gives you | | | | interest only payment. Since banks are not in |
| $100 a month in positive cash flow. Or does | | | | the business of losing money, they will still |
| it? On paper it looks good, but if you | | | | calculate the full interest only payment for |
| analyze the big picture and take into account | | | | that month, they will just be happy to accept |
| your entire cost to own that rental property, | | | | your minimum payment. So happy in fact, that |
| you are losing money in a big way. Let's | | | | they will take the difference between your |
| analyze those costs over the period of a | | | | minimum payment and the interest only |
| year:Holding costs. Let's say it takes three | | | | payment, and add it to the outstanding loan |
| months to find a tenant for your property. 3 | | | | balance. So now you owe them more than last |
| months mortgage payments down the tubes: | | | | month. Ouch.But wait, that may not be so bad. |
| $3,300Spend marketing dollars to attract a | | | | Why?You can still pay it like a 30 year or 15 |
| tenant: $500. Yard signs, newspaper ads, | | | | year mortgage and only use the minimum |
| flyers etc...Termite treatment: $150. Just | | | | payment when you have a vacancy. It will |
| the annual treatment, not to set up a | | | | reduce the pain in your wallet when you have |
| bondLandlord's Insurance: $350. This is a | | | | to spend money for marketing in addition to |
| conservative estimate. It could also be | | | | making the payment on that vacant |
| included in your mortgage paymentCleaning the | | | | property.This is an okay reason for getting |
| property after the last tenant moved out: | | | | an option ARM. But not a great reason. Why? |
| $350. This is if they did not trash the | | | | Because the rate (not the minimum payment |
| property. Carpet cleaning, touch up paint, | | | | which is fixed for a year), will typically |
| drive way powerwash, mowing, trash removal | | | | adjust monthly based on the index it is tied |
| etc...The water heater went out in February | | | | to. The most popular index is the MTA index, |
| and you had to replace it: $400. I don't know | | | | followed by the COFI. If rates are trending |
| about you, but I had years where this | | | | down, this mortgage is unbelievable. Every |
| happened, as well as the AC went out, the | | | | month you have to pay less since the interest |
| carpet had to be replaced, and the tenant's | | | | only payment is going down, and you have the |
| dog chewed all the window sills | | | | choice of the minimum payment in addition to |
| | | | that. If rates are trending up, then every |
| Total mortgage payments for the year: | | | | month your interest only payment will be |
| $13,200. Other costs: $1,750. Total cost of | | | | going up (while your minimum payment is fixed |
| ownership: $14,950Rental income of 9 months: | | | | for a year). When this happens, this is no |
| $10,800. Net loss for the year: $4,150Now the | | | | fun. By the way, as of May 2006 the market is |
| picture looks very different. Even after your | | | | trending up.Since this mortgage can make me |
| tax deduction of mortgage interest and | | | | cash flow very well every month, but also has |
| depreciation, you still lost money. The | | | | a downside, in which particular situation |
| simple answer is to increase the rent, but | | | | should I use it?Great question. This is the |
| normally your market does not support the | | | | question you should ask on every mortgage you |
| higher rent. I think the picture above proves | | | | ever get on an investment property. I would |
| that you need to have several hundreds of | | | | recommend this loan very strongly under the |
| dollars a month in cash flow instead of just | | | | following scenario:Your goal is to sell the |
| $150 a month, or you will have a loss for the | | | | property in the next two years or less, and |
| year. If you have multiple properties, the | | | | you will owe no more than 80% of the |
| situation gets worse in a hurry.How do you | | | | appraised value of the property on this loan |
| fix the problem?The simplest answer of course | | | | (90% is okay if you are going to sell in one |
| is to buy right. This could mean putting down | | | | year or less). This is the perfect fit for |
| 20% so that your mortgage is much lower than | | | | this loan program. Here is why:You can make |
| the market rent, or it could mean that you | | | | the minimum payment every month and enjoy the |
| need to buy your rental properties at steep | | | | maximum cash flow right now. You will incur |
| discounts. Putting down 20% every time you | | | | negative equity, but since your loan to value |
| buy a rental property will obviously limit | | | | is fairly low, it will not make much of a |
| how many properties you can buy, so the | | | | difference over a one or two year period. You |
| simplest answer here is the second option of | | | | will have roughly $460 per month of negative |
| paying less for the property.Let's say you | | | | equity for a total of $5,520 after one year, |
| bought your first property with 100% | | | | or $11,040 in two years (Not totally |
| financing, and at the end of the year your | | | | accurate, as your minimum payment will go up |
| CPA points out to you that you made a net | | | | by 7.5% of the PAYMENT, not interest rate, |
| loss of $4,150 for the year. This was not | | | | once a year. But close enough for our |
| part of the plan. If you can't increase the | | | | illustration here.)That may sound high, but |
| rent you are asking, what is there to do? | | | | here is the hidden benefit: that negative |
| Well, it depends on what the problem is. | | | | equity is deferred interest. When you sell |
| Let's analyze it:The 5 Biggest Reasons For | | | | the property after one or two years, you can |
| Negative Cash Flow Investment Properties | | | | take that accumulated deferred interest as a |
| | | | tax write off in the year that you sell the |
| You paid too much for the property. If your | | | | property (check with your CPA on this since I |
| mortgage is not significantly less than the | | | | am not a tax expert and I do not give tax |
| rent coming in, (and I mean several hundred | | | | advice). Since you can time this sale to a |
| dollars a month less), then you paid too much | | | | certain degree, you can use this deferred |
| for the property.You overestimated the rents | | | | interest deduction to reduce your total tax |
| you can get for your area. If you worked with | | | | bill should you have a windfall profit on |
| a real estate agent to buy your property, and | | | | another transaction in the same year. In |
| trusted their opinion of market rents, you | | | | other words, use the deferred interest |
| may have a rude awakening. Unless you are | | | | deduction to offset the gain in another |
| working with an agent that does rentals every | | | | area.Remember also that you always have the |
| day, or are a real estate investor themself, | | | | choice of making the full interest only |
| they will do a MLS lookup of rents and tell | | | | payment - you don't have to incur the |
| you what it is. That may be accurate for your | | | | negative equity if you do not want to. The |
| general area, but may be way off for your | | | | beauty of this mortgage is that it gives you |
| subdivision, or your particular home because | | | | options. Cash flow when you need it most, but |
| of property issues.You paid too much for the | | | | still reducing your balance if you want |
| propertyThe price you paid for the property | | | | to.The absolutely perfect fit is if you have |
| was too highYou should have paid less for the | | | | a high equity situation and are selling on a |
| property | | | | lease purchase. That way you can enjoy the |
| | | | positive cash flow now, and still get a good |
| | | | profit on the sale. Many investors don't make |
| | | | money on a lease purchase during the lease |
| If your problem is that you paid too much | | | | period. They only make money when the sale |
| for the property, then the rents in your area | | | | happens. In the time between you still have |
| of course will not be high enough, and if you | | | | to put gas in your tank and provide for the |
| overestimated the rents on top of paying too | | | | family though, and you need cash to do that. |
| much, you better have deep pockets or you are | | | | Let's see how the math works:You bought a |
| going to face foreclosure.Short of selling | | | | rehab with hard money, fixed it up, and |
| the property immediately, you can:Increase | | | | refinanced into an Option ARM. You choose to |
| Your Rental Income Without Increasing Your | | | | sell on lease purchase so that the sale will |
| RentsI am going to give you a financing | | | | take place at least a year since when you |
| strategy here that can let you cash flow | | | | bought the property, so that you will reduce |
| hundreds of dollars per month. But. Like | | | | your capital gains tax by half (since it is |
| everything else that sounds too good to be | | | | long term capital gains, not short term), and |
| true, it has a downside.There is a relatively | | | | so the property will season for mortgage |
| new mortgage product on the market (Been | | | | purposes. Since you have to feed your family |
| around for about 6 years), called an Option | | | | in the meantime, you get $680 cash a month in |
| ARM. It gives you 4 different ways you can | | | | your pocket while you wait for the big |
| pay it every month: | | | | paycheck.Now multiply this by 5 properties |
| | | | using the above scenario. Five times $680 is |
| Pick a payment similar to a 15 year mortgage | | | | $3,400 a month of positive cash flow. Can you |
| (build equity fast)Pick a payment similar to | | | | do with a little extra cash while you wait on |
| a 30 year mortgage (build equity slow)Pick a | | | | the big paycheck when you sell?Author: John |
| interest only payment (build no equity) | | | | Visser |
| ORPick the minimum payment (accrue negative | | | | |
| equity) | | | | our mortgage strategies for real estate |
| | | | investors forum at Visser |
| | | | |
| | | | Real Estate Investor and Mortgage Lender. |
| The minimum payment in option 4 can be as | | | | |
| low as 1.5% (calculated like a fully | | | | I have been investing in real estate in the |
| amortized 30 year fixed payment). If you | | | | Atlanta market for 5 years, using creative |
| choose to pay the minimum payment, your | | | | real estate strategies and many different |
| payment in the scenario of this discussion | | | | techniques for finding, funding, fixing and |
| will be $520 per month instead of $1,100 per | | | | selling.For the last three years I have |
| month (I'm assuming that taxes and insurance | | | | worked as a mortgage broker, helping many |
| are escrowed). Now if your rent is $1,200 per | | | | investors be successful in their investment |
| month, you have a positive cash flow of $680 | | | | strategies through the use of proper |
| a month on the same property with the same | | | | financing. |
| tenant and you never increased the rent. | | | | |