Should You be Buying New or Existing Homes for Rental Properties

Should you buy new or existing homes for rental properties?  The rental property investor is seeking cash flow and value appreciation over the long term.  For years since the crash that began in 2007, rental investors who do not do their own fix & flip have for the most part been buying existing homes.  Many times they’re buying from fix & flip investors, or they’ve purchased ready-to-live-in foreclosure homes.

However, the foreclosures coming onto the market now are often “zombies,” homes in poor condition that have been abandoned through a long foreclosure process.  The fix & flip investors are enjoying a great market, as they can buy these at deep discounts and rehab for sale at retail or to rental investors.

There is a lot of competition for fewer foreclosures, so prices are rising.  This of course increases the amount the rental investor will have to pay.  Zombie homes cost more to rehab as well.  This evolving market brings the question of whether prices have risen to a point that buying a newly constructed home could be a viable rental property deal.

Builders are cautious.  They’re not flooding the market with spec homes, but they are beginning to become active again.  Let’s compare and contrast new versus existing homes for a rental property purchase:

New Delivers Desired Features

Renters want what buyers want; the newest popular home features.  The fix & flip property can be outfitted with some of them, but things like great rooms with dining, living and kitchen together aren’t as easy.  The new home hits all of the tenant’s hot buttons.  Usually they will pay higher rent for these features.

The Right Neighborhoods

Home builders are building in the popular areas of town.  Where buyers want to live, tenants want to live.  Your market research has been done for you, and buying in these growing areas can also be a good equity-growth strategy.

What about the Cost?

The first concern is usually whether a new home price will cut cash flow at competitive rent levels.  Obviously, you’ll want to compare what’s available to you for pricing.  However, sometimes you may be able to help a builder with a win-win deal.  They need to turn homes to roll funding for new building.  This keeps their sub-contractors happy as well.

Watching the market for new homes that aren’t moving as quickly as others could yield opportunities.  A builder has holding costs just like investors.  Helping them to turn a house that is sucking up interest and marketing money could help you to negotiate a great deal.

Factor in Warranty Savings

Buying a new home carries a warranty, and some builders even have extended warranties available.  Your budgeting to determine cost and potential rents should factor in lower maintenance and repair costs for the warranty period.  Over the long haul holding period, your repair costs should be lower due to the all new major appliances, plumbing and electrical.

It is Still all in the Numbers

Considering the pros and cons, it still boils down to the numbers and going out into your market and working deals.  Talk to builders and particularly check new home listings with longer than average days on market.  There could be a deal out there that will cash flow.  Of course, if you can buy existing homes at double-digit discounts to new home prices, then the numbers rule.

Financial Benefits to Owning Triangle Real Estate Investment Properties

There are basically four financial benefits to owning Triangle Real Estate Investment Properties:

1) Income by CFBT, or Cash Flow Before Taxes

2) Principal Reduction

3) Tax Savings by Depreciation

4) Appreciation

I will address each individually below.

1.  CFBT/Cash Flow Before Taxes:  To calculate the CFBT, you first need to know what your Gross Operating Income is.

Gross Operating Income (GOI) = Annual Rent (based upon the unit being 100% leased for the year), less your vacancy rate.
So if your unit leases for $1,000 per month and you historically have a vacancy rate of 5%, then your Gross Operating Income will be:

$1,000,00 x 12 months = $12,000.00
$12,000.00 x 5% = $600.00
$12,000.00 – $600.00  = $11,400.00
GOI = $11,400.00

Now that you know your GOI (Gross Operating Income), you subtract from that your Operating Expenses.  Operating Expenses can include such costs as:

  • real estate taxes
  • repairs
  • homeowner association dues
  • leasing fees
  • management fees
  • homeowner insurance
  • utilities
  • advertising
  • supplies
  • miscellaneous (anything else).

Let’s now say that your annual operating expenses will run about $5,400.00 per year.

So, you take your $11,400.00 (GOI) and subtract the $5,400.00 (Operating Expenses), you now have $6,000.00…and this is known as your Net Operating Income.

From your Net Operating Income, you will now subtract your Debt Service.  Debt Service is just a fancy term for your mortgage.  It includes your mortgage (principal and interest) over a 12 month period.

Presuming you pay $3,600.00 per year in Debt Service (that’s $300.00 per month x 12 months), you will subtract that $3,600.00 from your Net Operating Income of $6,000.00 and you now have $2,400.00.  Another term for this $2,400.00 is your Cash Flow Before Taxes.

2.  Principal Reduction:  This is the decrease in the principal amount you owe on your loan.  When you make a payment to your lender every month, part of that payment is allocated to the principal, and part of it to the interest that the lender is charging you. So therefore you are ‘paying down’ or ‘reducing’ the amount of the loan each month with each payment.

3.  Tax Savings by Depreciation:  We will get into depreciation a little more in a different blog post, but basically, you are able to write off the Personal Property Value, Building Value and Land Improvement Value of your property over ‘x’ amount of time.  The ‘x’ amount is determinant upon each category.  So with this depreciation, you SHOULD be able to save money on your taxes each year.

4)  Appreciation:  This is where the value of your real estate investment increases each year.  The percentage amount has been kinda screwy these last couple of years, but once things settle down, the appreciation of your real estate investment should equate to at least 2% annually.