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.

Cost Recovery / Depreciation for Real Estate Investments

If you have purchased property that you intend to rent or converted a previously owner-occupied unit to rental property, you cannot deduct the entire cost of the property in the year in which you purchased it. The Internal Revenue Service, IRS, considers real estate a capital asset, meaning it has a useful life of more than one year. The cost of all capital assets must be allocated over the useful life of the asset as determined by the IRS. Current IRS regulations require you to depreciate all rental property with the Modified Accelerated Cost Recovery System, MACRS. Before you can calculate depreciation for real estate investments, you must determine the cost basis in the asset.

Cost recovery (depreciation) is the periodic allocation of the cost of qualified assets.  When a taxpayer, or in some cases a lessee, purchases a qualified asset they are allowed to recover the acquisition cost of the asset through certain deductions set forth in the Internal Revenue Code.  The method and length of recovery periods depend on the type of property purchased.  The IRS has produced cost recovery tables for the various types of property.

As of the time of this writing (Fall 2013), the following are the current depreciation categories and recovery percentages:

Recovery Percentages for Residential Rental Property
27.5 years

Recovery Percentages for Non-Residential Rental Property
39 years

Recovery Percentages for Land Improvements
15 years

Recovery Percentages for Personal Property
5 years

Sorry, no depreciation is allowed for land