Buying Investment Property: How to Make Quick ROIs

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Buying property is a long-term investment. If you’re looking to make quick income from property, the only way is to buy low and sell high with minimal input for remodeling, upgrades, or even paint. However, if you intend to keep your property as a rental here are a few of the basics to make it profitable sooner.

Show Me the Numbers

Say you buy a house for $300,000. To get a loan for an investment property you’ll need a minimum of 20% down; so in our scenario, that’s $60,000. Closing costs depend on so many things that even an estimate is difficult, but rule of thumb is three to four percent of the purchase prices. Go with an even $10,000 to keep the numbers easy. You’re out-of-pocket $70,000 by this point.

The mortgage is for the remaining $240,000, so a 30-year fixed rate at 4.5 percent makes your principal and interest payments about $1,200 per month. Add to that property taxes of about $6,000 per year, or $500 per month, and homeowner’s insurance for about $150 gives you a monthly payment of $1,850. If you have an HOA, that might be an additional $50 per month. That’s $1900 for the basics, every month.

These numbers do not factor in upgrades, changes, paint, flooring, appliances or anything else, so remember that those items eat away at your profit too.Say that you rent it for $2,500 per month. That gives you a $600 difference. From that amount comes management fees if you pay someone to manage it for you. It also pays for lawn care unless you turn that over to the renter. Plus, for every month it goes unrented between renters, you carry the entire amount. 

Positive Cash Flow

You decide to manage it yourself and have the tenant take care of the lawn. Presuming no major systems require repair during the first year and you rent it within a month, you receive $27,500 ($2,500 x 11) in rent. You pay out $22,800 ($1,900 x 12) leaving you with $4,700 positive cash flow.

Assuming you never have to spend anything on repairs, maintenance, increases in taxes or refurbishing between tenants, it will take you 12 years and nine months to make back your down payment. Of course, if you raise the rent every year or so, you’ll shorten the time to repay the down payment, but you may lose more tenants.

Is It Worth It?

Yes! After year 12, your profits increase. But only if you follow these guidelines:

  • Do buy in a nice, livable area where people want to rent.
  • Don’t overspend for the property.
  • Avoid frivolous upgrades with low R.O.I.
  • Vet your tenants.
  • Remove tenants that damage property or don’t pay rent.Use a property management and marketing service to reduce unrented months.
  • Know the property owner and tenant laws in your municipality. 

Some properties are more profitable than others or are profitable sooner. Your investment real estate professional knows the difference and can help you choose the right property for your investment situation. If you want to invest in real estate, let your professional agent guide you.

1031 Exchange Basics

“1031 exchange” or “like-kind exchange” are terms you may have encountered in the real estate world. While the name might make it sound like a tax form, it actually refers to an entire type of business transaction. If you are interested in buying or selling investment property, it’s important to understand what this type of transaction entails. Once you learn the basics of 1031 exchanges, you’ll know what to expect and if you may benefit.

A 1031 exchange is a specific type of transaction involving the sale of an asset specifically as to avoid losing profits to taxes. In real estate, this would mean selling an investment property and using the money earned toward acquiring a different investment property. This way, the seller can avoid paying certain taxes they would normally be liable for in the property’s sale.

What Type of Taxes Can Be Deferred?

According to Investopedia, the most common reason to use a 1031 exchange is to defer capital gains tax. Capital gains tax is based on the difference between the price you paid for an asset and the price you sold it for. Therefore, a bigger profit equals higher tax. When you complete a 1031 exchange, you may defer that tax as long as you don’t gain any additional monetary benefit from that original sale. You can technically defer this tax indefinitely, saving money to use in future investments.

Another tax incurred by selling a property is known as depreciation recapture. This tax is in place to balance out the deductions property owners can claim for depreciation in their tax returns. Depending on the seller’s tax bracket, this can add up to a big number on the tax bill for a property sale. 1031 exchanges can also allow you to defer this depreciation recapture tax to save money.

What Does Like-Kind Mean?

One of the key requirements for an 1031 exchange is that the property you buy must be “the same nature or character” as the property you sell, according to Millionacres. Though it might sound like it, this rule does not limit you to purchasing the same type of property in terms of style, function or size. You may “exchange” a retail property for a duplex, for example. You may even sell a plot of undeveloped land for a fully furnished office building. The “like-kind” requirement refers to the purpose of the acquisition rather than the literal purpose of the property. The required purpose is to hold on to the property as an investment.

I Want to Flip a House. Can I Use a 1031 Exchange?

There is an important difference between intending to hold a property as an investment versus the intent to sell that property quickly for a profit. Technically, there are no specific guidelines about how long you need to hold on to a property for it to be eligible for a 1031 exchange. However, most properties bought to “fix and flip” are not likely to be approved for this type of transaction. Always consult a qualified tax professional if you’re unclear about what does and doesn’t qualify as an investment property.

A 1031 exchange can be a great strategy for real estate investors. Though it’s a long and complex process, knowing the basics of the term will help you navigate the financial side of the real estate world with more confidence.