The property that was purchased a year ago for $350,000 is now worth $409,500. Although interest rates remain low, they don’t make up the difference in affordability. That means many would-be homebuyers can’t afford to purchase and continue renting.
What does this mean for investors? A serious cashflow opportunity. In today’s market, rental investments are yielding excellent returns.
However, it’s important to take note of additional factors that can contribute to an increase in cashflow and ROI. These include deciding between short-term versus long-term rentals, tax advantages of owning rentals, knowing the right financing options and more to ensure you’re not leaving money on the table.
Long-term vs. short-term rentals
One of the first considerations when acquiring a rental property is whether you plan on using it for short-term (vacation) rentals or the traditional long-term rental route.
Your first instinct might be to scoff at the idea of short-term rentals after watching the pandemic virtually shut down all vacation rentals in the country. However, don’t be too hasty in ruling it out.
Before the pandemic — and even today, as the market recovers — short-term vacation rentals have been outperforming traditional hotels in high-demand locations.
A recent AirDNA data report showed short-term rentals surpassed the hotel industry in 27 major metro markets. The top three markets were Nashville, Miami and Philadelphia. Some key trends in the report to consider include:
- Large, single-family properties massively outperformed in 2020, and the pace has continued in 2021. Keep this in mind when determining which property type you purchase.
- Travelers book longer stays in homes than hotels. In fact, last year, there were twice as many trips with long-term stays than in 2019. Many hosts that rely on short, more expensive weekend stays may have to pivot and factor in longer stays.
When it comes to short-term rentals, one of the main advantages is the potential for high income — the key word being “potential.” Bookings are not guaranteed, which means neither is the income.
The ability to generate higher income stems from having a dynamic pricing strategy that includes rate adjustments during peak travel periods. In the right location, increased rates during peak seasons typically make up for slower months when the vacancy rate is higher.
To those put off by the vacancy volatility of short-term rentals, long-term rentals offer welcome stability. The difference is reflected in the market rate for rent, which is substantially less for long-term rentals than for vacation properties. However, cash can still flow handsomely.
With the housing resale market contracting, single family property rentals are booming as an asset class. Apartmentlist.com’s most recent rent report shows the cities with the highest increase year-over-year in rental income. Knowing how significantly rents are increasing in your area can help you determine if long-term investing could ultimately yield higher profits.
As with all real estate, location is location. Is the property in a suburb where housing demand is high and single-family and multifamily vacancy rates are low? How is the local economy? What is the median household income? How good is the school district? Is there access to recreational areas? The answers to these questions could lead you to long-term rental stability with reasonably high yield.
On the other hand, if you have a property in a popular destination city and it conforms with local rental guidelines, then a short-term rental could be the winning choice. Keep in mind some major cities have strict regulations on short-term vacation rentals, so be sure to check state and local ordinances to determine if your property is in compliance.
Maximizing tax advantages
After making money, the second most important thing is keeping it. With real estate, there are many tax benefits for investors, the mecca of these benefits being depreciation.
According to Tony Watson, a senior tax consultant Robert Hall & Associates, certified enrolled agent and an expert at real estate tax issues, properties that are turned into rental investments must be depreciated.
In fact, he says, “when depreciation is allowable, it must be taken.” The tax code clearly states this, but the concept of depreciation is often ignored because investors fear the idea of recaptured depreciation or the collection of taxes on the gain if the property is sold for more than its depreciated value.
This is where an expert tax adviser can help. They can evaluate options to alleviate the potential for recaptured depreciation, like a 1031 exchange, for example.
Although depreciation typically implies loss, it is quite the tax benefit for rental property investors. With the exception of the land, everything that comprises the property — such as toilets, sinks, windows, etc. — is depreciable and can be taken as a deduction.
To fully grasp how this can help you maximize your rental income, let’s assume you buy a rental house for $300,000 and below is the property tax card:
Deducting the value of depreciation doesn’t occur all at once. On residential rental property, it is spread out over a 27.5-year period. For our $300,000 property above, the owner would be able to deduct the improvement value of the building ($200,000) and not the land value ($75,000).
Over the course of 27.5 years, the annual deduction would be around $7,272. That’s a depreciation rate of about 3.6 percent each year, which is in line with the average rate according to the IRS. Depreciation essentially shields whatever taxable income is generated from a rental investment.
Investors can deduct all expenses related to their real estate business, from taxes and mortgage payments to property management, landscaping, pool services, repairs and maintenance.
As a landlord, you can even deduct travel expenses. If you are traveling from your house (which must be considered your office to count) to your rental, you can use the standard mileage rate deduction — 57.5 cents per mile as of the 2020 tax year.
The IRS states things like repairs, maintenance, advertising, insurance and utilities that are paid by landlords are deductible, as they are ordinary and necessary expenses for maintaining your property. Small upgrades to kitchens, bathrooms and flooring tend to yield higher returns on rental prices, while diligent screening of potential tenants and hiring professional property managers save time and headaches.
The structure of your real estate investing business can have a lot of influence over your profits. In a recent CIVIC Industry Insights event, Watson discussed the power of incorporating and maximizing tax benefits, so you get the most out of your rental investment.
Financing and access to capital
When acquiring or refinancing a rental property, the right loan program can make a huge difference on the total cost of ownership as an investor.
With conventional financing, you can acquire rental investments up to a certain number and within certain debt-to-income limits, but you’ll be expected to pay the principal balance plus interest.
Hard money and private money loans require interest-only payments and are far less burdensome in terms of documentation, credit and income requirements. This is because hard money loans are based on the hard asset (the property) rather than the creditworthiness of the borrower.
Whether you’re just starting out buying your first property or refinancing an entire portfolio the traditional route, a private or hard money loan is often a good option that most people don’t consider.
Real estate investing is not just about acquisition. Successful investors are always finding ways to maximize returns on their current investments through recapitalization.
Increased equity is the silver lining of today’s market, but what you choose to do with it is key. Absent (or in lieu of) cash out of pocket, your current investment properties may very well be the gateway to accruing significant wealth through real estate.
Yes, the concept of a refinance is fairly simple. However, many investors don’t take advantage of the concept of cross-collateralization.
Whether you have a few properties with established equity or several properties with slimmer amounts of equity, cross-collateralization enables you to tap into the equity of multiple properties at the same time and refinance them together under a single loan. You can then recapitalize that portfolio and take up to 80 percent cash out to acquire additional properties as a cash buyer.
For investors who have maintained a fix-and flip strategy for the past decade, pivoting to a buy, fix and hold strategy is becoming one of the most lucrative options as the real estate market adapts to a new normal. But it’s the extra things investors do to maximize cash flow that makes all the difference.