Pro Tips
Pro Tips

Higher Down Payment → Lower Returns

In general, the more you put down, the lower your returns over a similar time horizon.

Let's say you buy a property for $100,000 and sell it 10 years later for $150,000. Your profit is $50,000.

If you had put $1,000 down, you would have ended up with 50x your initial investment.

If you had put down $50,000, you would have ended up with 2x your initial investment.

Obviously, there's a lot more involved, as your mortgage expenses are clearly affected by your down payment, and you may not be able to be immediately profitable with such a small down payment. However, it still generally remains that a smaller down payment will generally result in larger returns on your investment.

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Consider Getting a Real Estate License

The real estate agent fees dramatically affect your bottom line when selling a property. The 6% eaten by real estate agents is 6% of the total sale price. Your proceeds (after down payments and such) is smaller, meaning it's an even larger percentage of your overall proceeds.

Concrete example: You buy a house for $200,000 and put down $50,000.

You sell it a few years later for $250,000. Your proceeds would have been $100,000, after paying off the bank, but the real estate agents will be taking 6% of that $250,000 sale, or $15,000. This is 15% of your $100,000 proceeds.

If you had a real estate license, there is not much you can do about the buyer's agent fees, but you can at least get back the seller's side of the fees, which, in the example above, gets you another 7.5% on your net proceeds from the sale.

There are often courses for these licenses at local community colleges.

Beware of HOAs Limiting Rentals

Before you get too excited about a property, be sure to read the disclosures carefully and find out if there is a homeowner's association that may disallow you from renting the property.

Often, neighborhood or condominium building HOAs will heavily limit the number of properties that can be used as rentals in an effort to improve the quality of life of the permanent residents.

Leverage Existing Properties

Once you've got a bit of equity in one property, people will often use that equity to buy another property.

Let's say you buy a rental property for $200,000, using a $50,000 down payment. Your equity is $50,000 at this point.

After 10 years, let's say the property is worth $300,000, and you have paid about $25,000 of what you owe the bank. At this point, you have $175,000 of equity in the property. Assuming the bank wants you to keep 25% equity in the property ($75,000), this means you have $100,000 you could pull out of the property in a cash-out refinance, and use that money to buy another property that is currently worth $400,000.

Repeat this a few times, and you'll can start building a portfolio of income-producing properties.

Deducting Losses

In general, it's recommended to only buy rental properties that allow you to be in the black from day 1. That is, only buy properties where the total revenue in is higher than the to total costs.

Deducting against regular income

If you do end up with losses, those losses can be put against your regular income in some cases. Namely, if you have less than $100,000 modified adjusted gross income (MAGI), you can fully deduct up to $25,000 of these losses. For MAGI between $100,000 and $150,000, you lose $1 of deductibility for every $2 of MAGI. So, if you have a MAGI of $110,000, you can only deduct $20,000 of losses on rental properties.

Carrying losses forward

If you don't want to (or can't) deduct losses against regular income, you can carry forward those losses to apply in a later year when you are profitable. This is especially helpful in years where you have unusually high repair costs that push you into the red, or in early years of owning the property if you end up in the red. You can then offset your gains in subsequent years, though this is usually capped at $3,000 per year.

That said, you can accumulate as much loss as you want, and then apply whatever you haven't used on any annual return at the time of sale. So, let's say you accumulate $25,000 of loss one year. You apply $3,000 of that each of the next 5 years, so you still have $10,000 of accumulated loss. When you sell the property, you can apply the remaining $10,000 to offset the capital gains on the property.

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