08/07/07: Buying For The Future? Is It A Good Investment?
By Benny L. Kass
Q: My wife and I bought our house about 30 years ago. We still owe some on it because we refinanced a couple of times in order to make major repairs and improvements.
I plan to retire in December 2009 but my wife has to work until 2011 before she can retire. We are both Federal workers. Our oldest son lives down South and wants us to sell our place in Virginia and move closer to him and his wife when we retire. We have thought about the idea and for the past 2 years we have casually looked at different areas near our son's house. We have noticed that the prices of the houses down there are going up. Do you think it would be a wise idea to purchase a house now, hire a property manager and rent the house out until we are both retired? What are the pros and cons?
A: If you can afford it, by all means go for it.
Despite the depressed real estate market currently in many areas, I still think real estate is a good long term investment.
In fact, now is a good time to buy when prices are low.
You should be looking for a home near your son in which you will be comfortable. Obviously, you are in no rush, since you won't be moving down there for several years. Take your time, shop around and make sure that the rental market is strong enough so that the rental income will at least allow you to break even.
Keep in mind that becoming a landlord is not for everyone.. Investigate the landlord-tenant laws in the State and County where you plan to purchase. Are those laws balanced or do they favor the tenants - such as we have here in the District of Columbia.
As a landlord, you will be required to pay your mortgage, real estate taxes and insurance. You will also have to make periodic repairs to the house in order to keep your tenants happy. And you should always anticipate that you may have a two-three month vacancy every time you go to rent out the house.
You suggested that you would hire a property manager to handle all of the landlord-tenant issues. That's not a bad idea, but you should first discuss this with your son. Perhaps he has the time to take on this responsibility. A property manager will charge you between 6-10 percent of the monthly rent (depending on the going rate in the area). Your son may be willing to do this for nothing
Finding a tenant can, however, be a difficult task. You should go to the local (or state) planning office to investigate the demographics of the area that is of interest to you. How's the job market? Are companies going out of business? Is a local military based scheduled to be closed down in the foreseeable future? Are any major highways planned which will divert traffic away from your house? Or worse, cause traffic to run right in front of your proposed property?
Once you find a prospective tenant, even if you have retained a property manager, I strongly suggest that you -or your son - personally meet with him or her. While credit checks and references are always helpful, my experience is that a face-to-face meeting is perhaps the best way to gauge what kind of person this is.
Don't forget to check the local landlord-tenant court docket before you sign up any tenant. Unfortunately, there are many people that I call "professional tenants". They convince a landlord to enter into a lease, and then just do not make any rent payments. They know that it can take months before the legal process will ultimately evict them, so they basically are staying rent free. They then move on to another house, and the process starts all over again.
Many Courts are now equipped with computerized programs where you can quickly determine if your prospective tenant has a history of being a defendant.
Once you find the house you plan to buy, how do you go about financing it? Even if you have enough cash in the bank to pay for it, I do not recommend this route. Keep in mind that you will have rental income, and to save on income taxes, you want to offset this with the deduction for mortgage interest.
Furthermore, we all assume that your house will appreciate in value in the coming years, regardless of how much of your own money you have put into the property. So in effect, this money is what I call "dead equity". You can use your cash for other investments, or just keep it available for any emergencies which may arise. After all, our bodies (and sometimes our minds) deteriorate as we get older, and you want to make sure that you have a "nest egg" for any emergencies which may arise.
Accordingly, you have two financing alternatives: you can tap into the equity in your current house or you can borrow the money by using the new property as security. If there is sufficient equity in your current house, that would be my preference. Since you are currently living in the house, you will get the benefit of the "owner occupied" rate; otherwise, you will have to pay a higher interest rate and put more money down because your lender will consider your loan as "investment".
I think you are smart to start considering your retirement future at this early date. However, before you sign any documents, you should discuss these issues with your own financial and legal advisors.