It's often said that buying a home is a good investment. Taking it a step farther, purchasing multiple houses as rental properties can also be a great way to increase your assets and make money. However, be aware of some fundamental differences between buying a property as your home and purchasing properties to rent out.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
The purchase of a home is, for the vast majority of people, the single largest investment they will ever make in their entire lives. Many people consider the purchase of a first house to be a rite of financial passage. It means liberating yourself from the shackles of paying rent to another else and starting to pay yourself instead by developing equity in your own home.
But what about purchasing a second property, perhaps one to use for vacations? Is purchasing it a wise financial move?
Personal preferences, long-term goals, and one's existing financial circumstances are all relevant factors to consider, just as they are with a great many other financial choices. Before you go out and purchase a second house, here are five things you should think about... as well as another option in case you decide that this one isn't right for you.
When you've gotten your feet under you with one rental property, you might feel like you're ready to grow your portfolio by purchasing additional homes to rent out. When you begin to amass a number of rental properties, you will notice that, despite the fact that certain steps continue to be the same – such as organising your financing, assembling your team with a dependable lender and an experienced real estate agent, and locating a property – there are a few key distinctions that come into play. One of these distinctions is the degree to which you will need to manage the maintenance and upkeep of your properties.
In this chapter, we will go over the facts that you need to know in order for you to properly manage your property portfolio and purchase a large number of rental properties.
Investing in rental property can lead to financial gains, but it also comes with some risks, such as having tenants who don't pay their rent and the stress that comes along with being a landlord. Despite these risks, investing in rental property can result in financial rewards. You will need to think about things like taxes, the appreciation of the property's value, the cost of the mortgage, and the costs of maintenance in order to determine whether or not purchasing a rental property is a smart financial decision for you. If you decide that it is, then you should go ahead and make the purchase.
What Is an 'Investment'?
There are many different contexts in which the word "investment" is used, and depending on those contexts, the phrase can refer to a wide variety of different things. There are many different types of investments. The definition of investment that is provided by Merriam-Webster, which is "the spending of money usually for revenue or profit," is applicable from the point of view of pure finance.
Putting this another way, an investment may be thought of as anything that you put money into with the expectation that you will make more money as a result of doing so.
An investment is defined as the act of purchasing assets such as stocks and bonds with the expectation of realising a profit at some point in the future. The expense of higher education can be regarded as an investment if it is anticipated that the student will earn more throughout the course of their career as a direct result of the degree earned.
This type of financial decision is distinct from others, such as those that might be beneficial but are not considered investments.
For instance, you might make the decision to buy furniture of a higher quality, even if this will result in a higher initial investment on your part but will ultimately end up saving you money in the long run because you won't have to replace it. However, in a strict sense, doing so would not be called an investment because there would be no "income or profit" from it; however, the vast majority of people would agree that doing so would be advantageous to one's financial circumstances. Even if it is more reasonably priced than other available choices, the furnishings will still require a financial investment on your part.
Let's transfer our attention back to your house while keeping this description in mind, and let's begin.
Consider the Reasons Behind Your Purchase of a Second Home
The first thing you need to do is determine the reason(s) behind your interest in purchasing a second residence. Let's take a look at some of the most popular explanations so that you may gain a better understanding of your own motivations.
Real Estate for Leisure Use
You might be interested in purchasing a home along the beach, in the mountains, or in close proximity to your relatives. I am aware of that! Nevertheless, take a moment to weigh the benefits against the drawbacks. If you only want a place to stay for two or three weeks out of the year, there may be a less stressful way to accomplish this, such as splurging on a lovely Airbnb from time to time. If you want to buy a second house, don't let your feelings or the need to "keep up with the Joneses" influence your decision.
Investment
When it comes to real estate investments, there are primarily two basic options for purchasing a second home: one is to renovate it and resell it, and the other is to rent it out as a source of passive income.
Real Estate For Rent
You need to go into the commitment of renting a second property with both eyes open in order to avoid any unpleasant surprises. The following is a list of items that you need to bear in mind:
- The income from the rental property is not assured. The number of tenants fluctuates. If it is not located in a resort or other region frequented by tourists, you may go weeks or even months without any renters.
- Renters can cost you money. There is no way to ensure that other people will look after your property, not even if you ask for and review the references they provide. People are capable of causing significantly more harm than can be compensated by a security deposit.
- Long-distance properties require the care of their neighbours. If you want to buy a second home to rent out, the prudent thing to do is to look for one in the same general neighbourhood as your primary residence. This will allow you to keep an eye on the property and make any necessary minor repairs quickly.
Flipping and Reselling
If you are willing to put in the effort, flipping houses can be a lucrative business venture, but only if you go into it with the right mindset. It's not nearly as glamorous as they make it seem on HGTV! Those thirty-minute programs, only scratch the surface of the difficulty and headache that are inherent in house renovations. You need to give some thought to whether or not you possess the knowledge, patience, and time necessary to flip swiftly. After all, time is money!
You also need to consider the repercussions that this will have on your taxes, particularly the tax on capital gains. If you sell something for more than you purchased for it, such as a house, then you are subject to this rule. It is highly possible that you will be required to pay taxes on any profits made from the resale of a home that you have owned for fewer than two years and/or have not lived there. Be sure to plan ahead for that additional expense so that you are not taken aback by it when it comes up.
An investor stands to gain apparent benefits from making investments in real estate that provide a positive cash flow, particularly if the investor maintains ownership of the property over an extended period of time. Every property that generates cash flow has three potential sources of income: cash flow, the reduction of the principal on the mortgage, and appreciation in property value.
Cash flow can be defined as the amount of rent collected less the total expenses. In any of the major Australian markets, a modest cash flow on a single-family property can look very different, but for the sake of this example, let's say it's $250 each month. Take the property's monthly cash flow of $250 and multiply it by the 10 years you will hold it to get a total of $30,000.
Paying down the mortgage: If you rent out a home and have a mortgage on it, the tenant's rent will help pay down the principal of the mortgage over time. When you sell the property, you will have equity equal to the difference in value between the day you first received the mortgage and the day you sold the property. This difference is yours to keep.
Take the following scenario as an illustration: the purchase price is $300,000, there is a down payment of 20%, the interest rate is 3%, the amortization period is 25 years, and the mortgage amount is $240,000. After ten years, the total amount owed on the mortgage would be $206,008, representing a difference of $33,992.
The third source of income is the appreciation of the property, which is typically responsible for the highest growth in an investor's net worth. Historically speaking, the value of the property has increased throughout the course of time. Let's imagine you invest $300,000 in a piece of real estate with the expectation that it will appreciate at a rate of 4% annually; after ten years, the property will be worth $426,990. You've just gained $126,990 in equity, so please accept our congratulations on this achievement.
When all three of these potential sources of revenue are combined, the investor stands to make a total profit of $190,982 from the transaction. Not bad for a twenty per cent initial deposit of sixty thousand dollars. In point of fact, when you compute the return on investment of the actual money invested (which is merely the down payment of $60,000), you get a return on investment of 318 percent, which is equivalent to a return on investment of 31.8 percent each year on your money.
Investing in real estate is widely regarded as one of the most successful types of investments, particularly when it produces profitable returns after a period of time. Those who already have a comfortable financial situation may want to think about expanding their real estate holdings so that they can have an even more secure future. You, too, probably harboured aspirations of becoming a landowner and managing prestigious real estate properties. In addition to providing improved financial security, the ownership of numerous residences also has a number of other advantages, some of which are detailed below.
Tax benefits
It is important for all landlords to keep in mind that they are required to declare any revenue they receive from rents collected on their properties. Each of the interest payments that you make on your first two mortgages may be eligible for a tax deduction. You are allowed to make a claim for a deduction on your first mortgage, and you are also permitted to do the same with your second mortgage, provided that the aggregate amount of your home loans does not exceed the limit that has been set. You would also be required to reside in your second residence for a few days in order to be eligible for the interest deduction; if you did not do this, you would not be eligible for the deduction.
Consider the following scenario: you borrowed money after April 1, 1999, and the property has not been built within a period of five years beginning with the end of the fiscal year in which the money was borrowed. What are your options?
If you have rented out one or more of your properties, then you may be eligible to claim a deduction for the interest that you have paid on any mortgages that you hold. However, if you own numerous properties and you live in more than one of those homes, you have the option of designating any one of those properties as self-occupied, while the rest of your properties can be shown as rented and their rent can be used to determine their value. In addition, if any of these properties have been rented out, you are eligible to claim tax deductions for the interest that you have paid on any money that you have borrowed.
If there is any interest that is paid during the time that a property is being constructed, then that interest can be claimed in five equal instalments commencing at the beginning of the year in which the construction of the house has been finished possession of the house has been taken.
In this scenario, you won't be able to file for the deduction until you really have possession of the property. But you won't be able to take advantage of this perk if you've already started paying the principle amount before you've even taken ownership of the property. In addition, repayments for loans received from family and friends do not qualify for this deduction under any circumstances.
In addition to this, the property taxes that you pay on all of your residential accommodations are eligible to be deducted from your income when you file your taxes. You are only allowed to use the money that was really paid to an appropriate government entity, not the amount that was put into escrow by the lending institution.
Make an appointment with your tax preparer as soon as possible to verify that you are eligible to claim the correct tax deductions so that you can enjoy exact tax deductions.
Properties as a form of investment
If you use your homes as investments and, more importantly, if you hire a property management business to handle the more laborious tasks on your behalf, then you will be able to take advantage of passive income. These profits may even be adequate enough to enable you to retire earlier than you had planned or take the trips that you have always dreamed of taking on vacation. If you hired a real estate manager to handle the renting of your property, you may increase the likelihood of finding a good tenant rather than simply any tenant.
You can lower the risk associated with the generation of income by investing in a variety of assets. Even if you were to lose your renter, you would still have other properties that were rented out and receive payments from renters, so you would continue to get income. In addition to this, having numerous properties enables you to experience a greater profit because you are able to obtain various accommodations at a reduced interest rate as opposed to owning a single accommodation at a higher rate.
Financial matters
When you own a single piece of real estate, it can be a little inconvenient when things require repair so that you can come up with the funds you need to pay for them. On the other hand, if you have a number of properties in your portfolio, you can use one of them to finance another. For instance, if you are ready to invest in another asset, the equity value in one of your houses might help you make the down payment for a new asset that you are considering acquiring. This is because the equity value in the first house is used as the basis for the calculation.
Because it is a proven truth that having several houses comes with a variety of advantages that can help an individual build their savings, you ought to give serious consideration to investing in real estate if your current financial situation enables you to do so. However, before making the ultimate choice, it is best to get advice from a professional in order to prevent any kind of difficulties that may arise in the long term.
The Positive Aspect of the Arguments in Favor of and Against Owning Multiple Properties
When discussing the benefits and drawbacks of owning numerous properties, the majority of investors' first thought is that it is advantageous to have the ability to keep all of the income as well as the appreciation in the value of the properties. This is wonderful news when the properties in question are producing a significant amount of income. If there was always a positive income flow and there was no risk associated with owning real estate, then everyone would want to buy many homes. The ownership of property is not without its inherent dangers, that much is a fact. When the market crashed between 2008 and 2011, we all received a clear image of this for the first time. There is unquestionably a level of danger involved with owning property.
For this reason, I want to control properties without actually owning them in order to keep the amount of financial risk that I am exposed to a minimum. Because of this, the lease option or the sandwich lease option, both of which I frequently write about, are the ones that I favour the most. Let's take a closer look at the benefits as well as the drawbacks of owning various pieces of real estate.
The Negative Aspect of Owning Multiple Properties Considering Its Positive and Negative Aspects
The fact that you are accountable for one, two, three, or even more things when you own many properties is considered by many people to be the most significant disadvantage of owning multiple properties when comparing the benefits and drawbacks of this investment strategy. Your name is on the title of the property, which means that it is in your name whether you gain money, lose money, or incur liability. One simple error might result in the loss of all of your investments and possibly even your whole personal fortune if your company is not properly organized as a sole proprietorship, partnership, or corporation.
I am a major believer in leasing options for this reason as well as a great number of other reasons. Lease options and sandwich lease options give you the chance to control and benefit from a greater number of properties while simultaneously requiring you to invest a smaller amount of your own money and reducing the amount of risk you are exposed to. When it comes to the benefits and drawbacks of owning numerous properties, it seems obvious to me that holding many properties with lease options is the superior solution. This is because lease options give you more flexibility. If the lease agreements are arranged correctly, they will bring in consistent positive cash flow until the eventual buyer generates a satisfactory return on the sale in around a year's time.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
A Financial Illustration of the Benefits and Drawbacks of Owning Multiple Properties
The direct cash flow that you receive each month from the properties that you own is the primary advantage of owning real estate if you are investing for the long term. It is essential that you carry out all of the necessary research before making an investment in order to guarantee that there will be a good cash flow. When weighing the benefits of owning several properties against the drawbacks, one of the most significant drawbacks is the requirement that you make an initial down payment that is large in amount. If the home costs $100,000, the down payment may be $5,000 or it could be $20,000, depending on the circumstances.
Simply taking that into consideration will make it substantially more difficult for you to purchase many houses. A lease option, on the other hand, calls for the payment of merely an option fee. a few hundred dollars is a common starting point. The same investment of $5,000 to $20,000 enables you to control a great deal more real estate in a far shorter amount of time.
If you are the owner of a home that rents for $1,000 per month and has three bedrooms, you will bring in a total of $12,000 per year from that rental income. Despite this, there will be costs associated with this endeavour. You could have a mortgage payment of $7,000, which would leave you with only $3,000 in net income after expenses each month. In addition to the monthly mortgage payment, you will also need to pay property taxes and insurance, both of which will reduce the positive cash flow. You, as the property owner, might only notice a positive cash flow of $150 each and every month (not to mention maintenance and repair costs).
You will have the ability to control eight or ten properties with the same investment if you take advantage of different leasing alternatives. It's possible that your positive cash flow will be more than $1,500. When you buy a property with a lease option, you also get the benefit of any appreciation in value that occurs throughout the option time. If you sold the properties for more than they were originally purchased for, say, $50,000 more would be in your bank account after a year.