The idea of buying a house and renting it out may seem especially attractive now, with home prices still reasonable, though rising, in many places, and interest rates at levels practically begging you to borrow. And if you’re thinking about retirement, the income can serve as an inflation-adjusted annuity of sorts, since rents are likely to rise over time.
But our perceptions can be deceiving. “There is a lot of idiosyncratic risk associated with rental income,” said Christopher J. Mayer, professor of real estate, finance and economics at Columbia Business School. “That is the word that economists use for when a lot of things can go wrong, even if on average they don’t go wrong very often.”
Tom and Ana Vogel, a retired couple in their early 70s, are seasoned landlords. So they’re aware of the risks, having dealt with problematic tenants in the past. Still, with a sizable piece of their retirement savings tied up in certificates of deposit earning less than 1 percent, they thought they could do better by buying a house and renting it out. They recently bought a five-bedroom house in their hometown, Germantown, Md., for $350,000, and they expected about a 6 percent return on their investment, as well as some tax benefits.
“It is high risk, you just have to be careful,” said Mr. Vogel, who worked as a geodesist and information technology manager for what was the Defense Mapping Agency. “You have no control over the stock market,” he added, explaining that they didn’t have the stomach for the volatility after losing half of the $100,000 they had invested in mutual funds during the market downturn in 2000.
With a pension accounting for half of their retirement income, the couple may have more room for error than other retirees. They also paid for the property in cash — the C.D. money covered half, and they used a home equity loan on their primary home to cover the remainder.
If you’re thinking about testing these waters, you can expect to compete with cash buyers like the Vogels — they represented 32.3 percent of home sales in February, according to the Campbell/Inside Mortgage Finance HousingPulse Tracking Survey. But a lot of those investors have much deeper pockets. In certain spots across the Sunbelt, in particular, the homeowner next door may actually be a faceless private equity firm. The Blackstone Group and other Wall Street investors are gobbling up properties in places like the Tampa Bay area of Florida by the thousands. And their exit strategy could affect yours.
Jack McCabe, a real estate consultant in Deerfield Beach, Fla., said he had never seen large investors purchase so many homes in one fell swoop, giving them such great sway over pricing in the market. “A lot of the price increase is not due to a market that is getting healthy, but is due to the influx of hedge funds, and a high percentage of homes are selling at artificially inflated values,” Mr. McCabe said.
Should you decide to follow the Vogels’ lead, there are a variety of calculations you should make, and concerns and questions you should have ahead of time, several of which are sketched out below.
DO I NEED FINANCING? Taking out a mortgage obviously increases your financial risk, even if you believe there is a healthy spread between what you can charge in rent and what you owe on the mortgage (and other expenses). In fact, what you’re really doing is borrowing to expand the size of your investment portfolio, explained Professor Mayer, which can be particularly risky for retirees who are no longer working. “They can turn their $500,000 portfolio into $600,000 by borrowing, but if you told them you were going to borrow money to buy a REIT, people would say, ‘Gee, that’s really risky,’ “ he said. “Well, then why is it less risky to do that with a rental property?”
We don’t have to look back too far to remember what can happen if home values fall. “If stuff goes down in value, that leaves you much more exposed,” Professor Mayer said. “Borrowing money to earn a higher return involves risk.”
CAN I GET A MORTGAGE? Not only is getting a mortgage on an investment property more difficult than getting a loan on your primary home, it also tends to be more expensive. Mortgages on investment properties tend to carry slightly higher interest rates — anywhere from 0.25 of a percentage point to a full percentage point — and may require higher down payments, according to Keith Gumbinger of HSH.com, a mortgage data firm. “Things can also get more complicated where the income from the property is needed to support the loan,” he added. “The purchaser may need to provide a rental history for the property, if any exists, or they may need to have a rental market analysis conducted.”
AM I DIVERSIFIED ENOUGH? If you have a $600,000 portfolio, putting $300,000 into one asset is a highly concentrated bet. “People tend to mentally compartmentalize their investments, but really, you should be looking at them together,” Professor Mayer added.
Article source: http://www.nytimes.com/2013/03/30/your-money/investing-in-a-rental-home-isnt-as-safe-as-it-may-seem.html?partner=rss&emc=rss
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