Real Estate has been, and continuously will be, one of the most popular vehicles for investing. However, it seems that, nowadays, people are using their property as an income source rather than a primary residence. Whether you purchase a house to reside in, a condo as a rental unit, or a “fixer-upper” home that can be “flipped” (resold at a higher price), here are some beneficial tips to keep in mind when you contemplate investing in real estate.
Before purchasing an investment property, ask yourself these initial questions:
1. What’s my goal for the property I’m buying?
2. What type of return am I trying to get?
3. Are you buying the home to flip it and make a quick return, or using it to receive long-term passive income?
4. How long will the location of your property stay relevant?
*If the area of your home becomes less attractive to people, the value will fall.
If you can’t answer the above questions, I highly recommend living in the first home you own.
The home buying process sounds fairly simple: you get pre-approved by a lender, find the home you want, make an offer on it, and if your offer is accepted, and then go into escrow. Yet, it’s not always as easy as it seems. Searching for homes and getting pre-approved from a financial institution can be a struggle. Bear in mind, however, getting approved as a home buyer is much easier than getting approved as an investor. Why?
1. The down payment. Typically, the goal is to put down 20% of the home value upfront. This provides the best loan rate and a smaller mortgage payment. Anything below 20%, and you’re subject to “Private Mortgage Insurance (PMI)”, which will increase your monthly mortgage payment. This is why it’s so important to save as much as possible before you decide to purchase a home. The more funds available, the more likely to be approved.
2. The tax benefits are better. You’re actually eligible to deduct all interest payments applied to your mortgage. In addition, it is acceptable to deduct the annual property tax you pay. But the biggest benefit by far is the capital gains tax exclusion. If the property is your primary residence for at least 2 years, you can receive tax exclusions on the profit you make up to $250,000. If you’re married and file taxes jointly, that exclusion jumps up to $500,000! Imagine selling your home and receive $500,000 in TAX-FREE money that can be applied to your next home.
However, if you decide to begin with purchasing a rental property, make sure you recognize all the facts:
1. Getting approved is a much more difficult process. PMI does not cover investment properties, so you need to put down at least 20% to even be considered.
2. The tax implications are not as favorable either. First, you’re monthly interest payments are not deductible. You’re only able to deduct “Maintenance Repairs”. This does not include home improvement costs, and only applies to the costs of keeping the property functional.
3. Although property tax is deductible, you must realize that it will likely increase each year you home value improves. This is something many real estate investors often overlook. As you make changes and the value of your home rises, so will the amount of property tax you owe.
Real estate can be a great investment, both short and long term. However, it cannot be your only investment as you need diversification. It’s crucial you work with an advisor like me who can help and give advice on what you should really be doing with your money!
By Malcolm Jones
Investment Advisor Representative
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss.
Financial advisors at Gerber Kawasaki are registered representatives with, and securities offered through, LPL Financial, Member FINRA/SIPC. Investment advice offered through Gerber Kawasaki Inc, a registered investment advisor and separate entity from LPL Financial. Please consult your investment professional before acting on any advice.
Gerber Kawasaki Wealth Management, 2716 Ocean Park Blvd. #2022 Santa Monica, CA 90405. Contact us at (310) 441-9393.