A lot has been said in recent years about the viability of residential property as an investment. There are opinions on all sides. Some investors strongly recommend you stay away from residential rentals at all costs. Others claim that residential real estate is among the best investments going. Who is right and who is wrong? Neither.
It is impossible to make a blanket statement one way or the other. Any investor who tells you that residential real estate is bad across the board is not acknowledging its well documented potential. Likewise, any investor willing to tell you that residential real estate is the best thing ever is probably not considering the potential downsides.
Investors have to determine the viability of residential real estate based on their own circumstances. They have to consider their investment goals, how much money they have to work with, their risk aversion, and so forth.
Property Almost Always Appreciates
The one thing real estate has going for it is its tendency to appreciate. Almost all residential property, except under extreme circumstances, will eventually increase in value. The question is how long it will take and how much the increase will be. If you look at historical data, you will discover that over many years, property values tend to go up.
As property values increase, so do rental rates. The icing on the cake is that people will always need housing. There will always be renters in need of space. Therefore, investing in residential properties is investing in an asset that will be forever in demand.
Legitimate Regulatory Concerns
Despite the inherent nature of residential real estate being positive, there are things landlords have to be cognisant of. At the top of the list is regulation. More than anyone else, government regulators have a keen ability to make residential real estate not worth investing in.
Think of government regulations as similar to car park line marking machines. They exist to keep landlords within certain boundaries established by policy makers. Stay inside the lines and you’re good to go. Go outside the lines and there could be trouble.
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In the UK, the government took a rather definitive stand against residential investors a few years back. They took the position that landlords were contributing to the UK housing shortage by buying up the most inexpensive properties and then charging unaffordable rents. Regulators went as far as to change a few of the rules in order to make residential rentals less attractive.
To their credit, landlords found workarounds for most of the changes. Yet there are still concerns. With Brexit now a done deal, investing in residential property can be more challenging from both ends. A UK investor might decide it is no longer worth investing in EU properties. Likewise, a French investor may decide to stop looking at London as a viable market.
Another big concern for landlords is taxation. In most countries, income derived from rental properties is not considered capital gains. It is regular income no different than income earned from a job. That makes rental income subject to higher taxation in most cases.
A bigger issue is that of what constitutes actual income. Again, we go back to the UK and the regulatory changes enacted a few years back. Prior to those changes, landlords could write off mortgage interest as a cost of doing business. Doing so would reduce their tax liabilities. That has since changed. Mortgage interest is no longer deductible.
One way to get around this particular issue is to set up a limited liability company through which you will purchase residential properties. The company earns the revenue and pays you a salary. That way, you only pay income tax on what the company pays you. The company pays capital gains on the profits it earns from the portfolio.
Property Types and Sources
Whether or not rental properties make a good investment can depend on available properties and where they are sourced from. As a general rule, investors look for off-market properties that can be had for very good prices. Off-market properties are auction properties, short sales, foreclosures, etc. They can be had at below-market prices because owners just want to get rid of them.
In an area with a limited supply of off-market properties, it is best to hold off on acquisitions. Paying market value puts the real estate investor behind the eight ball right from the start. And in fact, it may be impossible to get a mortgage for a property being sold at market value.
In terms of property types, single-family homes are not always the most lucrative. Likewise, large apartment buildings may not generate the kind of return landlords want. Right in the middle are larger single-family homes that have been subdivided into multi-family dwellings. These types of properties tend to generate the highest ROI with the lowest tax liability.
Access to Financing
Yet another consideration is financing. A typical real estate investor doesn’t pay cash for every property. First of all, having that much cash laying around is not the norm. Second, even investors with sufficient cash tend to not want to tie it up in new properties. Thus, property investors frequently turn to standard landlord mortgages or bridge loans.
A standard mortgage could be a 5, 10, or 15-year at a competitive interest rate. A bridge loan usually has a term of one year or less. It will have considerably higher interest rate as well. Both options are worth looking at. In the end though, financing could make or break an investment. Landlords have to walk that fine line between just getting by and earning a decent ROI. Financing can make the difference.
Even with all of these considerations addressed, there is one more thing for investors to think about: their overall investment strategy. Residential rentals constitute a long-term acquisition. To make the most of it, you have to hold and rent properties for many years. If your idea is to get in and out quickly, becoming a landlord is probably not the best choice. You might be better off flipping houses instead.
It should be evident that there is a lot to consider before investing in residential real estate. It is not fair to qualify residential rentals as either a good or bad investment across the board. Each investor must evaluate residential property based on their own circumstances. It’s an excellent investment for some, but not for all.