Last week I shared information about investing in real estate, specifically purchasing a single-family home for use as a rental. This week, I’ll share why duplexes and four-plexes can be even better investments if they fit within your budget.
Let’s use a four-plex as an example. In Ukiah, you can purchase one for about $650,000 and expect rental income of $4,800 – $5,500 per month. That’s a higher rent-to-cost ratio than you can typically find with a single-family home.
Duplexes & Four-plexes
Like single-family homes, duplexes and four-plexes are easy to finance because they qualify for the same preferred financing, so you can get a 30-year fixed-rate loan (not true for most other real estate investment types). However, more units can mean a little more work.
Because of the lower monthly rent, it is often easier to find tenants for duplexes and four-plexes, but the turnover can be higher. (While I understand the desire to fill vacancies as soon as possible, remember that having a vacancy is better than having a bad tenant.) Screening tenants thoroughly is essential to your emotional and financial happiness. This means your neighbor’s niece and her boyfriend should get the same scrutiny other prospective tenants do. As the owner of a property management company, I am biased, but I’d say the work required to find and keep good tenants can be reason enough to consider hiring a property manager.
More living quarters means more people and more maintenance. Four-plexes are ideally suited to small families, adults looking to share expenses, or individuals who want a little extra space. Having all these people living in such close quarters (sharing walls or ceilings/floors) can sometimes lead to disputes, and without a professional property manager, it will fall to you, as landlord, to address them.
A four-plex will not require four times as much maintenance as a single-family home, but it will require more. As with a single-family home, you only have one roof to patch, four exterior walls to paint, and one driveway to seal. However, with a four-plex, you have four toilets to unplug, four heating/cooling units to maintain, and four sets of appliances to fix when they break.
Smart investors include these maintenance costs into their planning. Anticipate expenses of about 3-4 percent of the purchase price per year, or $19,500 – $26,000. This includes taxes, insurance, and maintenance costs. Although you won’t spend this much every year, you will over time. And when you need the money, you don’t want to dip into junior’s college fund to get it. Create a reserve savings account and pay into it each month.
Happily, you’ll benefit from your property’s depreciation, which helps offset your cash expenses. Depreciation is a bookkeeping expense that allows you to deduct the value of improvements over time. Depreciation is only a taxable expense, not a cash expense. This means, you have the ability to save on your income taxes and these savings should offset the cash expenses noted above.
So, now you own a $650,000 rental property with a break-even cash flow. You invested $135,000 (a 20 percent down payment plus $5,000 in closing costs), and your benefit is the potential appreciation in the value of this property. If values rise at three percent a year (keep in mind values do not always rise), you’d make $19,500 on a $135,000 investment or almost 14 percent. Not too shabby.
In addition, rents will likely increase over time. And while expenses go up with inflation, your mortgage payment won’t. The bottom line is, if you can afford to buy a $650,000 rental today, in 10-15 years, you should have an asset capable of paying for junior’s college tuition (or more rental properties to earn more income).
If you have questions about property management or real estate, please contact me at email@example.com or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery.