2

BUYING THE HOUSE THAT WILL MAKE YOU THE MOST MONEY

Now that you can see how buying houses can make you money, it’s time to get into the specifics of which house you should buy. Having a plan and buying a house that fits into that plan will help you to meet your goals in a shorter time. Most people who buy real estate do not set out to buy a particular property. They just look at everything that is for sale and hope to find a good deal. You can do far better by targeting a house that will make you the most money.

Not all houses are created equal. Some houses will appreciate more; some will produce more cash flow because they will attract better tenants; and others will require more maintenance and have higher expenses. No house is perfect, but you can increase your profits significantly when you target a certain house to buy. Buying houses with a plan will make you more money sooner.

BUYING DIFFERENT HOUSES FOR DIFFERENT REASONS

An advantage of investing in houses is that—over time—you probably will buy more than one. Owning different houses in different neighborhoods allows you to diversify. Some houses will produce more cash flow, and some will appreciate more. Owning houses of different sizes, different ages, and different prices makes your “portfolio” safer than owning one larger property, because your income and expenses are spread over many properties.

When you begin to invest, naturally you will focus on properties that produce more income. Less expensive “starter homes” will produce more cash flow. These homes often are built in tracts where all the lots are the same size and all the houses are about the same size and look a lot alike. They are around 1,000 to 1,200 square feet in total size, with small bedrooms and few frills.

These houses are in high demand and often appreciate at an above-average rate, because few new ones are being produced. Most new houses are larger, more elaborate, and more expensive. The more expensive house typically produces more profit for the builder.

Starter houses rent well and generally rent fast. During hard economic times, tenants often downsize to these houses to save money.

The next step up on the investment ladder is a slightly larger house in a little better neighborhood. There are several reasons to buy these houses as investments.

1.   Houses that are a step up from a starter are more likely to attract a longer-term tenant because they have more space and better neighbors. You can buy this size house in a neighborhood that is predominantly owner occupied. Owners take better care of their property than most landlords, so the neighborhood will look better and attract better-looking tenants.

2.   If you have other income, pay taxes, and want to reduce your taxable income, you can do that by investing in slightly more expensive houses. A more expensive house can produce larger capital gains but less net rent in relation to its value.

The tax rate on capital gains income is typically significantly lower than the tax rate on ordinary income, such as rental income. If you can buy a more expensive house at a bigger discount, then you are using the tax system to your advantage to earn larger profits and pay less in taxes. Study the example of houses that you can buy in different price ranges shown in Table 2.1.

Table 2.1   Making More, Buying Higher-Priced Houses

Images

These prices and rents represent no particular market, just the principle that as you buy more expensive houses, you are able to buy at bigger dollar discounts. Also, notice that the rents do not increase in direct proportion with the price of the house. The lower-priced houses produce more rental income as a percentage of their value. If the income is important to you, start with the lowest-price house in your town that is in a decent neighborhood.

A high-income taxpayer would have more after-tax profit if he bought a more expensive house, because more of the profit that the house produces would be a capital gain and less would be rent.

BUYING IN THE BEST NEIGHBORHOOD THAT YOU CAN AFFORD

Buyers and tenants are attracted to neighborhoods that are quiet, safe, well maintained, and populated by responsible people. Good neighbors make a good neighborhood. Buy houses in neighborhoods where you feel safe and comfortable talking to the neighbors. The tenant you are likely to rent to probably will look and talk a lot like the people who already live on the street. You need to be able to relate well to your tenant, so you should relate well to the neighbors.

Good neighbors are attracted by many factors, including geography. High ground, the right exposure, and proximity to roads, rivers, lakes or oceans, hospitals, work, and schools are all factors that affect desirability—and therefore value. Study the geography in your town and learn why certain areas are more popular and therefore more valuable.

Schools have a significant effect on neighborhood values. Get to know which schools in your areas are the most desirable. Become knowledgeable about which schools are improving and which are becoming less desirable. Watch for information about planned new schools and possible redistricting. Both tenants and buyers will want to live in the best school districts that they can afford. Often new schools are popular and attract both good teachers and good students.

Buy in the best neighborhood that you can afford. A house in a better neighborhood will make you more money. If you are beginning with little, then still buy in the best neighborhood that you can afford. As you build more cash and cash flow, you will be able to afford to move up a notch in location.

BUYING A HOUSE THAT WILL ATTRACT A LONG-TERM TENANT

When you buy a house that you want to hold as an investment, you want it to be attractive to good tenants—tenants who will stay a long time and take good care of your property. You want to rent to a tenant with long-term potential, not someone who is constantly on the move. Tenants with the long-term potential typically are coming out of another house where they have accumulated furniture and lots of other stuff. You want to buy a house that has enough space for such a tenant to live in comfortably.

The overwhelming majority of homebuyers prefer at least a three-bedroom, two-bath house. Renters have the same preferences. If you buy a smaller house, you will have to compete at a disadvantage with all the three-bedroom houses in your town for rent. There is not a big difference in price between a two-bedroom and a three-bedroom house, but there is a big difference in demand. The three-bedroom house will rent faster and stay rented longer. Buy houses that have three or more bedrooms.

Larger houses containing four or five bedrooms are common in communities with larger families. They also appeal to extended families where several generations share a house. This trend will increase as house prices and rents continue to rise. These larger dwellings have higher maintenance, but they can be as profitable when there is demand for them as rentals. You would learn about this from your research before you start making offers.

Garages or basements are big pluses both when you sell and when you rent. Storage space is important to everyone. Again, the cost of buying a house with a garage or basement is not that much higher, but the garage or basement is a big advantage when you rent or sell.

Yards are a big selling point to families with children and pets. In my town, most tenants have both, so having a fenced back yard makes it easier to rent or sell. Tenants will maintain a yard but rarely will improve one. Look for houses with average-size yards for your town. A large yard may scare off tenants who see it as too big of a job. The lack of a back yard that kids can play in is a definite disadvantage. A nearby park can compensate for a small yard.

SOME HOUSES ARE TOO BIG OR TOO FANCY FOR INVESTMENT

While you can argue that once you own the lot and the house, a few extra square feet costs little money to add, in reality, every square foot you add to a house does cost you. The fixed costs such as taxes and insurance increase with size and value, and so does the cost to maintain the house.

An investment house should be big enough to attract an average-size family with their belongings, but not much bigger. I would be comfortable living in any of my rental houses, because the neighborhoods are quiet and the neighbors are friendly. However, the investment houses are smaller and lack some of the luxury items that you may be used to in your own home.

Buy a house that is functional and well located, and then keep it in good operating condition. Don’t buy a house with a lot of fragile items such as fancy wallpaper, trim, elaborate landscaping, and so on. The tenants won’t take care of it, and it will not look as good in a year as it does today. Avoid houses with high-maintenance frills such as pools and hot tubs. They are expensive to maintain and insure, and only a small percentage of the buying and renting population will pay the price to have such things.

IT’S THE LOT THAT GOES UP—NOT THE HOUSE

Every day a house is wearing out and becoming obsolete. It’s the lot that is becoming more valuable. To make the most money, you want to buy the best lot that you can, and hopefully that lot will be improved with a house that you can rent to a decent tenant while you wait for the lot to make you some serious money.

Some lots are better than others. Avoid lots on busy streets or strangely shaped lots. Even corner lots are not as valuable as interior lots. With a corner lot, you have to set the house back from two streets. This leaves you with a big front yard on two sides but an unusually small back yard. Although corner lots are good for model homes, most owners would rather have a back yard. Always walk the lot line and look over any fences. If there is a problem property or neighbor next door, learn about it before you buy. You can fix a house, but it’s a lot harder to fix a bad neighbor.

The location of the lot is the key to how much money you will make in the long run. The advantage of buying several houses for investments is that you can target three or four neighborhoods in your town that you feel will appreciate at better than average rates. If you buy in all three or four, then you are likely to hit a couple of hot areas that will give you a larger than average profit.

BUY IN A NEIGHBORHOOD THAT IS ON THE WAY UP

Neighborhoods are changing constantly. When they are new, most neighborhoods are almost totally owner occupied. As the houses age, some owners will rent their houses or sell to investors who will rent them. The rental houses are rarely maintained as well as owner-occupied houses, and they have a negative effect on values. Sometimes the neighborhood will become completely owned by landlords. You can spot these streets by a lack of pride of ownership.

If these neighborhoods are in good locations, eventually owners will begin moving back in and buying bargains that they can fix up and live in. When this happens, property values will start to appreciate rapidly. Study the neighborhoods that interest you to see if you can establish where they are in this cycle. Buy in an area that is improving, and you will make more money.

FINANCING DETERMINES YOUR CASH FLOW

Your ability to borrow and to make down payments will change with time. You may start with little money and no credit. You can still buy a house. You will need to find a nontraditional source of financing, such as owners who will sell you their house and finance the purchase for you.

I have never borrowed money from a bank to buy a property.

When I started investing in real estate, I was working as a commissioned real estate salesman with no history of producing income and no predictable income. The banks would not make me loans to buy property because I had no demonstrable way to pay the loans back.

As I began to buy houses and accumulate both equity and cash flow, the bankers began courting my business. By then I had found both faster and cheaper sources of money. To this day, I have never borrowed money from a bank to buy a house.

Other investors, sellers of property, and private lenders provide a source of both down payments and long-term financing. In Chapters 8 and 9 you will learn to use all three.

The terms of your financing will determine if you can buy a house with the down payment that you have and afford the payment each month. Ideally, you will be able to borrow on a long-term, fixed-rate loan. With a fixed-rate loan, you get to keep the profits as your rents increase. With a variable-rate loan, the lender will make more money as interest rates rise.

A long-term loan is important to you if you plan on holding a house for investment. The longer-term loan will have lower payments. Low payments make this a safer investment. Avoid short-term loans. You may have to sell or refinance to pay them off. If interest rates are higher when you have to sell or refinance, you may end up paying a much higher interest rate or selling at a discount.

As the economy changes, you will borrow at different interest rates. When rates are the highest, you will make your best buys. When rates drop, you will be able to borrow at low rates and refinance your high-interest-rate debt, increasing your cash flow.

PRODUCING CASH FLOW

The cash flow a house produces depends on both its financing and its ability to produce income. If you finance the house with a long-term, low-interest-rate loan, then you have won half the battle.

The other half of the challenge is buying a house that will attract long-term tenants and will have average or below-average operating expenses, such as taxes, insurance, and maintenance.

Before you buy, research the property taxes and learn if they will change if you buy the house. Property taxes often increase when a property is sold. Contact a local insurance agent and get an estimate of what it will cost to insure a house of the construction and age you are considering.

Estimating the maintenance cost is more difficult. A well-designed, well-built, and well-maintained house should be cheaper to maintain. A house that has an older roof and mechanical systems will cost more to operate. An experienced home inspector or friendly building contractor can look over a house and give you advice about how much maintenance that house is likely to require. Don’t ask someone whom you might hire to do repair or maintenance work to inspect the house. That’s like asking your barber if you need a haircut.

RENTING TO RESPONSIBLE TENANTS

We all have little personality quirks. It bothers me when people don’t take care of things. If I loan you something, I’d like you to return it—and return it in good condition.

This can be a problem when you loan someone a nice house to live in, and then they don’t take care of it. Yes, they pay rent to live there, but that does not give them the right to abuse your property.

The good news is that if you buy a decent house on a safe street, you can attract tenants who will take good care of it. I have had hundreds of tenants—and only a few bad ones. One measure of your success as a landlord is the number of tenants you have to evict, that is, legally force to leave your house. I have had to evict only six tenants. The others have paid as agreed and taken reasonable care of the property.

This record with tenants is not just good luck. I learned many of my lessons the hard way—by making expensive mistakes. Hopefully, you won’t have to repeat the same mistakes to learn the lesson.

One of my first investments was a brand-new nine-unit apartment building. It was a beautiful property, and I thought that I would own it forever—until I met the tenants. I thought that there would be a certain efficiency in having nine tenants living close together. Collecting the rent should be easy: just drop by on the first of the month and pick up my money.

The first month I dropped by to find only one tenant home. There were plenty of cars in the parking lot, but after I knocked on the first door, no one else would answer. It took me nine visits to sneak up on all nine tenants, and after all of that effort, I still got several stories and promises to pay rather than actual rent.

Here I was, a young, poor landlord who needed every rent check from that building to make the mortgage payment. The tenants saw me as a wealthy landlord, but the truth was that they drove better cars than I did. To add insult to injury, many had bigger TVs than I did too, yet they would not pay me the rent.

It was a cultural difference. These tenants came from a culture where if you could talk the landlord out of the rent, it was a good thing. I learned that I wanted to own property that would attract tenants who felt that paying the rent on time was a good thing and would feel some remorse if they were late.

A TENANT—NOT TOO RICH AND NOT TOO POOR

Your first reaction might be that a tenant can’t be too rich. The problem with a rich tenant is that she won’t stay long. She will buy, and you will have a vacancy again.

Tenants certainly can be too poor. People are poor because they don’t have any money. There may be a lot of good reasons why they don’t have any money, but if they don’t have money, they will not pay the rent.

I divide potential tenants into three broad groups. Those with too much money, those without enough money, and those with just the right amount of money. Obviously, I want to buy a house that the last group can afford and wants to rent.

The amount of money that good tenants earn varies from place to place. Most of my tenants have hourly or commission jobs and earn between two and three times the base wage in my town. Often there is more than one wage earner in the family. Their income should be close to three times the rent. If they have several children and a car payment, they will need more. Many tenants have enough income to afford to buy a house if they would just pay off their bills and save up a down payment. Those two obstacles are insurmountable for most.

Study your market. Don’t rent to people at either end of the income range in your town. Aim at tenants who make enough money to afford your rent and their other normal expenses. Later you will learn about tenant screening and selection.

BUYING YOUR FIRST HOUSE

You want your first house investment to be a success, especially if you are married. You increase your chances of success by buying close to where you live. It may not be in your neighborhood, but it should be as close as possible. Most people live only a few minutes from an area of houses that would make good investments.

When you target an area close to where you live, you can spend time in that neighborhood and really learn the market. Walk the streets and talk to the neighbors. Tell them that you want to buy a house in their neighborhood and ask them if they know of anyone who wants to sell. You are complimenting them on living in a nice neighborhood. You will be surprised at how helpful they will be.

Call on every house for sale and for rent until you know the market well enough that you can walk down a street and give a price and rent for each house. Use a range: it would sell for between $200,000 and $225,000, or it would rent for between $1,400 and $1,500. You are making the assumption that the houses are in rentable condition and, of course, would offer less on a house that needed work. When a house comes on the market, you will know what it is worth and what it will rent for. You can confidently make an offer, knowing that if the owner accepts, you have made a good deal.

..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset