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How do I avoid overpaying for rental property?
Home » Real Estate » Investing in Rental Property » How do I avoid overpaying for rental property?It's been said that profit is made when you buy a rental property, not when you sell it. If you spend to much in the initial investment, you'll lose a lot of money that you could have potentially been enjoying during your tenure as landlord.
The real estate market is tougher on those investing in rental property who overpay than homeowners who make the same mistake. This is mainly true because a home is an emotional purchase and therefore when you're selling the house you can get a bidding war between families who have to have it. With a rental property, you sell to another investor who doesn't want to overpay.
It can be hard, however, not to overpay in a hot market. New York City apartments sell at a 60% premium over their "inherent" value. This is a fancy way of saying they sell for a ridiculous amount more than the apartment makes in rent. In cities like San Francisco and L.A., the premium is 10%.
One way to avoid overpaying is to use a formula, such as not paying more than six to eight times the rents they expect to make the first year. Another formula is to try and estimate what the property will be worth after needed repairs and upgrades and not pay more than 70% of that price, less the cost of those repairs.
Depending on your real estate market, though, these formulas may not work in your area.
At the very least you should make sure your rental income covers your out-of-pocket costs, including the mortgage payment, taxes, insurance, maintenance, repairs and a vacancy rate of around 5%. If you can break even, you'll be able to profit from any price appreciation as well as from tax breaks available to rental property.
When crunching the numbers, you should know that there's a big difference in how repairs and improvements are treated for tax purposes. You can typically deduct the cost of a repair, such as patching a roof or fixing a leaking pipe, on your tax return for the year in which the repair is made. However if you replace the same roof or the same pipes, it's considered an improvement, meaning the cost can't be deducted. The cost is instead added to the amount you paid for the property to determine the tax basis when you sell. The higher the tax basis, the lower your taxable profit is.
To better estimate your costs, get a thorough inspection before you buy a property. Some landlords have favorite electricians, plumbers and contractors that they send to any prospective property, promising them that they can do any repair work they find. Others use professional inspectors they trust.
Sources:
http://www.ehow.com/how_5513_invest-rental-property.html
http://www.turbotax.com/articles/FAQonTaxesandRentalProperty.html
http://moneycentral.msn.com/content/Investing/Realestate/P39214.asp
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