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Can't Sell That Second Home

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12-22-2005

Paul Katzeff, Investor's Business Daily

Days may be numbered for speculators trying to buy and sell homes quickly at a profit, as rising interest rates and high prices pressure sales.

Some may wonder if they should bail out - perhaps at a loss - before the slowdown worsens. Instead, it could be time to become a landlord.

"Investors need to understand that if they hold on, the rent side of their equation will increase," said David Lereah, chief economist at the National Association of Realtors. "And that will increase the value of their property over time."

Indeed, a stronger rental market has kept landlords like Archstone-Smith Trust (ASN) from losing tenants. The real estate investment trust develops and runs apartment complexes in six metro areas, mostly on the East and West coasts.

"We had an occupancy rate of about 95% through the recession," said Scot Sellers, chief executive. "Since then, it's gone up."

For landlords in general, metro area vacancy rates have slid to 5.8% from 7.1% since the start of 2004, real estate research firm Reis says.

Reis expects the average apartment rent to grow 2.7% this year, topping '04's 2.2% hike.

Several factors are helping rentals. If rising rates put mortgages out of some renters' reach, they'll have to remain tenants. Also, rental supplies are tight in some key markets because of building or zoning laws.

"We're in markets where it's extremely difficult to build new apartments, and that's helping make the market stronger," Sellers said.

Once you decide to become a landlord, the question becomes how much rent to charge.

To get a handle on that, list your likely costs, says Hugh Bromma, CEO of Oakland, Calif.-based Entrust Group, which manages retirement accounts that invest in real estate.

First, assuming you have a mortgage, you should divide that into its components for tax purposes: principal, interest and taxes.

Second, consider what other costs you'll pay, such as regular maintenance, gardening and utilities.

Plan For Expenses

Expect to call a plumber or electrician once a year, and count on paying for two to three hours of each one's time, Bromma advises.

As for utilities, you'll pay for those until you rent the home, and maybe longer depending on the lease.

Make sure you have cash on hand while you're seeking a good tenant.

"One of the most underconsidered factors is vacancy rate," Bromma said. "People think a home won't be vacant long because the rent is in line with the market. But your property can be vacant for four to six months."

When trying to determine how much rent to charge, there's no one better to ask than your competition.

"Ask rental agencies, real estate companies and management agencies," Bromma said. Make sure you note the property's square footage, age and condition.

Check in advance with your insurer about its policies regarding pets.

"If your insurer puts any restrictions on damage stemming from pets, use their language in writing your damage-liability clauses into your lease," Bromma said.

Reward Good Tenants

Make sure your lease distinguishes a security deposit from first and last month's rent. And don't forget to build in your profit target. Bromma adds 20%.

Also, consider a discount for tenants who pay on time.

Finally, if you can't make enough in rent to cover costs, know how to turn a loss to your advantage.

If you end the year in the red, you can offset certain other passive income, says Gibran Nicholas, president of Nicholas & Co. Mortgage Planners in Ann Arbor, Mich.

That includes net rental income from, say, another home you rent out, or income from a qualified limited partnership.

"It does not have to be a real estate LLP," Nicholas said.

Generally, you can't use a loss on rental property to offset income from wages or securities. But an exception may let you offset up to $25,000. You must have taxable income of less than $100,000, own at least 10% of the real estate that suffered a loss and actively participate in the property's management.