Earn money collecting rent
In some cases, managing properties on your own can be a big mistake, but professional property managers can help, according to Forbes magazine writers Scott Woolley, Stephane Fitch and Christopher Steiner.
In the Aug. 3, 2009, series “You Can Still Get Rich in Real Estate,” Woolley, Fitch, and Steiner suggest that the days of selling houses for a profit are over, but in many cities you can make money by charging the rental.
In the “Property Poor” article, Woolley states: “…no other asset class has turned out to be as rotten as real estate.” Real estate investment trusts (REITs) fell an average of 60 percent compared to a 40 percent drop in the broader stock market. Woolley asks: “What is the best way to invest in this recently unreliable asset class?” His response: “You should buy more.”
So far this year, REITs have raised $14 billion in new capital and are using much of the capital to acquire properties at reduced prices, making this a “once-in-a-generation opportunity to recharge your portfolio of properties,” Wooley writes.
Wooley suggests putting a “significant portion of your investable assets in real estate.” But how big is a slice, right? Ibbotson Associates says an allocation of “between 9 and 22 percent” is adequate. David Swensen, manager of the Yale University endowment, believes that “up to 20 percent” should be invested in real estate.
This asset allocation should not include your home, which, according to Michael Kirby, industry analyst and founder of Green Street Advisors, is not an investment, but simply “a living expense.” Excluding inflation, according to Yale economist Robert Shiller, “home prices have barely been budgeted for in the last 120 years.”
In “Liquid Real Estate,” Fitch writes, “Given the way property has performed recently, why own it?” Precisely because its recent decline may offer an attractive entry point into an asset class that, over the long term, has added a nice boost to stocks and bonds.
Why invest in REITs instead of owning your own properties? REITs take the hassle out of becoming an owner. “The best-performing stocks in the real estate universe are proprietary REITs,” Fitch writes. They collect rent and pass the money on to shareholders.
There are 113 registered REITs in the US that specialize in everything from apartment buildings to shopping malls, office buildings, self-storage facilities, warehouses, and even mobile home lots. The average return is 7.3 percent. All REITs have the same basic objective, “to buy property and put it to ‘higher and better’ use,” Fitch writes.
REITs are trading at 13 times their projected “adjusted funds from operations,” which is a multiple of 25 times less, according to industry researcher Green Street Advisors. Fitch suggests six reasons to own REITs:
1. Scale: REITs own dozens of properties, giving them an advantage in purchasing power.
2. Intelligence: REIT managers are savvy investors.
3. Debt: On average, REITs had debt equal to just 43 percent of the fair market value of their holdings, with the exception of General Growth Properties, which is now bankrupt. Compared to private real estate funds and partnerships that have debts of up to 80 percent of property value, the top 18 operators have managed to keep debt below 55 percent.
4. Taxes: The REIT dividend is a combination of ordinary income (taxed up to 35 percent) and return of principal, which has no immediate tax consequences.
5. Investor influence: REITs retain so little of their earnings that they are constantly looking for new capital, which means they must treat their shareholders, analysts, and lenders well.
6. Performance: REITs have generated an average annual total return of 9 percent from 1983 to the present.
In his article, “Home Sweet Tax Break,” Fitch argues that renting out your home can get you a nice tax break. Owners can deduct interest costs, property taxes, monthly condo fees, insurance, and anything else you pay to the property manager. Plus, homeowners can depreciate their property, which provides another big tax deduction. A good part of the cash return is protected from taxes by the depreciation deduction.
The amount of expenses that exceed rent are called passive losses and can be used to house up to $25,000 in other income, unless you are a real estate professional, defined as someone who spends at least 750 hours a year and at least 50 percent of your work. time in business – then these losses become “assets” and can be fully deductible against other income. Proceeds from the sale of a converted property depend on when you sell it. A good tax accountant can give advice on how profits are treated.
Finally, Steiner writes in “The Landlord Game,” “With real estate prices down 50 percent or more in some areas, the landlord’s game is back in vogue.” In many metropolitan markets, rental property yields are at the upper end of their historical ranges.
A standard measure of real estate value is the capitalization rate, which is calculated by dividing the property’s operating income (annual rent minus maintenance, insurance, and administration costs) by the sales price. This is comparable to the dividend yield of a stock. Real estate cap rates are better than the current 2.4 percent return in the stock market.