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Webinar #148: Smart Real Estate Investing

February 24, 2023

Propy Webinar #148: Smart Real Estate Investing

Kris Pope, Head of Sales at Propy, and Kirsten Heslop, Senior Account Executive at Propy Title are joined by Kylie Pont and Brad Patterson to discuss the key benefits of real estate investing. Additionally, they discuss ways to avoid some of the pitfalls of real estate investing, and tips for making your investment successful.

Background

Kylie grew up in Nebraska and moved to Arizona ten years ago. Brad grew up in California and relocated to Arizona three years. They met skydiving, which is a passion they both share. Brad was a skydiving instructor for ten years, with over 10,000 dives. Kylie and Brad also enjoy playing golf and spending time with their dogs.

Because of their interest in real estate investing, they decided the best way to learn how to invest was to get into the industry, so Kylie because a real estate agent, and Brad became a home inspector. They wanted to be able to understand all aspects of the industry, and in the process, they fell in love with real estate. Their niche is helping people purchase investment homes.

What makes real estate a good investment

“Purchasing a home for a place to live is a great way to build equity versus renting your entire life, but there is more than you can do with real estate,” Kylie explains, saying, “It’s a great investment tool, and a great way to diversify your portfolio.” A person can put their money into the stock market, and if it crashes, they can lose all their money. Real estate is a safer investment, because you have a physical house and property with the added benefit of passive income from the rental, and the ongoing appreciation on the house. Even though the real estate market fluctuates, in general there is an upward trend, so if people invest wisely, they will rarely see a loss with this investment.

Additionally, there are some good tax benefits that real estate investing provides. Kylie explains that the IRS sees a loan as a non-taxable event, and when the home appreciates over time, you can borrow against that appreciation to purchase other properties. Rental income is considered passive income, and is taxed more favorably than active income, like what is reported on your W-2. That makes for some good tax benefits while you diversify your investment portfolio.

Choosing the right investment property

Kylie states that one of the first things to consider before purchasing an investment property is what kind of renters will be in that property. For example, a vacation rental has short term renters, the turnover is fast, and the investor will typically get a higher income from that property.

Long term rentals will typically take less effort, and the investor won’t make as much money, but the rent will cover expenses, and of course, the house will continue to show appreciation. Regardless of which type of renter an investor is looking for, a property management company can allow the investor to be hands off if they don’t want to be involved in the day-to-day efforts to maintain the rental property.

Another important aspect is deciding what market to invest in. It’s not necessary to invest in your own marketplace, but whatever market is decided on, the investor will want to know the answer to these questions:

• Is the city/area expanding?
• Are more jobs coming to the community?
• What’s the median rental income?
• What’s the unemployment rate in this city?

For example, Kylie explains that Phoenix and Scottsdale have a lot of short-term rentals as this area is a highly sought-out vacation destination due to the good weather, golfing and other recreational opportunities. Additionally, there are several companies building microchip manufacturing in the Phoenix-Scottsdale region, so the market is expanding, and is creating a lot of opportunity.

Of course, there are many other attractive markets across the country, but there are some things that an investor needs to be aware of. First, some cities don’t allow for short-term rentals, so it’s important that investors do their research and know the rules and regulations for that market. Second, some cities have very high transient occupancy rates. As an investor, it’s critical to know about those rates so you don’t end up being taxed out of profitability.

There is a tool called AirDNA that looks at 10 million Airbnb and Vrbo vacation rentals, and tracks the performance data of those properties. Using this tool will help you determine if an area has a good market for rentals, what the percentage of rentals is, and what rental prices range in that area. Understanding these analytics is important for making a good decision on properties to buy.

Another tool the savvy investor will want to use is called an Annual Property Operating Data calculator (APOD). This tool allows you to input different data points to determine if the property will be profitable. Data points to use include:

• Sales price
• Closing costs
• Expenses, such as taxes, property management fees, and utilities
• Mortgage interest

The importance of home inspections

Brad explains that when a potential buyer is walking through a house for the first time, there are a lot of things that may not be obviously wrong, but can be costly to repair—and that eats into the profits of an investment property. Getting a full home inspection is a smart idea whenever shopping for an investment property. Having a full roof-to-crawlspace inspection, including appliances, will be very detailed report, and puts a lot more information into the hands of the buyer to help inform a solid decision on purchasing the property.

The five major inspection points are:

1. HVAC
2. Roof
3. Structure of the home, including the foundation
4. Electrical
5. Plumbing

HVAC systems average lifespan is about 10 to 15 years. While some systems can last longer, if you are looking at an investment property with the HVAC in this age range, it’s important to budget for that replacement cost. For a 2,000 sq ft home, the replacement cost will around $8,000-$10,000, and in a 4,000 sq ft home, those costs can be up to $20,000 due to the number of units that have to be replaced.

The average lifespan for a roof is between 20 – 30 years, depending on your climate and environment. A new roof will cost about $14,000 for a 2,000 sq ft home, and up to $30,000 for larger homes. A thorough home inspection can uncover evidence of roof leakage, which will potentially save the investor from large, unexpected expenses down the road.

Plumbing is a frequent issue in older homes and is often overlooked in disclosures. Sewer line repairs are roughly around $100 per foot to replace, with a typical sewer line 5,200 feet long. This out-of-pocket expense will range between $5,000 – $10,000 to replace. One thing that many buyers don’t know is that the homeowner is responsible for everything from the city tap all the way to the house. A sewer scope inspection, where a video camera is run through the pipes, will give the buyer a good idea how the water is flowing through that line, and if everything is functioning well. Pipes will typically last between 50-to-100 years on average, however problems can show up earlier than that.

Electrical panel upgrades can be quite costly and can run up to $10,000 depending on what is needed. “Many of these older homes in Arizona only have 100 amp services,” Brad explains, “and modern homes are requiring 200 amp service.”

While the cost for structural repairs vary depending on the severity of the problem, having a structural inspection to make sure the house is sound is important. Brad shares that he had a friend buy a 1,500 sq foot home without a detailed inspection and ended up with $120,000 in structural repairs.

Costs for replacing these five key areas in a 2,000 sq ft home could exceed $44,000, so it’s well worth your time to get a full inspection anytime you are looking at purchasing an investment property. The inspection will also test the function of every appliance in the home and will be able to give you information on the age of that appliance.

Another item that is commonly overlooked are water heaters. The average water heater will last about 8 – 12 years. If the property has a pool, it’s a good idea to have a pool inspection that looks at the pool condition and the operating equipment of the pool. Depending on the size of the pool and the types of pumps and filters used, that price tag can be $5,000 – $10,000 to replace.

Brad recommends that all buyers should get a home warranty whenever they purchase a home. That warranty will cover anything that fails during the first year of owning that property.

The best market to buy investment properties

The Scottsdale area is a good market for investment properties, according to Kylie. The area has a lot of short-term rentals, due to the number of people who come for vacations, or the “snowbirds” who spend their winter months there. She says that Scottsdale is a great destination for vacations, but they are also seeing a lot of people moving in due to the new jobs being created there.

Tips for purchasing an investment property

“Having a really good lender on your side is really helpful,” explains Kylie, because you have to stay within your means when buying an investment home. While you want your investment property to be rented at all times, sometimes that doesn’t happen, and you have to have enough of a financial cushion to help you absorb the expenses during the times the property is vacant.

A good lender can help you come up with creative ways to handle the financing. There is a debt service coverage ratio (DSCR) loan, and that allows a buyer to get a mortgage based on the cash flow of that property, as opposed to the buyer’s income.

When buying a property that needs some work, the property will increase in value quite a bit as you complete those repairs. The investor will be able to refinance that property and pull out some of the equity to then purchase another property.

Lowering the downpayment

Getting the downpayment to purchase an investment home can present a challenge for first time investors. Kylie shares that there are down payment assistance programs that can be helpful in that situation. Other options can include getting a financial gift or loan from a family member, so you don’t have to go through the bank for those funds.

Additionally, there are some loans available that only require 3-5% downpayment, which will allow a first-time investor to get started without needing a large amount of cash up front.

Kylie adds that an investor doesn’t need to start out with buying a large property. Purchasing an affordable one bedroom, one bathroom condo will attract plenty of renters who are looking for something that size, and give the investor a good start.

“I’ve noticed that some new investors need to get over the idea of buying a house mentally,” Brad shares, “because there is a lot they don’t know about the process.” He recommends that anyone who feels that way should use the tools that were mentioned and get a good home inspection because it will “put all that knowledge in your court, reduce your fears, and allow you to move forward strategically.”

Managing the rental property

“One thing to keep in mind if the property is going to be a furnished rental, is you have to furnish the entire home,” explains Kylie, “and that can cost $10,000 per room.” There are companies available that can help with those services. Property management companies can allow the owner to be completely hands-off, and will furnish the property, make sure it is clean, that all supplies are in stock, and change the locks every time a new renter is there.

Another benefit of using a property manager is the responsiveness they have when problems occur onsite, such as a leaking water heater. The property management company will have contacts with service providers to get problems repaired quickly, which will lower the stress on the property owner.

Property management companies earn up to 20% of the rental fees, depending on the services they provide. Ultimately, they are making sure your renters are happy and leaving positive reviews, which is important for the success of your rental.

Most important take-away

“Do your homework and crunch the numbers to make sure the finances work for you,” is Kylie’s top take-away. She explains that you have to do your research so you don’t put yourself in a tight place financially. If you don’t plan for unexpected expenses or lulls between renters, you might put yourself in a position where you must sell the property, and that undermines your goals. Doing your homework will help ensure you’re successful.

Contacting Kylie and Brad