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This Old House - Do-it-Yourself

Long Term Strategies For Second Home Investments

Written by Posted On Tuesday, 08 March 2005 00:00

Perhaps you are ahead of the curve and already own a second home as an investment property, but do you know how to keep the door open on long term returns?

A real estate investment is a long term investment and even though the housing market has been favorable for years, that doesn't mean you don't need to keep the pump primed.

With the fast run up in real estate values compared to the sluggish securities markets it's not surprising that investors accounted for what's likely a record 23 percent of all home sales last year, according to the National Association of Realtors' recently released "2005 National Association of Realtors Profile of Second-Home Buyers" .

Not only is real estate a tangible asset you can use, it's also a more easily leveraged investment. That means a smaller percentage (the down payment) of the larger investment (the value of the home) actually faces risk. With today's mortgages, financing can be a breeze.

"Many lenders will finance a second home just like an owner-occupied home, same rates, qualifying requirements. Even 100 percent financing is available for second homes," said Brandon Knapp a broker with Lawson & Associates Mortgage Planners in Campbell, CA.

The investment also comes with some built in versatility.

"A great aspect of real estate is that the investor can buy properties according to his particular financial and personal needs. Different properties are geared more toward achieving one of these types of return than another," said Eric Tyson a personal financial counselor from New England who, with Robert S. Griswold, co-authored "Real Estate Investing For Dummies" (Wiley, $21.99).

"An investor with significant earned income may focus on properties with tax benefits and not worry as much about cash flow. Investors nearing retirement will prefer properties with cash flow. And all investors look forward to appreciation," Tyson added.

A second home's potential has captured not only the investment money, but also the hearts of American home buyers.

All second home purchases -- investment properties, vacation houses, and retirement homes -- accounted for 36 percent of all home sales last year, and second homes now comprise 38 percent of the nation's entire existing housing stock, according to NAR.

So how do you make such a gift keep on giving?

Tyson, Griswold, and others offer the following advice for real estate investors in it for the long haul.

  • Raise the rent. It sounds like a no-brainer, but too many property owners are green landlords and reluctant to raise the rent, the life blood of an investment property. The idea, however, is to raise the rents gradually, as you keep both the property's condition and the rents inline with market levels. Tenants recognize that costs rise and so must rents.

  • When it's time to sell a rental property with an established rental record it can sell for a premium because you are selling both a property and an established business, says Christine Karpinski, investor and author of "How To Rent Vacation Properties By Owner"(Kinney Pollack Press, $26).

  • Reduce Turnover. Frequent turnover causes not only lost income, but also increased maintenance, repairs, and improvements to help the unit show better to prospective tenants. Release the hounds, says Karpinski. Renting to pet owners often captures a shunned market that will help keep your place purring with income. Pet owners will also pay a premium in higher rents that can be set to cover the potential cost of cleaning or upgrading after the dog, or cat lover leaves. Also, long term, rather than short term leases, cut down on maintenance and upkeep generating traffic.

  • Opt For A Lease Option. Lease options give the renter the option to buy the property at a predetermined price within a given time. The contracts require sweating the details, but they are commonplace. Lease options are often more favorable for the lessee (landlord) than the lessor (renter-buyer) because they come with an initial option payment the owner gets to keep if the renter doesn't buy. There's also the possibility, with a predetermined price, the property will sell for more than the current market would otherwise allow.

  • Carve A Niche. Non-smoking housing units in Vegas (a breath of fresh air after working all day in a casino), student housing to serve the growing number of Echo Boomers about to enroll in college, vacation condos in resort towns all meet a specific need, but require special management skills.

  • Avoid Neglect. Keeping your properties tidy and well maintained gives them a high profile in the midst of eyesores, and that means higher rents and a larger source of tenants. Kitchen and bath renovations rule the roost when it comes to both value returned to the property and higher, long-term rents. Who doesn't like shiny gadgets? The other rooms are boxes. Keep them clean and well finished, like a new model home.

  • Cut Costs. Consider energy audits, solar equipment, Energy Star appliances and other energy-efficient steps that both the environment and your tenants will appreciate. Also, combine two or more rental properties under one insurance policy.

  • Watch Your Assessments. The property tax and supplemental property tax on a newly built $500,000 property in California can suddenly hit you with a $10,000 bill over the course of a few months. If your tax is tied to property values, don't be afraid to appeal any assessment you think is too high. A lower assessment can mean a smaller tax bill and more cash flow.

  • Build Equity Faster. When your cash flow improves (say due to increased rents or reduced costs) to the point where you can handle a higher mortgage payment, refinance to a shorter-term mortgage to increase principal payments and reduce interest costs. You can also cut financing costs and shorten the term by making more payments directly to the principal. Make sure you don't have a prepayment penalty that will cost you to pay off the full loan early.

  • Get Under The Tax Shelters. Tax law allows serial home selling every two years. The law excludes capital gains taxes on profits of up to $500,000 when you sell a home and qualify. Tax deferred exchanges for larger properties can help keep money working, rather than in Uncle Sam's coffers. Depreciation reduces taxable income. Help from a tax expert, accountant, or tax attorney is mandatory for ducking under tax shelters if you don't have a degree in the subject.

  • When All Else Fails, Move. Real estate typically increases over time, but there are local market conditions that can put appreciation in reverse. When that happens, move your investment to a property in a community more hospitable to returns.

  • Manage wisely. Karpinski takes the do-it-yourself route to exponentially increase returns. Some property managers can take as much as 50 percent of your rental income, and more.

"With the WorldComs and Enrons of the last few years, people are looking to have more personal control over their investments. They also want to invest in things that are within their comfort zone," said Karpinski.

That assumes however, that you are near enough to actually manage properties, or can handle the task of juggling management for several or larger multi-unit properties.

You may also decide on using both strategies depending upon what each property dictates.

In any event, Tyson says, learn early what management approach you need so you can hone it to meet the needs of your investment, and your tenants.

"The ability to control and implement different management strategies can lead to more satisfied tenants and longer-term tenancies. So whether you're very hands-on with your property, or you prefer to let a professional handle the day-to-day challenges, make sure your management is top-notch. Diligence in this area can make the difference between a so-so return and a great one," said Tyson.

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Broderick Perkins

A journalist for more than 35-years, Broderick Perkins parlayed an old-school, daily newspaper career into a digital news service - Silicon Valley, CA-based DeadlineNews.Com. DeadlineNews.Com offers editorial consulting services and editorial content covering real estate, personal finance and consumer news. You can find DeadlineNews.Com on LinkedIn, Facebook, Twitter  and Google+

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