I talk about real estate a lot in this blog because I really do love it and believe that most professionals looking for investments needlessly get intimidated and stay away from it. Why do I love real estate so much? Because, as a real estate owner, you have significant tax advantages from the IRS. Owning real estate as an investor is seen as any other kind of business. In other words, you get to write off your expenses and depreciate your assets. This is sort of paradoxical because, as you know, most of the time real estate appreciates. So, as long as your rental income exceeds your mortgage, taxes, and other expenses, you are in great shape. In other words, you have passive income that is typically offset by depreciation and is, therefore, essentially tax free. In addition, because real estate actually increases in value over time, you are actually enjoying and appreciating asset at the same time as you are depreciating it in the eyes of the IRS! This is the way it works…this is not some kind of loophole.
What about buying your own home? Of course this is always a good idea. If you can put down a certain amount of money up front and then pay what you might pay in rent to build equity, why wouldn’t you? I do understand that for most people, including myself, buying a home is a big life milestone. It’s like taking root. You like your neighborhood, think it’s a good place to raise a family, etc.. But do you HAVE to wait? Not really. Many people are concerned that if they buy a place to live early on that they might get stuck with it…that is, they are concerned that they will not be able to sell it when they are ready to move on. So what? There is a great rental market out there, especially these days. And, contrary to popular belief, renting a property out DOES NOT mean you have to be a landlord who gets calls in the middle of the night to fix leaky toilets. That’s what property management companies are for. Even if you make NO money on your rental and as long as you are not losing money, you are good. After all, the renter is now building equity for you with monthly payments. Over time, rents will go up and you will increase your profit margin. If you pay the property off, you have lots of profit!
Property ownership can be easy as buying a condominium that is the size of an apartment. Generally speaking, I am not a big fan of the condominium because the ability to rent your property is sometime restricted by the condo association and you have to be sure they are not going to switch something up on you two years after you buy the property.
If you are a resident or fellow, you might be wondering to yourself, great Dr. J, where the heck am I supposed to get that down payment for the mortgage? Aren’t banks requiring 25-30 percent down these days? I don’t have much money sitting around right now. Well, there are two great options for you still if you don’t have much money to put down. First, be aware of properties that are “seller financed” or “owner financed”. What this means is that the home seller is essentially willing to act as the bank. You will still likely have to put down some money, but frequently a fraction what the bank would require. As a physician or student physician, you are in a unique place where society deems you trustworthy (as you should be). Leverage this in negotiations with sellers to get the terms you want including the amount you put down and the interest rate. Most of these loans utilize a “balloon”. That is, even though your mortgage may be amortized over thirty years, you will be expected to refinance (and therefore pay the seller in full) over the course of a few years (perhaps when you are out of medical school or residency, etc). If these words are foreign to you, we will talk about them in more detail in different posts so don’t worry. Just remember, if you want to get into an asset as soon as possible, buying a place to live, even if it is temporary, is a great way to go.
In addition to private financing options as noted above, banks are often friendly to doctors and other professionals who underwriters see as stable and low risk of default. I will do my best to alert you of these kinds of deals on this blog so when you are ready, check back. Finally, I have to tell you about the best kept secret in the real estate world: the Federal Housing Administration (FHA) loan. Why not buy real estate with and FHA loan? You might be thinking, “Dr. J, isn’t FHA stuff for the poverty stricken?” It’s got sort of that urban, housing project sort of feeling, right? But that’s why it’s such a great secret. The FHA loan requires only 3.5 percent down to purchase a property. So, you want to buy a condo or small house for 200K? Can you put up 7K? If so, you’ve got yourself an asset. Now here’s the real kicker. The FHA allows you to buy not only a single family occupancy, but you can also use the loan to buy up to a 4 unit building!!!
So…let me give you an example on a GREAT business move that you should seriously consider if you’ve never bought a home before (the FHA is for first time home buyers).
If you’ve never bought a home before and are considering renting instead, why not buy a 2-4 unit building instead? For 2012, here’s info from the FHA site on what you can buy using the FHA loan in my area of the country:
|MSA Name||County Name||One-Family||Two-Family||Three-Family||Four-Family|
|CHICAGO-NAPERVILLE-JOLIET, IL METROPOLITAN DIVISIO||COOK||$410,000||$524,850||$634,450||$788,450|
So, what this is telling you is that if you are looking at buying a home in Cook County with an FHA loan, you can get a loan up 410K for a single family home or condo and up to 788K for up to 4 units. Say you found a 4 unit place with a unit in it that you wouldn’t mind living in for a few years and you got the price negotiated to 780K. With 3.5 percent down, you would be putting down just over 27K—tack on some closing costs and fees and say you put down a total of 30K. If the total sum of the rents of the 4 units in the building (including the one you will be occupying) would be equal to or exceed the monthly mortgage and taxes payments, the FHA will allow you to buy this building!
So why is this so great? 30K is a lot of money, right? Also, you can’t depreciate anything since you live there and it’s not considered an investment. Well, consider this. If you live in the place for a minimum of one year (FHA requirement), you can rent out the place you occupied and now you have an asset that is paying for itself with rental income. In addition to possibly making a small amount of income, you also now have an asset that is being paid down by your renters. You can get yourself a property manager and never hear from them again! In my market, that 780K property will likely appreciate to well over a million dollars in 5-7 years. Think about it. All you did was put 30K down and lived in the building for a while. You moved out, and the building didn’t cost you anything anymore but the mortgage kept getting paid down month by month by your renters. For that 30K you put down, 5-7 years later that asset might have appreciated to the extent that then have 300-400K in equity!!! For 30K, that’s a bargain. Remember that a 4 unit building is essentially appraised by determining the sum of its rental income. In other words, you don’t have some appraiser eyeballing it to determine its worth. If you are raising rents by 2-3 percent per year, the value of your property can increase significantly. Now, one more thing, at some point after a few years, you may decide to refinance this building. If you decide to sell it to your own legal entity for fair market price, it can now be a business asset and you can take advantage of all the benefits of real estate investment that I discussed earlier.
In case you’re wondering how I thought of all this…it’s because I almost did it myself. The problem was that having done a long surgical residency, I was getting that “move on with your life” fever shortly after I started making some money. I had a wife and 2 year old and decided to move to a single family home in the ‘burbs instead. I love my house but I really wish I could have done this FHA thing with the 4 unit that I discuss above. When I was looking into it, I thought, “I could buy this thing for 30K now and it would easily pay for my kid’s college education in 16 years”. It’s true. If someone ends up doing this because of this post, PLEASE write us and let us know. I live vicariously through you!!!