My previous post described the opportunities that exist for first time or entry level homeowners in the current real estate market. Another group that is starting to benefit from the distressed housing market is the real estate investor.

When home prices were escalating over the last few years, it was difficult, if not impossible, for an individual to purchase a rental property and obtain a positive cash flow. The rent received from the property was not enough to cover the mortgage payment. The investors who purchased rental property had a negative cash flow. Now, with declining home prices coupled with increased rents, positive cash flow is possible in many areas throughout California.

The main reason for increased rents: The people who have recently lost their home to foreclosure or short sale are adding to the number of potential renters. These previous homeowners will not be able to purchase another home for quite a few years; the availability of loan programs for a borrower with bad credit as the result of a foreclosure or short sale are almost nonexistent. Therefore, they will have to rent. Since we have more renters than homes available for rent, the rent prices have increased.

A recent example of a rental property purchase: I have a client who purchased a duplex in Sacramento for $215,000. The mortgage payment including property taxes and insurance is approximately $1,400 per month. My client has already rented out both sides for $950 each, for a total of $1,900 per month. That’s $500 per month gross cash flow to start. Of course you do have to consider the interest expense on the money that he used for the down payment. He put 20% down -$43,000 - the monthly interest lost on this money is approximately $250 per month.

The other benefit of owning rental property is the depreciation write-off. In this case, my client will be able to claim an annual $8,000 depreciation expense write-off directly against his yearly income. The result is an approximate income tax savings of $2,400 per year = $200 per month in real dollars. Thus the equation looks like this:

$1900 Gross rent

- 1400 minus mortgage payment

500

- 250 minus interest cost on down payment money

250

+ 200 plus income tax savings from depreciation

$ 450 per month cash flow

There is the also the likelihood of increased rents in the future. Since the mortgage payment is a 30 year fixed, it will never increase. Yet the rents could easily increase over the next 30 years, making the net cash flow even higher in the future.

The negatives to owning rental property include the hassle of being a landlord, (you can hire property management for less than $100 per month). Vacancies and repairs can also be costly. However, if you can obtain a stable long-term renter who does not abuse the home, the positives will far outweigh the negatives.

MARKET UPDATE

With all of the turmoil regarding Fannie Mae and Freddie Mac, along with the bailout/failing of IndyMac Bank, our mortgage rates have increased this last week. The average 30 year fixed with no points for an owner occupied home is approximately 6.75%.

Inflation has also been a factor. This week the consumer price index was reported much higher than the experts predicted. I can’t see how the experts were surprised that our food and energy costs have increased. Most items that we purchase have to be shipped by a vehicle or manufactured by equipment that runs on gasoline or diesel. Therefore, the cost to produce or deliver these goods has to increase. When the costs increase, that causes inflation.