Jan. 27, 2006: Phoenix-area rentals can be a good investment if you can weather negative cash flow
One of the side effects of our recent run-up in home values is that the tenant pool is suddenly larger than it has been in recent years.
Would-be buyers are priced out of low-end starter homes, so they have to rent for a few more years as they accumulate savings or improve their earning power. This is good news for present and future landlords: Vacancy is down, and rents will trend upward in the long run.
But there is a cloud enshrouding that silver lining: A rental home that will appreciate well will probably yield a negative cash flow. The outflow - mortgage, insurance, taxes, maintenance, vacancy and tenant-acquisition costs - will probably exceed the rent. Depending on how little you put down, the negative cash flow could be as much as $250 a month after you have realized all the tax benefits of owning a rental home.
But Arizona is no place for clouds. If you can weather the negatives out of your regular income, at 6 percent annual appreciation you could turn a nothing-down down payment and $3,500 in closing costs into $50,000 in eight years.
If appreciation averages 11 percent over those eight years, you could run your $3,500 up to as much as $175,000.
But if you can't bear that monthly negative cash flow - or the glares from your spouse - you can use your accumulated home equity to make a substantial down payment. An initial investment of $48,500 could grow over eight years to $112,000 at 6 percent a year and to $236,000 at 11 percent. You'll still net out a little negative, but only by about $67 a month.
As your home and your rental homes continue to grow in value, you can use them as leverage to acquire more properties. Most of your added wealth will come from the profits you make on borrowed funds, and your capital gains are tax-deferred if you sell using an IRS Section 1031 exchange.
Greg Swann is the designated broker for BloodhoundRealty.com, a full-service Metropolitan Phoenix real estate brokerage. This article originally appeared in the West Valley regional sections of the Arizona Republic.
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