A few millennials I’ve talked to in the District are considering it for several reasons: They have above-average salaries. They’ve paid down their debt. They’re building their retirement funds. Yet they were looking for an investment that would provide them a little more aggressive growth.
For young people, as with many later in their careers, investing in rental property provides diversification of investments beyond the common 401(k), IRA and mutual funds standard to retirement planners. Whereas a retirement portfolio often depends on how long the beneficiary will be living into retirement, investing in the real estate market provides a different opportunity to invest with a focus on immediate cash flow.
A rental property would allow investors to earn some monthly income, build equity over time and perhaps acquire a residence that could be their home in the future.
Here are five tips for millennials considering purchasing an investment property in the District:
• Learn the market, analyze the risk: Real estate investment, especially within a solid and conservative market like Washington, can provide the investor a steady cash flow, and the potential for growth in a market that has a lower barrier to entry than other markets within the Atlantic region (for example, the high-priced market in New York City).
The first step for any young real estate investor should be to understand the D.C. real estate market’s trends. Understand that the real estate market works like any market with a dependence upon supply and demand. D.C.’s market is considered highly restricted on supply — thus, a seller’s market.
• Set a cash flow goal: The name of the game is cash flow. For instance, a young investor purchasing a $300,000 one-bedroom condominium in Northwest Washington could expect to charge $2,000 a month in rent. With 25 percent down and an interest rate of 4.6 percent (higher as the investor is not purchasing a primary residence), the investor would pay about $1,150 per month in principal and interest.
When adding in taxes, insurance and a condo fee (in this case, let’s assume the investor purchases in a low fee building around $200 a month), the total payment per month would be about $1,600. Thus, after renting the property out for the market rate of about $2,000 a month, the property would yield around $400 in profit, or $4,800 in return per year. Simultaneously, the property will build equity for future resale and further investment.
• Know the benefits, anticipate the cons: Investors can deduct the interest paid on money that has been borrowed on an investment loan just like you would on a personal residence. Just like with any level of risk, diversifying an investment portfolio to include rental properties provides its own drawbacks.
For one, providing a sizable enough down payment to deliver a rate of return that meets the investor’s goals is certainly difficult, especially given the amount of debt held by today’s young professionals.
Also a new landlord must be well versed with the D.C. Office of the Tenant Advocate and its Tenant Bill of Rights in order to function legally within the tenant’s rights.
• Capitalize on rental market: In a market like D.C.’s, a young investor also captures the demand for rentals, a market still in high demand at a high cost given the nature of many of the city’s transient individuals. For investors who have yet to purchase a residence for themselves given a preference for a larger home before entering the market themselves, investing in the market provides an avenue to build a larger down payment and build equity in their existing investments.
• When faced with high barrier for entry, explore business partnerships: For a young investor whose debt-to-income ratio weighs heavy on student loans, purchasing into the real estate market may be difficult. However, uniting with business partners to create either tenancy in common (nonequal shared interest in the property) or joint tenancy (equally shared interest in the property) reduces the costs associated with the barrier to entry.
In order to protect interests among business partners, a young investor should consider setting up a limited liability company (LLC), a strategy used to protect the interest of the investor.
What is the end goal for this type of potentially risky investment?
The answer is simply to give the young property owner more liquidity while also protecting his capital with the potential for appreciation and future investment.
Tim Savoy can be reached at 202-400-0534 or Timothy.Savoy@cbmove.com.