My wife and I recently had a chance to spend some time with our daughter and her fiancee. We had excellent time together talking about their careers and their desire to get into home ownership. Ok, Ok, don’t bring up the subject of them buying a home without being married. It’s scheduled for sometime next year. And they’re really debating how big of a wedding to have considering the alternative of investing tens of thousands of dollars into buying a property versus spending it instead on a bigger cake or a glitzier location. We discussed the alternative of buying a first home or buying a rental property in a more affordable part of the US and arranging with a good local property manager to keep it rented out. The challenge with trying to purchase a first home in California is affordability. They have the cash flow to make payments but not enough for downpayment on a $500,000-$800,000 “starter” home, but they do have enough saved for a downpayment on a $150,000-$200,000 property, maybe two within another year. If they purchased a rental property in parts of the US that have not experienced a real estate boom, but rather have good steady 3-5% per year appreciation and strong rental housing demand, they would be able to have a renter help them pay the mortgage. In a year or so the rental would be cash flow positive. The rental would enable them to deduct depreciation and property ownership expenses. If they purchased a rental home in the Gulf Opportunity Zone, the GO Zone of Louisiana or Mississippi during 2008 they would be able to deduct 50% of the depreciable basis of the rental property from 2008 taxes owed. We talked about the pros and cons of owning rental property out of state. We discussed the benefits of taking advantage of the investment networks that help to research good rental areas and link investors in with good local realtors and property managers.
The key deciding factor was the benefit of owning rental property on helping them legally reduce taxes in 2008 and 2009. By owning a rental property in the GO Zone they would be able to reduce their tax burden significantly and in fact be able to save more money for downpayment on their own home in California. They would be able to save enough in two years that they could purchase a California home for 10% down using a FHA loan. Hopefully the real estate market would have stabilized but not totally rebounded by then and the risk of purchasing California property still in decline would be minimized.
I think it’s important to look at the big picture when considering purchasing real estate. Is the goal simply to own you own home? Or is the goal to increase your assets and make the best use of your household cash flow? If the goal is the latter, you can do better by being an investor and deferring purchase of your first residence. That’s what smart business minded people would do, but most young people are simply following the conventional wisdom that owning your own home is a good thing and they are stressed and stretched to accomplish that goal in California.
Here are the links to the investment groups that I recommend www.icgre.com and www.conferwithus.com
Also here is a spreadsheet from the www.Conferwithus.com group that really helps people think about what kind of cash flow they should be planning to be able to generate in the future in order to have a worry free retirement. Much of the cash flow will come from 401K retirement accounts, but there is usually a gap between what is needed and what is being accumulated. That gap can be filled by enhancing your investment strategy with smart cash leverage and making investment decisions that produce beneficial tax treatment. Smart real estate investing is one part of a complete solution.
I suggest downloading this spreadsheet and the documentation and playing around with the financial gap in your plan. You may be motivated to attend an investment workshop in the future.
retirement-account-planning-model-description.pdf
