There are a number of reasons for this—two big ones being exceptionally low prices and interest rates that are at a 65 year low. In addition, real estate offers a number of clear tax benefits that are hard to beat. These include write-offs for fix-up costs, taxes and insurance, plus, says Robert Ramsey, Broker-Owner of Charlotte Ramsey Real Estate, Inc., best of all is the annual depreciation allowance that helps shelter some of your other income. Taken together, for many people, these are powerful reasons why real estate compares favorably to other types of investments such as the stock market.
While these are general incentives to invest in real estate, there also are a number of reasons why Charlottesville area properties are potentially profitable places to put your money. A big one, of course, is the stability associated with the University which, according to Jim McVay, of Roy Wheeler Realty Co., can be depended upon to provide “a stable base of rental prospects.”
As in other markets, Charlottesville area prices are significantly lower than they were a few years ago when the market was very hot, and according to the 2011 4th quarter market report, they were continuing to decline somewhat compared to 2010. However, this may not be the case for long. The report also noted that the number of new listings was down over 20 percent compared with the end of 2010 and pending sales (homes under contract but not closed) were up almost 20 percent during the same time frame. In other words, if you are waiting for the market to bottom out, don’t wait much longer.
Financing and Interest Rates
While the combination of low prices and interest rates makes a powerful argument for investing now, this is tempered somewhat by the relative lack of invester funds. There are several reasons for this.
One is that money is a lot harder to borrow than it once was, which means you have to work harder to get a loan. A few years ago when loans were easier to obtain, explained Tommy Richards, a loan officer with StellarOne Bank, investors took advantage of these much looser standards and often got in over their heads. All was well until real estate prices started coming down instead of going up, and investors who were unable to make their payments also could not sell their properties. The resulting foreclosures caused banks to tighten up credit standards significantly.
“Expect to provide about three times the documentation as you would have a few years ago,” said Lee McAllister, a senior loan officer at Fulton Mortgage. Both lenders also agreed that you need excellent credit, good income and the ability to put 20 to 25 percent down. More is better, advises McAllister, who said there is a big interest rate advantage associated with a larger down payment.
For those who already have several mortgages on investment properties there is another important consideration. According to McAllister, Fannie Mae’s requirements limit investors to 10 mortgaged properties including their home, considering more than that to be too big of a risk. In addition, investors with more than four financed properties have to show six months of payment reserves for all of them.
While at one time there was other money readily available to accommodate investors with more than 10 properties, today it is harder to come by, commented Ramsey, who owns many rental properties.
When he was just starting out, Ramsey said that he had a goal of acquiring at least one new rental property per year. However in the last several years, with the dearth of funds for larger investors, he has been unable to meet that goal, and has run into the same frustration when seeking property on behalf of his larger investor clients.
There is good news, however. Some local sources are now making loans again which they portfolio (keep in-house) eliminating the need to meet Fannie Mae or Freddie Mac requirements. Richard’s bank, StellarOne, which is headquartered in Charlottesville, is one of those. “It is a big advantage to be local,” he said. “We know the area and the neighborhoods and can drive over and look at a property if need be before making a loan.”
Because of the increased risk, “loans cost more today,” said Richards, “but usually not so much as to be a deal breaker.”
Who are Today’s Investors
People invest in Charlottesville real estate for a number of reasons. A big one is that they fell in love with the area when they went to school here, explained McAllister. They purchase property here both because they understand the Charlottesville market with its stable base of renters and its potential for long term appreciation, and because they have plans to return eventually when they retire. When they do, they already have a place to live.
In other cases, she said, people do the opposite. They move here to retire or just because they love the area, but rather than sell their previous house they keep it as an investment property.
In some instances students purchase a starter home or condo while they are in school with the idea of keeping it for rental when they graduate and move on. McVay described some buyers who did just that. They purchased a townhome while in graduate school, and lived there several years, enjoying the proximity to the University.
When they purchased the property it was with the foresight that not only was it a good long term investment, but the realization that they could always network with contacts in their respective departments to find qualified renters after they had moved out. Coming from families with some experience in real estate and investments, they were familiar with the challenges of property management and were comfortable with their ability to do so successfully. If you are contemplating following their example, do some research on what is required to be a good landlord before you jump in.
Richards said it is not uncommon for investors to be empty nesters with disposable income looking to diversify their portfolios. These are the folks who can get loans for investment properties because over the years they have established the kind of credit scores and acquired the depth of assets needed to qualify.
The main question we want to answer when qualifying a borrower, he said, is “can they handle the bumps in the road? A solid set of assets and an excellent credit score are not things you acquire over night,” he explained. When a borrower has these in place, they are more likely to be considered a good risk.
Charlottesville’s Rental Market
People choosing to purchase investment property should be confident in the stability of the rental market. According to Ramsey, today Charlottesville’s market is what he calls “pocketed.” However, “in general, rents have remained strong through the recession,” he added.
A number of factors contribute to the strength of our local rental market. In addition to the demand for properties around the University, the higher than average foreclosure rate means there are a whole class of people who are unable to purchase a home and are forced to rent. At the same time, the condo market is complicated by tighter Fannie Mae, Freddie Mac rules which make loans for these units a lot harder to obtain than they once were. This means people who may have purchased a condo in the past may be more inclined to rent today.
Property Management
Before you decide to start acquiring rental property, consider whether you are cut out to be a property manager. “After 30+ years in the real estate business,” said McVay, “I always tell clients that you can make good money owning rental property, but it can be a real headache.” A big part of this headache is learning how to choose good tenants.
Ramsey expressed similar sentiments when he said that he advises about 50 percent of the people who express interest in purchasing rental property to give serious thought to putting their money elsewhere. The reason is “not everyone can be a landlord.” It takes someone who is willing to research rental prospects carefully and recognize who is and isn’t a good risk. Ramsey always runs a credit check and asks for a recommendation from their current landlord. He added that if someone can’t come up with the first month’s rent and tries to negotiate their security deposit, it’s a good sign they won’t be a strong tenant.
Of course you can always pay someone else to manage your property and that is a good option for many people. The 6 to 10 percent of your rental income which you can expect to pay for this purpose cuts into your cash flow, but may be well worth it. Also, it’s a good idea to check with your accountant since if you don’t actively manage your property, the IRS may consider you a passive investor, in which case you may also lose some of your write offs.
The Costs of Property Ownership
Whether or not you make money on rental properties depends on a number of factors, and inexperienced investors may overlook some of the real costs. For example, McVay said it helps to be handy, and/or to have a good list of people you can rely on who are. If you are handy yourself and know other people who are, or if you own a number of properties, you can do your own fix up and repair, or have a better chance of negotiating good prices from others. If you are regularly forced to pay retail prices on repair this will eat quickly into any profits.
Another consideration is your market. While the University provides good demand for rental properties, you can also count on a lot of turnover as students come and go; and don’t expect them to be good at maintenance and yard work. It usually takes a year to recover the costs of fixing up a rental unit for the next tenant, even if there is just normal wear and tear, Ramsey explained. This means you are into your second year before you start making money again on that unit.
The cost of turnover is also a good reason to stay reasonable with rents and not raise them too often or too much. Keeping tenants happy enough to stay for several years can be good business, and more profitable in the long run than continually raising rents.
Celeste Smucker is a writer, editor and author of Sold on Me Daily Inspiration for Real Estate Agents. She lives near Charlottesville.
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