Question: My husband and I are ready to buy a home but given the uncertainty of these times and of even our seemingly secure jobs, we’re thinking of buying a 2 or 3 family building, living in one of the units and using the rental income as a hedge against one of us losing our jobs one day. Or, if that doesn’t happen, we would have the option of converting the building to a one-family home.
But my question is this–will banks take into account the value of the rental income when we are figuring out what we can afford and get a mortgage for? Is there any rule of thumb for that? Our income is about $250K and we would need to spend at least $1.1 million for a multi-family unit in our neighborhood in NYC. That’s on the upper range of what most online calculators say we can afford, but with a rental income to help out, do you think we can do it? Any thoughts about whether this seems like a good idea? Erin, Brooklyn, NY
Answer: Buying an income producing property such as a duplex or fourplex is a classic way of lowering the cost of ownership. But the difference between being a homeowner and a landlord is comparable to the difference between driving a Volkswagen Beetle and a Mack Truck. Like a truck driver, when you’re a landlord you’re running a commercial business dependent on cash flow.
When we buy a home we hope to make money over time through forced savings (paying off the mortgage) and appreciation (a vague hope sometime in the future considering the state of housing). But a home is much more than an investment. It’s a lifestyle, a neighborhood, a commute to work, school for the kids, and the like.
A rental property is a business. Like all small businesses, you’ll get some tax advantages, such as depreciation (an offset to taxable income) and deductions tied to the repair and maintenance of the business. If the business does well and generates a good cash flow it will more than cover your mortgage and other expenses. It’s a way to create wealth.
The size of the mortgage and the mortgage will be affected by a number of factors, such as the down payment, your income and debt ratio, and whether the apartments are empty or have tenants. The basic dynamic is the same as a home purchase: The larger the down payment the easier it is to get a loan and a decent rate. Mortgage loan limits are higher for a commercial mortgage, but so is the interest rate. The big issue for you–and the lender–is your ability to meet the monthly mortgage and other monthly financial payments even if rental units are empty. The banks will take the rental income into account, but at a discount because apartments can be empty.
In other words, like all small business there are genuine downside risks. For instance, you have to keep good books and your taxes will be more complicated. You’ll need to work with a professional insurance agent to get the right kind of property and casualty coverage. Any landlord will tell you that the business is highly dependent on the quality of your tenants. It’s a highly regulated business, especially in large metropolitan areas like Brooklyn or San Francisco, and landlords are sued more than any other group of business owners in the country. I would talk to landlords in your area about their experiences, go to some local landlord meetings, and tap into on the ground experience.
To be clear, owning rental property can be a great business. I just want to you to be sure this is the entrepreneurial venture for you.
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