Owning
Ownership is the beginning, not the end
Vacancy, maintenance, management, leasing, laws, insurance and taxes. This is where an investment either performs or quietly underperforms.
Vacancy
Do not assume a property will be occupied 365 days a year forever. Tenants move. Repairs happen. Turnover takes time.
Even a highly desirable rental should have some allowance for vacancy. A conservative analysis is usually better than an optimistic one.
Maintenance
Every property eventually needs something. Consider reserves for:
- HVAC
- Appliances
- Plumbing
- Electrical
- Water heater
- Paint
- Flooring
- Fixtures
- Landscaping
- Roof
- Windows
- General wear and tear
Condos may shift some exterior responsibilities to the HOA, but owners still need reserves.
Property management
Should you manage the property yourself? Maybe.
Self management
Potentially saves management fees but requires the owner to handle:
- Marketing
- Showings
- Applications
- Tenant screening
- Lease documentation
- Rent collection
- Maintenance requests
- Emergencies
- Legal compliance
- Security deposit procedures
- Turnover
Professional property management
Adds expense but can significantly reduce the owner's day-to-day involvement. For some investors, that convenience is worth the cost.
After closing: preparing the property to rent
The goal is usually not to create the fanciest property. It is to create a clean, durable and desirable rental.
- Fresh neutral paint
- Durable flooring
- Professional cleaning
- Functional appliances
- Window coverings
- Updated lighting
- Secure locks
- Smoke and carbon monoxide detectors
- Landscaping
- Minor repairs
- Professional photography
Think durability. The beautiful material you would choose for your own home may not always be the best material for a rental.
Pricing the rental
Pricing too high can be expensive.
The math of one vacant month
Suppose market rent is $4,500 and you list at $4,800 hoping to get more. If the property sits vacant for one month, you have lost $4,500. It can take a long time to recover that lost month through an extra $100 or $200 in monthly rent.
Price accurately. Attract strong applicants. Reduce vacancy.
Tenant screening
Tenant selection should be consistent, objective and compliant with applicable fair housing and landlord-tenant laws. A screening process may include legally permissible review of:
- Application
- Income documentation
- Credit
- Rental history
- References
- Identity verification
- Other lawful screening criteria
Criteria should be established before reviewing applicants and applied consistently. Fair housing compliance is essential.
Landlord laws matter
California has extensive landlord-tenant laws. Depending on the property and circumstances, rules may affect:
- Security deposits
- Rent increases
- Required notices
- Tenant screening
- Habitability
- Entry into the property
- Repairs
- Lease termination
- Eviction
- Disclosures
- Fair housing
- Local rent regulations
These laws change
Before renting a property, owners should use current California lease documents and consult a qualified property manager or California landlord-tenant attorney when appropriate.
Short-term rentals
Never buy a property assuming Airbnb or another short-term rental strategy will be allowed. Rules can come from multiple places:
- City
- County
- HOA
- CC&Rs
- Mortgage
- Insurance
Verify before purchasing. A property's projected income should never depend on a rental use that has not been confirmed.
Insurance
Investment property insurance is different from standard owner-occupied homeowners insurance. Discuss with an insurance professional:
- Landlord coverage
- Liability
- Loss of rental income
- Water damage
- HOA master policy
- Deductibles
- Earthquake coverage
- Flood exposure
- Additional coverage appropriate to the property
Get insurance information early. Do not wait until the day before closing.
Property taxes
California property taxes are generally based on the property's assessed value after purchase, plus applicable local assessments. Do not assume the seller's current tax bill will become yours. When analyzing an investment, estimate taxes based on your anticipated purchase price.
- Mello-Roos
- Special assessments
- Supplemental property tax bills
These can materially affect cash flow.
Tax benefits and tax questions
Real estate ownership may create important tax considerations involving:
- Rental income
- Deductible expenses
- Mortgage interest
- Property taxes
- Depreciation
- Capital improvements
- Repairs
- Capital gains
- Passive activity rules
- Personal use
- 1031 exchanges
- Estate planning
Tax treatment depends heavily on the owner's individual circumstances. We provide real estate guidance. For tax strategy, buyers should consult their CPA or qualified tax professional before making decisions.
Depreciation in simple English
Depreciation is a tax concept that may allow an owner to recognize the gradual use of an income-producing building over time. It can potentially reduce taxable rental income even though the property itself may actually be increasing in market value. Land is treated differently from the building for depreciation purposes. This is one of the reasons a CPA should be part of an investor's team.
1031 exchange
A 1031 exchange may allow qualifying investors to defer certain capital gains taxes when selling investment real estate and purchasing qualifying replacement real estate. The rules and timelines are strict. Do not wait until after selling a property to investigate a 1031 exchange. Involve a qualified intermediary and tax professional before the sale closes.
Personal use + rental use
Some investors want the best of both worlds: rent the property while also using it themselves or allowing family members to use it. That can be possible. But personal use can affect:
- Tax treatment
- Expense deductions
- Financing classification
- Insurance
- Lease structure
- Availability
- Rental income
The more complicated the intended use, the more important it is to discuss the plan with the lender, CPA and insurance professional before purchasing.
Should you put the property in an LLC or trust?
This is a legal and tax question, not simply a real estate question.
Possible ownership structures
- Individual ownership
- Joint ownership
- Trust
- LLC
- Other entities
Each can affect
- Liability
- Financing
- Taxes
- Estate planning
- Insurance
- Administration
We can coordinate with the appropriate professionals, but an attorney and CPA should advise the buyer on the best ownership structure.
What happens when you eventually sell?
Think about the exit before buying. Possible future strategies include:
- Sell and take the proceeds
- Sell and purchase another investment
- Complete a qualifying 1031 exchange
- Move into the property
- Hold it for income
- Transfer it as part of an estate plan
A good investment should provide options.