If young families in New England can’t find a starter home to buy, she might be partly to blame. As a small-time real estate investor, she swoops in and buys would-be starter homes before families can and turns them into rentals. She says she feels badly about it … but she also feels she has to do it, for her own security, and because tax laws nudge her that way. As a single mother, she and her son live in a condo while she bets long on land, and being a landlord is the only path she sees to financial security.
“It is a dog-eat-dog world out there,” she told me.
At Credit.com, we’ve chronicled the disappearance of the inexpensive starter home, and the frustration that’s causing first-time homebuyers around the country. Smaller, cheaper, older single-family homes — and homes in foreclosure — are being snapped up by investors and turned into rentals around the country. According to RealtyTrac, about one-third of all three-bedroom homes purchased in the past year weren’t bought by people who live in them. They were mostly bought to be turned into rentals.
That’s made life harder for families just starting out, and some believe making America a land of renters instead of owners threatens the very fabric of what makes a community.
So who’s doing the buying? Recently, I got some unexpected insight in the form of reader feedback.
“Regarding your starter home article, I found it lacking,” the reader wrote. “Sure, there may be fewer starter homes available, but why? You seem to blame institutional investors gobbling them up. But why are they doing that?“
You probably guessed that in the next paragraph, she answered her own question.
“Small-time investors are gobbling them up one by one. I live in a condo with my son. But I own a three-bedroom starter home as a rental — I bought it because it was a good deal, in a good school system,” she said.
So I called the woman to hear her side of the story. She agreed to talk with me on condition of anonymity, lest that interfere with tenant relations.
Her main point: Sure, some landlords gobbling up small single-family homes are big corporations looking to squeeze out quarterly profits in this newly lucrative part of the housing market. But not all of them. Some are small-time, hustling homebuyers trying to make money and save for retirement the old-fashioned way: owning land.
A Good Investment?
“I’m just trying to take care of myself and my family,” said the landlord. “Employers don’t take care of people anymore. My father has three pensions, and my parents used to say to me in the ’80s, ‘Get a job with a pension.’ Well, there weren’t many then, and there aren’t any now.”
There aren’t many good answers to retirement savings, either. Savings accounts and CDs offer paltry interest rates. Stock market investments come with serious risks. But this New England landlord, who began buying properties about 15 years ago, found if she could suss out the right deal, rent payments could cover the loan payments she makes.
“I do feel bad, somewhat, that I usurped a starter home potentially from a young family,” she said. “There is some ambivalence … The one I feel bad about is my most recent one, which I had under contract three days after the sign went up and one day after it hit the MLS … It is in a cute neighborhood only two blocks [from] a terrific elementary school.”
She has bought and sold 14 properties. She’s doing well but hardly rolling in cash. By the time repairs and other surprises pencil out, she insists on being in the black with every property – but not much in the black. When she closed on her first rental in 2002, she cleared about $100 in the black every month. Now, that property generates $700 per month. Her others range from $400 to $1,000 per month.
But she figures her future is fairly secure. As a very rough calculation, were all her mortgages paid off, she’d be generating about $16,500 in monthly income. And that figure is probably conservative.
“Cash flow tends to increase over the years — rents tend to increase faster than property taxes and other expenses,” she said.
An Edge on First-Time Home Buyers
Why do small investors like her have a leg up on first-time buyers? That’s easy. The woman described the transaction she completed just a couple of weeks ago to acquire a new single-family home.
As a “strong buyer” who could promise a quick, hassle-free closing, her offer easily beat out families looking to buy the same home. The bank knows her and her financial situation; she knows properties well enough that she feels comfortable waiving inspections if she needs. The implications of that aren’t lost on her.
“I said to the seller, I wouldn’t pick it apart in the inspection. I already had my financing in place. There’s no way a first-time home buyer would be comfortable, or advised, to do that,” she said. “I don’t know what to say. I guess it’s a bit dog eat dog.”
Why did she feel like she had to buy the property? The landlord says that federal and state tax laws encourage people who own property to buy more property. If she sold a property, she’d have to pay capital gains taxes … unless she used the proceeds to buy another property. Ironically, she can’t use profits from a property sale to pay off her debt, for example, without facing a big tax bill. So instead, she and her small-time investor friends are starting to hoard property.
Debt … or Taxes
”I really would have liked to sell an investment property — or two or three — and use the profit to pay off student loans, invest for my son’s college, pay off other debt, renovate my 30-year-old kitchen in which the cabinets are literally falling apart, or most of all, pay cash for a single-family house to live in. But I can’t, due to the tax laws,” she said. “Tax laws are designed to keep investors invested. If I do a 1031 exchange and reinvest, I don’t pay the taxes and just ‘park’ my money in another building, that generates some cash flow.”
The landlord began paying attention to the housing market in her late 20s after struggling to find a satisfying career. The germ of an idea for buying properties came from a bit of observation-driven jealousy.
“It occurred to me one day as I saw my landlord walking around my apartment … that he did not have to hold down a real job,” she said. “And then it occurred to me that I was, bit by it, buying that place for him.”
She didn’t act on the feeling until her late 30s, however.
“The real catalyst was when I became self-employed. I was single, 38, [with] no real retirement savings, and I realized I’ve got no backup other than my brains. Luckily, I like real estate and I like old houses.” She also had a law degree and could handle the details of real estate transactions on her own.
When a friend called to ask for legal help with a real estate transaction, she bought the property and rented it right away. She was hooked.
The Costs of Being a Landlord
“People think landlords are just rich and they provide housing for free,” she said. “Tenants have no idea how much things cost … things like taxes, repairs … They don’t realize when they say, ‘Hey, can you send someone over, the oven’s not working,’ I’m looking at a bill of $95 just for the guy to show up, and at least another $50 for time and materials on top of that. A broken screen, minimum $25; re-sanding floors, $2,000; changing locks, $150.”
For one of the “starter” homes she owns, she had to spend heavily before she got her first rent check.
“I put about $14,000 into renovations. Not the fun stuff like a new kitchen but the ugly stuff, like new wiring and fixing a roof and a wall, and fixing the porch and the windows,” she said. “I had budgeted about $6,000, but then the state electrical inspector — because it’s now a rental, and is subject to safety ordinances — required the house to be completely rewired — a shock to me and to the electrician who had inspected the house for me.”
And while repair costs eat into the monthly income her properties generate, she knows the real estate creates a far more secure future for herself and her son.
“A lot of people expect someone to take care of them. A company, a spouse,” she said. “Becoming a landlord got me out of the ‘work at a job and hope and pray that what the employers pay is enough to live on and save for retirement and maybe take a vacation,'” she said. “I am profoundly grateful for the opportunities I have had and the wealth I have built. I just wanted you to know a bit of what might really be going on … as I see the issue with my small-time real estate investor friends … they can’t stop buying or they will get taxed so much that it is unworkable.”
Remember, buying (or selling) a home can affect your credit. You can see where you currently stand by viewing two of your scores, updated each month, for free on Credit.com.
Image: © Amy Myers