Rarely when I hear people complain about being able to buy a house today that makes sense as a rental do I ever hear them mention using anything other than conventional bank financing. They are quick to point out, that even in the relatively low interest rate environment that we have today, the rising prices of houses has outstripped rents so far that nobody can afford to buy a house and hold it as a long term rental. This ignores the fact that the reason expensive houses aren’t feasible as rentals is because of the high leverage used to buy them. A free and clear house will cash flow.
I think that giving yourself a reason not to succeed is the surest route to failure; so I absolutely refuse to believe that the rental house business is not practical anymore. The key is to take a clue from homeowners and trade up into houses you want to hold long term.
Last time I explained how people with average incomes can wind up with expensive houses by selling houses they bought years ago and using the money to trade up. A friend of mine for years has tried to buy 10 houses each year. He sells half of them and uses the profit to pay down the loans on the other half to make them feasible as long-term rentals. The same technique opens the door for entrepreneurs who want to build long-term wealth using rental houses. Fortunately the tax code will help.
Here’s how: Instead of buying a small house and waiting for it to appreciate, the entrepreneur can buy a fixer-upper and add value by fixing it up; or buy a heavily discounted foreclosed house and sell it at retail. By combining these two approaches by buying “ugly” houses in need of extensive repair at foreclosure sales where there will be little competition and great potential for outstanding profit once it has been fixed up and sold; and the process can be repeated.
There are a number of ways to make this a tax-free: The least complicated method is to move in for 2 years while you fix up the house, then sell it tax free under the residential sale tax exemption.
If you don’t want to move in, the next step is to sell something that you bought at a discounted price and fixed up as a rental or as an investment for over a year. When you sell it, have the sale proceeds held by a Qualified Exchange Intermediary until you located a replacement that you can buy at a bargain price, then use this money as the down payment on a fixer or foreclosure.
