It is time to eradicate the myth that buying an investment property in New York City is only for elite real estate moguls. Investors come in all shapes and sizes, and some properties are available for reasonable prices.
While owning your own home has many benefits, there is a way to invest in real estate that can also produce a steady flow of income. However, this oversimplifies the subject. We will cover everything you need to know about investing in real estate.
Table of Contents
- Buying Investment Property in New York City
- How to Buy an Investment Property
- Cash is King when Investing in Real Estate
Buying Investment Property in New York City
Approximately 45% of New York City Housing consists of rental units, according to the U.S. Census Bureau’s American Community Survey, presented by the National Multifamily Housing Council. This is the highest among cities in the United States. For instance. Los Angeles had 39% or its housing devoted to rental, while San Francisco’s was 37%. Other sources estimate about 67% of Manhattan’s housing stock are rentals. While there is a ready source of demand, the economy is performing well.
Do Not Chase Yield
Baseball season is upon us, so you sit down to watch your favorite team. The star player is at the plate, and he is ready to hit the ball with a cricket bat. Of course, this scenario is ridiculous, but we equate this to New York City real estate investors playing the wrong game. Instead of hunting for yield, capital appreciation is the main game in the city.
The yield, or cap rate, is your net cash flow divided by your purchase price. In this city, it has historically been 3%-4%. This is much lower than yields across the country. For instance, multi-family properties in Atlanta and Chicago are about 4.75% at the low end and over 6% in Indianapolis, according to a study done by Cushman.
Many cities offer a higher yield, making rents an attractive source of steady income. However, despite the high rents commanded in New York City, this is not the primary factor generating returns. This naturally leads to the question: why invest in New York City? After all, an investment in the ten-year Treasury note currently has a 3% yield, but this has been an unusually low period for rates.
Since it is backed by the full faith and credit of the United States government, repayment of the principal is considered risk free. Unlike real estate, it is a passive investment that does not involve inconvenient calls for emergency repairs and unruly tenants. Since real estate involves more risk, there must be a higher potential return. There is a missing piece to the return equation.
The answer is that investors have generated a large portion of their gains from rising prices. For instance, real estate appraisal and consulting firm Miller Samuel examined Manhattan prices for 100 years, from the 1910s through 2010s. In the 1970s, the sale price was $45 per square foot for luxury properties, rising to $1,200 in the 2000s.
In a narrower period covering 2004 to 2013, the median sales price for Manhattan rose from about $606,000 to $855,000. This is a 141% rise or a 3.5% compounded annual growth rate. There are a couple of things to note. The 2004-2013 includes part of the build-up during the bubble and sharp contraction during the recession. But, over a decade, these large swings balanced out to a 3.5% annual gain.
While this is about equal to the historical yield, it includes data across the entire borough. Doing some homework would have helped you outpace this gain. As an investor, you are going to be more discriminate in examining trends. For instance, if you invested when you noticed gentrification in certain Brooklyn and Queens neighborhoods, your appreciation was notably higher.
New York City is also a liquid market compared to other parts of the country, which is appealing for investors. There is demand from global buyers, meaning it is not solely dependent on the local economy. This provides a measure of support in a recession as foreign buyers step up to bargain hunt.
Return on Investment Properties
Measuring profitability is important. However, in isolation, it means very little. Rental income, less monthly expenses such as maintenance, repairs, and financing costs, gives net income. However, it should be compared to the amount invested. The percentage should be compared to other investments.
For example, if you have a 2% return, and the ten year Treasury bond is yielding 2.8%, you would be much better off in the latter. This is especially true since the risk of losing your principal is extraordinarily small (most consider it a risk-free investment). There are a couple of other considerations. Although the purchase price is typically determined based on square feet, renters usually look at the number of bedrooms.
Therefore, if extra bedrooms can be created, a smaller unit may command a higher rent while costing less to purchase. Also, it is crucial to analyze sales and rental data. The two do not always move in lock-step, and there have been instances where sales prices have risen faster than rents. In real estate, leverage, or borrowed funds, is often used. This potentially increases returns since you can purchase a property with a down payment and pay the balance over time. Of course, it also increases risk and magnifies losses in a downturn.
How to Buy an Investment Property
We do not mean to dismiss the rent collection. Hopefully, it provides you with steady annual cash flow. However, for those that are patient and astute, capital appreciation can be the real wealth generator. To get started below is our comprehensive guide to help you begin planning your NYC property investment.
Hire an Attorney
You will need to protect your assets in the event of bankruptcy or litigation. Many form a limited liability company (LLC) or limited partnership. There are ways to do it online, or you can consult an attorney. This is one area where it may pay to ask an expert since the cost of not doing it right could be catastrophic to your finances.
Choosing a Location
Investment properties in New York have favorable characteristics. It is a cultural and commerce powerhouse. Unlike the 1970s, the city has a reputation as a safe city. This blog gives a better explanation of the attractive characteristics of New York’s real estate climate. But, you must still decide on a neighborhood. In general, economic factors such as income growth, proximity to transportation, and neighborhood characteristics such as the types of shops and restaurants are considerations.
A well-informed agent can assist with this task. For a risk-averse real estate asset, we recommend thinking about micro markets within New York City. We won’t repeat the maxim about the three most important rules for real estate, but location matters for your investment.
Your decision on which neighborhood to invest in comes down to the risk/reward, similar to any investment. If you have a high tolerance for risk, an up-and-coming area should provide you have higher price appreciation potential and a higher capitalization (cap) rate. You may feel comfortable purchasing an investment property to rent in an established neighborhood. In our experience, below 23rd street offers the best rental potential.
There are a lot of amenities that draw people, such as excellent restaurants and cafes. You can bring comfort to knowing that it has been this way for decades. The more established areas are, the safer choice, particularly in today’s market. While more speculative properties should have more capital appreciation upside, you are in for a wilder ride when the housing market corrects.
The rental yields are not necessarily higher than you could expect to receive in a more established area. Our simple rule is to invest in areas where New Yorkers want to live, and there is a lack of competition from rental buildings.
Know the market trends for the neighborhoods you’re looking in and research other rental buildings and inventory nearby. Find out if anything new is coming to the area that will make it more desirable, such as a new subway station or grocery store. Research the property tax rates and school zones, especially if you’re purchasing a two-bedroom apartment. Ask a professional in real estate about which neighborhoods in NYC are anticipated to grow and why.
What type of Investment property?
The same factors that go into choosing the right residential property to invest are useful in finding a property that will outperform as a rental (e.g., neighborhood, building). There are other things to consider since this is an investment property, however. There is a myriad of investment properties. Will you purchase residential properties?
If so, will it be a single condo or co-op unit, or the building? If it is a co-op, the board may have restrictions on subletting. Multi-units or multi-family townhouses may have more upkeep, but you will still have a cash flow if some of the units remain empty. Condo units are easier to rent than co-op units.
The former typically has less restrictive rules regarding renting, with some placing a complete ban while others limit the amount of time. It is also likely to take longer to purchase a co-op since you have to pass muster with the board.
While you may be willing to bear this hindrance if you plan to live there, the extra time means a more extended closing date and a delay in rental payments. A wide range of commercial properties are available, should you choose to go that route. While the tenant typically is responsible for taking care of more things, the complexities also rise. Delving deeper, you will find one, and two bedroom units are easier to rent than three bedroom condos. Three bedroom units compete with single-family homes.
If you choose a studio, your unit may be vacant for a greater amount of time since the tenant may leave for a bigger apartment. There is further work to do, such as the rent a similar unit fetches. A buyer’s agent can help you with this information.
Always see the property for yourself, even if virtually, before you buy. If you are purchasing a condo, get in touch with the building’s management to learn about what changes are coming up in the future. If you can, get a copy the building subletting policy and leasing application, and see what fees you might be responsible for paying. Some buildings even offer tax abatements or temporary tax reductions.
Sales Versus Rental Rates
You don’t want to end up paying more for a property than what you will be receiving in rent from tenants each month. Compare sale prices for properties in similar neighborhoods against typical rental rates to gauge the potential rental yield for the property; currently, rental return in NYC is between three and five percent. Be sure you know what the rental rates are, and stay competitive so that your units will always have tenants. If you are flipping the property, you’ll still need to know this information for potential buyers.
Hold Time Frame
As with most investments, your time horizon is an important consideration. You can buy a fixer-upper, in the hopes of making a reasonably quick profit. This can be high risk as hidden problems could get discovered or the real estate market changes direction. However, the potential rewards could also be high. Conversely, your time horizon might be measured in decades, and you will be content collecting stable rents, although potential appreciation could be substantial given the long time frame.
Know how long you want to own the property and study market trends. Are you going to hold onto the property for a decade and always keep it occupied or are you going to renovate and flip it? Whether it’s long-term maintenance or renovation costs, the length of time you intend to own the property should factor into your budget.
This is a broad category to consider, but an important one. If there are existing tenants in place, that provides immediate income. But, contemplate whether the rent is market-rate. Also, it is important to remember you have not personally done the background check and vetted the tenant.
If you choose to become a landlord, you will be working with rental agreements, liability concerns for tenants, possible evictions, and more. Be sure to have an attorney on your side who can help you navigate these scenarios as they arise. Be aware of your rights as a buyer and seek advice when encountering contracts, titles, and other legally binding documents.
Identify what costs are involved in acquiring and managing an investment property. If you’re purchasing a condo with the hope of renting it out, review the rental applications at your desired building so that you are informed about any fees involved for owners and tenants. You may want to consider paying a company to maintain the property for residents if you rent it out, in case something breaks or needs to be replaced. For individual condo management, 5% of the gross monthly rent is the average rate. Most condominiums collect common charges for the building’s operational and maintenance expenses.
Outside management or go alone?
There are management companies that will lessen your burden. Typical tasks include collecting rent and dealing with troublesome tenants. However, this comes at a price. Most charge a fee that is a percentage of the rent.
There are special considerations. This is a complex area, with many rules, such as deducting non-cash items like depreciation. Investors should also be mindful of tax abatements. These buildings have had property taxes lowered for a specified period to help revitalize an area through development. The cash savings will increase your take-home income, and your property could experience price appreciation, providing things go according to the city’s plan.
This goes beyond examining structural issues like the condition of the roof. Since it will be rented, the apartment must be clean. Beyond that, it might have to be spruced up, so it includes items such as up-to-date appliances. This could require additional cash outlays, and may cause a loss of rental income until the unit is ready.
If you are investing in a condo or co-op unit, financial stability will be crucial. There should be sufficient funds put aside for wear and tear items such as a new roof. Otherwise, maintenance fees could increase, which you might have to bear until you can raise the rent sufficiently. In a multi-unit building; examining the financials is also essential to see how the returns are derived. For instance, if there is a large unit that generates a disproportionate share of the rent, this is an essential factor.
Cash is King when Investing in Real EstateOne strategy for real estate investors involves renting out commercial or residential property. You can actively monitor and manage the property yourself, or hire a specialized company to do so on your behalf. Either way, it is essential to accurately budget your cash inflows and outflows and measure your return.
Collecting rents should be the fun part of real estate investing. Each month; a rent check is expected to come in. However, there are challenges in measuring your expected incoming cash flows in advance.
There are monthly rents, and your income should merely be this amount times the number of units you own. However, this does not take into account vacancies, which should be factored into your calculations. One approach is to use a historical number. You can also choose to be more conservative and use a higher vacancy figure, particularly given the economy has been growing recently, and the rental market has been active in New York City over the last several years.
For example; if you own a building with ten units, each with a monthly rent of $10,000, that is a monthly cash flow of $100,000. Assuming a vacancy rate of 10%, your budgeted monthly income is $90,000.
Of course, you can also have a more conservative rent figure in case you can’t receive the same amount from a new tenant. Keep in mind; New York City has one of the most favorable laws for tenants in the country. This means you may be stuck with a non-paying tenant for quite a while.
While there are difficulties in budgeting for rent collections, doing so for cash outflows presents even more significant obstacles. Certain expenses are known; such as your mortgage payment, assuming the interest rate is fixed. However, taxes and insurance tend to go up annually.
There are also monthly expenditures for utilities (the property owner is responsible for certain ones such as water and gas), and maintenance/common charges if you own a co-op/condo, which is more difficult to estimate, mainly since these tend to increase over time. Should you hire someone to manage the properties, there will be a fee. Lastly, maintenance is an unpredictable but omnipresent cost.
While certain repair costs will be covered by your monthly maintenance/common charges, that is not the case for all of them. For instance, broken appliances such as a refrigerator or stove may fall under your umbrella. In a condo, you own the airspace, meaning you are responsible for fixing anything that is in the interior of the building.
In real estate parlance; the annual return is called the capitalization rate; or cap rate. Ideally, your budgeting process has proven to be reasonably accurate, and your properties should generate positive cash flow. Dividing your net cash flow (income fewer expenses) by the purchase prices equals the cap rate.
Even before purchasing the property, you can determine your estimated cap rate, providing your budget is based on reasonable assumptions. You can decide whether or not the return is adequate. A buyer’s agent can help you examine historical cap rates to put the figure in context. Over an extended period, the cap rate has typically been 3%-4%.
In Sum – Income Taxes and Depreciation
We have not factored income taxes into the equation. IRS rules allow you to deduct depreciation on your rental property, providing you own the property, use it in your business or income-producing activity, the property has a determinable useful life, and it is expected to last more than one year. If you rent your co-op, the IRS allows you to depreciate your stock. This deduction serves to reduce your taxes, and increase your after-tax cash flow.
Potential capital appreciation was also not considered. While the cash flow should provide a steady income stream, there are also possible rising real estate values that can increase your wealth. However, focusing on the cash flow basis is the first place for investors to start.
This gives an outline for investors to consider. Investment properties can be profitable through rental income as well as price appreciation. It would be wise to investigate and consult a buyers agent before a significant property investment. It is important to budget your cash inflows and outflows, and calculate how a potential vacancy affects your finances. While not a get rich scheme, rental units can provide a steady source of extra income. If you choose, you can use your income stream to buy additional properties as time goes on.