Question: Is it true that two-bedroom condos are a better investment than one-bedroom condos?

Answer: If you’re asking this question strictly as an investor, the answer is purely based on the numbers. If you’re buying for yourself, you’ll want to consider appreciation as well as what makes the most sense for your lifestyle. For example, do not spend an extra $150,000 because a two-bedroom will appreciate faster, if you’ll end up using the second room for storage and an occasional guest.

Two-Bedroom Condos Appreciate More than One-Bedrooms Condos

Below is a graph showing appreciation of one and two bedroom condos in Arlington since 2010. To maintain consistency, the data set uses condos built from 2000-2008 limited to one bedroom units with 600-800 sq. ft. and two-bedroom units with 900-1,400 sq. ft.

 

The average one-bedroom sold for $364,000 in 2010 and is selling for $409,000 in 2017 while the average two-bedroom sold for $529,000 in 2010 and is selling for $638,000 today. If you bought the average one-bedroom in January 2010 with 20% down, you’d have approximately $172,000 in equity today. If you bought the average two-bedroom in January 2010 with 20% down, you’d have approximately $294,000 in equity today by putting an extra ~$33,000 down in 2010.

If You’re An Investor

If you’re an investor, you’re looking at rental income, in addition to appreciation. As I wrote this spring, rental rates have been pretty flat in Arlington, especially along the Rosslyn-Ballston corridor, due to a lot of new rental buildings being built the last 5-10 years.

 

Based on the average 2010 purchase prices, rental income and a 25% down payment (most common % down for an investor), the average investor along the Rosslyn-Ballston corridor has no cash flow from their investment. The table below does not include maintenance or property management fees and assumes average condo fees, taxes and insurance.

 

So Why Invest?

Considering that the above monthly cash flow summary does not include maintenance costs, property management fees or vacancy periods where is the value in owning an investment property?

  • Equity Build-Up: For a one-bedroom, your tenants would have contributed an average of $460/mon over the last 8 years ($44,000) to your equity balance and for a two-bedroom, your tenants contributed an average of $680/mon over the last 8 years ($65,000)
  • Tax Benefits: Another major benefit of investing are the tax benefits. Being able to deduct expenses like condo fees, tax payments and repairs. As well as depreciate the value of the condo and provide a huge annual financial benefit to off-set the weak monthly cash flow. A one-bedroom investor may be able to deduct about $20,000 per year and a two-bedroom investor about $30,000. Of course, you’ll want to discuss any deductions with your tax professional first.

 

If you’ve invested in property in other areas of the country, you may be shocked by how little monthly cash flow a condo along the Rosslyn-Ballston corridor produces. A major reason for the lower ROI is the lower risk that comes with investing in Arlington condos. Your downside risk during an economic dip is much lower and the rental market is consistently strong with a large pool of well-qualified renters. It follows the basic economic tenets of risk and return.

If you’re considering buying an investment property, feel free to send me an email at Eli@EliResidential.com to set-up a meeting to go through your investment goals and options.

Question: We are buying a vacation home this winter and wondering how the process and rules differ from our experiences buying our primary residence.

Answer: Buying a vacation home is a little like buying a primary home, but there are key differences you should be aware of. Lenders tend to set more stringent lending requirements and you must be clear about your plans for the property. With these considerations, potential buyers can plan for the financial obligations and time commitments common to the purchase of a second home.

What Counts as a Second Home?

Lenders treat primary residences, second homes or vacation homes and investment properties as unique types of property purchases. Typically, lenders are more likely to grant loans with more favorable terms to people purchasing homes as a primary residence, as the occupation of the home usually ensures a higher degree of timely repayment. Properties that will never be occupied by the owner have different lending and tax obligations. As such, to buy a second home or vacation home, lenders often require you to choose properties that are a set distance away from your primary residence. You must also indicate that you’ll occupy the property for a set amount of time each year.

Vacation Home or Investment Property

Given that a vacation home must be a notable distance from your primary residence, you should consider the type of arrangement that works best for you. Homes suffer from lack of attention, so you should be prepared to make regular visits for maintenance and repairs, or hire a local company to do so. Larger or more remote properties may demand more care, while a condominium in a developed area might require less. You may also choose to rent out the property in your absence to help pay for the mortgage. However, this may affect the classification of the property purchase, and have other tax implications.

Capital Gains Taxes

Selling a primary residence often qualifies the seller to exclude up to $500,000 of the capital gains from their tax liability for a married couple ($250,000 for a single person), but vacation homes are viewed differently. Typically, a homeowner must have lived in the home as a primary residence for at least two of the past five years to qualify for the maximum capital gains tax exclusion.

People who never occupied the home as a primary residence do not qualify for the exclusion and may be required to pay capital gains taxes. Buyers who eventually intend to occupy the vacation home as a primary residence should carefully consider when they plan to sell both properties. For example, a person who sells a primary residence and moves into a vacation home may be able to claim the vacation home as a primary residence, if they occupy it for a minimum amount of time. However, they cannot claim the capital gains tax exclusion more than twice in a two-year period.

Down Payment and Mortgage Interest Rates

People read about down payments as low as 3 percent to buy a home, but these programs are generally aimed at borrowers looking to purchase a primary residence. A vacation home represents a higher degree of risk, since the lender cannot count on the buyer’s full time occupancy to entice adherence to the loan.

As a result, you should plan to make a down payment of at least 20 percent of the second home’s sale price. You may need to pay more to satisfy lender requirements, particularly if your debt-to-income ratio is on the higher side. Due to the increased risks inherent to second properties, lenders may also set higher mortgage interest rates.

Mortgage Interest Deduction

The mortgage interest deduction can be an excellent way to offset some of the costs of purchasing a home and paying a mortgage, but there are limits on this deduction for owners of multiple properties. First, the total mortgages that owners can use in the mortgage interest deduction must be less than $1 million total–possibly somewhere around $500k if the laws change–if they are married filing jointly. Second, owners of more than two properties can only deduct the interest of one primary residence and one second home. Third, people who own a vacation home but rent it out periodically must occupy the home for at least 14 days a year, or 10 percent of the amount of the time the home was rented throughout the year, whichever is greater.

People who convert a vacation home into an investment property may also be able to deduct a portion of the mortgage interest they pay on the home, but the tax guidelines for investment properties are different than owner-occupied homes.

Buying a second home is an investment that turns out to be quite unique from buying a primary residence. Hopefully these tips will help you make a better decision. Most importantly, good luck finding your perfect vacation home!

Question: After reading your article two weeks ago about remodeling before selling a property, I was wondering what your thoughts are on remodeling our rental property. It’s a 1BR + den a couple blocks from the Virginia Square metro with a perfectly functional bathroom and kitchen, but about 15 years old.

Answer: A couple of weeks ago, I warned about spending money on major remodeling projects before selling your home and you should be equally cautious about making major updates to a rental property. In your case, it doesn’t sound like spending $15,000+ remodeling the bathroom and kitchen is a good investment at this time. Here are some of the questions/factors you should consider:

Payback Period

How long will it take to break-even on your remodeling expenses based on projected increase in rent? A moderate remodeling of your bathroom and kitchen is likely to increase the amount you can rent your unit by $150-$200/month (this is case-by-case), meaning your pay-back period is likely 10+ years. Keep in mind that the market value of your updates will depreciate annually and usually at a faster pace under the wear and tear of a rental unit.

Tenant Profile

The ROI of remodeling is heavily based on the type of tenant you’re most likely to have. Your tenants will most likely place more value in convenience, affordability, and functionality than they do aesthetics and upgraded finishes/appliances. As the tenant profile shifts towards families and higher-end properties, the ROI of upgrades increases.

Length of Stay

The less time a tenant plans to stay in a property, the less concerned they’ll be with updates, but tenants planning to stay for three or more years will consider their rental to be more of a home and place great value in an updated kitchen and bathrooms. As the tenant profile shifts to longer rental periods, the better the ROI on remodeling. In your case, the tenant profile is more likely to stay for 12-24 months, diminishing the value of remodeling.

Tax Write-Offs

According to Joseph Aiken, CPA with Aiken & Company, the current tax code considers any capital expenditures on remodeling to be depreciable assets, meaning you can’t write off the cost of your remodeling in the year you spent the money, rather deduct it over a 27.5 year depreciation schedule.

My advice for investing in a rental property is similar to investing in pre-sale improvements. Fresh paint, quality floors, lighting, and a deep clean go a long way on a rental property without breaking the bank and can usually be written off as maintenance expenses on your taxes. Check out IRS Publication 527 for tax details on rental properties.

Question: Is there anything the community can do to protect our trees from being removed by developers creating room for large new homes?

Answer: I’d like to dedicate more columns to this topic because it’s one of the most common questions I hear when talking to non-condo/townhome dwelling Arlingtonians and something I think needs more attention from the real estate community. I feel strongly that maintaining existing trees not only contributes to the long-term value of the neighborhood, but can actually maximize developer profits as well. To highlight how it can be financially beneficial to developers’ bottom line, I decided to use one of my favorite properties of 2016, 512 N. Littleton Street of Boulevard Manor, in my first video post.

As of the filming of the video, the property was under contract, but has since sold so I now have the benefit of knowing the final sold price. The developer, Ahmad Khreshi of Home Perfection Consulting, made an effort to keep as many trees as possible and the result was an incredibly profitable investment.

Here’s a summary of how well he did, with the biggest differentiating factors between his home and similar new construction being the maintenance of mature trees on the property and infusion of neighborhood character into the design.

  • 512 Littleton was listed for $1.55M and sold for $1.5M in just 55 days
  • 512 Littleton had the highest asking price of any of the 435 single family homes sold west of Glebe between Route 66 and Route 50, since 2014
  • Within that market, the average sale price of a similar new home was $1.255M, meaning 512 Littleton sold for $245,000 more than comparable homes
  • It took an average of 107 days for new homes to sell in 2016, meaning 512 Littleton sold twice as fast as its competition

 

With so many new homes on lots devoid of trees, there is clearly a demand for a lot with the natural privacy and shade provided by mature trees, even if it means knocking a few hundred square feet from the finished product. Ahmad didn’t set out to build the biggest house he could, rather design a home around the existing footprint and trees, which allowed it to blend more naturally with the neighborhood. In doing so, he delivered what may be the most profitable investment in Arlington in 2016.

I look forward to continuing to explore the relationship of real estate development and the environment more often to encourage responsible development in Arlington. I’d also like to incorporate more video into my columns, although, I don’t think I’ll be leaving real estate for a job in front of the camera any time soon!

Question: I’ve been gearing up for a home purchase and wondering if the winter is a good time to buy or if I should hit the pause button until spring. What are your thoughts on buying in the winter?

Answer: I love working with buyers in the winter because the chances of negotiating major savings increases substantially. In Northern Virginia, the winter market generally runs from late November through mid March (Thanksgiving to March Madness) and is defined by deeper discounts, less contract activity and fewer new listings. While many buyers can benefit from winter shopping, it’s not the right time for everybody.

Negotiate In The Winter If…

  • You’re a bargain hunter
  • What you like is priced just outside of your budget
  • What you like is fairly easy to find
  • You can accept losing on a few deals

Be Patient If…

  • You have specific, hard-to-find criteria
  • You value the perfect home over a great deal
  • Your purchase is contingent on selling your current home (requires additional conversation)

That’s not to say you can’t negotiate a great deal in the spring or find a unique property in the winter, but if you’re playing the odds, the above is a good set of guidelines for deciding the best seasons to focus on a purchase.

I’ll let you review the trends for yourself:

Chart #1 shows that in the winter buyers pay about 2% less, relative to original asking price, than they do in peak months. On a $500,000 purchase, that’s $10,000 in savings! The numbers along the Y-axis represent the percent of the sold price to the original list price (100% means the buyer paid full price). These numbers do not factor in any seller credits.

 

Chart #2 highlights why buyer leverage increases during the winter. It shows the number of homes that go under contract each month and there’s clearly a lot less activity during the winter, meaning sellers are seeing a lot less showings and offers.

 

Chart #3 shows a significant drop in the number of new listings from November to March, meaning you’re less likely to find the perfect home if you have a difficult set of criteria.

 

If you’re on the fence about buying this winter or not sure if you have time to prepare yourself to make a purchase, give me a call at (703) 539-2529 or send me an email at Eli@RealtyDCMetro.com to discuss your options and put a strategy in place.

Question: By year and areas of Arlington, what percentage of original house sales have been to developers and what percentage have been to individual/family occupants?

Answer: The numbers suggest that since 2009, just over 1,000 detached home sales in Arlington are to an investor. Unfortunately, it’s difficult to accurately determine the true numbers because so many investors buy properties off-market, but I’ll walk you through the data I used, some caveats, and my findings to get as close to an answer as I can.

The Data

  1. Data set includes all 8,004 sales recorded in MRIS (REALTOR database of record for “on-market” sales) of detached/single family homes in Arlington from Jan 1 2009 to Aug 20 2016
  2. Despite attempts with tax records and the County, I couldn’t come up with a good way to account for off-market deals. Since many tear-downs are off-market purchases I’ve attempted to back into the data using the sales of the finished home.
  3. Defining investor activity
    • I targeted tear-down/new build sales by parsing out homes sold within three years from when they were built
    • I targeted flips by parsing out two transactions at the same address where the second sale had a % return and time to market that suggested investor activity (quick re-sale w/ high mark-up)

Tear Down/New Build Sales:

Of the 8,004 detached home sales, 711 are likely tear-down/new build investor projects. Most should have a 1:1 corresponding purchase, but are small developments where multiple homes were built on one or more sub-divided lots (one purchase results in multiple new home sales).

Ask Eli Aug 30 2016 table FINAL

Tear Down/New Build Sales Stats:

I was able to locate corresponding purchase data in MRIS for 188 out of the 711 tear-down sales summarized above. Some sales statistics for those 188 sales below:

Ask Eli Aug 30 2016 Table 2

 

House Flipping:

While not quite as common, I identified 232 likely flips by investors in which two sales occurred over a short period of time (usually within 12 months) and the second sale sold for a significantly higher price. Here’s a summary of the non-tear down investor sales. Each has a corresponding purchase recorded in MRIS:

Ask Eli Aug 30 2016 Table 3

Based on the above data, I’ve identified 420 sales by investors since 2009 with corresponding purchases in MRIS and approximately 500 off-market, tear down purchases. There’s also likely to be a small number of off-market flip deals, but not nearly as many as off-market tear-down purchases.

There are currently 91 detached homes listed for sale or under contract that were built since 2014 that have a corresponding purchase by an investor either on or off-market. Additionally, the historical flip numbers suggest that there are about 20-30 flips purchased in the last 12 months by investors that have yet to be sold.

This brings us to approximately 1,050-1,100 homes sold to investors since 2009, which represents approximately 10-12% of total home sales. With each investor purchase having a corresponding sale by the investor, the total transaction activity for detached homes in Arlington attributed to investors is around 20%.

This week’s question was brought to us by one of ARLnow’s most prolific commenters and I enjoyed the challenge! It certainly put my data/Excel skills (and patience) to the test. I enjoy this type of data-driven article and welcome similar questions from other readers.

Question: Will a rental cap in a condo building increase or decrease my property value?

Unless you live in a community that relies on a high percentage of FHA loans, a rental cap will decrease property value. However, some communities decide to introduce a cap in order to maintain a quality of life desired by current residents.

Pros:

  • Better quality of living: Owner-occupants generally invest more in their home, take better care of common areas, and take more pride in developing a strong social community. In small associations or those intent on maintaining a certain standard of living, quality of living may prevail over property value.
  • Protect FHA and investor loans: Once an association has 50% or more of its unit rented, potential buyers won’t qualify for FHA or investor loans. If a community relies on FHA loans on a significant percentage of its home sales, property value will drop as soon as the rental rate exceeds 50% due to a reduction in the buyer pool. However, before making a decision based on historical use of FHA loans, Jake Ryon, Loan Officer with First Home Mortgage, points out that “with Fannie Mae lowering their down payment requirements for conventional loans (3-5% depending on loan size), we’re seeing fewer buyers interested in FHA financing, particularly when purchasing a condominium. These recent changes by Fannie Mae are targeted at first time homebuyers, the market FHA was supposed to be helping.”

Cons:

  • Fewer Buyers: I regularly have clients tell me they won’t consider a condo with rental caps because they plan to hold and rent as a long-term investment. If a buyer/buyer’s agent doesn’t know a rental cap exists when they make an offer, they’ll find out when they review the condo docs and can void the contract (3 day review period) without penalty.
  • Lack of owner options: Financial struggles? Job ships you to a new location? Decide to go to grad school? Married and moving in with your spouse? These are common occurrences for homeowners and they don’t always occur with warning or during hot real estate markets. If rental caps exist, selling becomes an owner’s only option, even if renting makes more sense. The result of an owner being forced to sell is often a lower sale price, which depresses property value in the community.

In every scenario I’m aware of, the introduction of a rental cap is considered a change to an association’s by-laws, which requires a supermajority of owner votes to pass (usually 67-80%).

Question to condo owners — what are some other factors that have been considered within your association when discussing whether or not to introduce a rental cap?