In my last post I promised that I’ll write in some more detail about the apartments we rent out currently and about their respective rental models. Voilà, here we go. Our home made REIT is not literally a REIT, of course. The rental real estate we own is simply part of our personal assets.
You can rent out apartments as a business. Depending on the circumstances that might carry tax advantages or disadvantages. I don’t have any experience with this legal construct myself. But you can find a lot of basic information on the internet if you want to start digging into topic.
We just happened to buy our apartments in different locations and ended up with different ways of renting them out as well. So real estate is the dominating asset class in our net worth. But within this asset class we are diversified regionally and by business model. That’s a comfortable position from my point of view and maybe it is an interesting model for you as well.
Our first home
How did things turn out this way?
We bought our first apartment shortly before our son was born. At that time I worked in Paris and was very much used to small apartment. On top of that we didn’t want to take up too much debt since we already earned good salaries but hadn’t built up any significant savings yet. That’s why decided to buy a 1.5 bedroom apartment with just over 60 sqm.
Eventually the apartment became too small for us after all. But generally this combination of number of rooms and square metres was a good choice. Both singles as well as couples are in the market for this type of home. And since the apartment is located on the first floor, there are few exclusions due to age as far as renter potential is concerned.
Buying on the way up is not a bad thing
It’s also a plus as far as filling potential is concerned that the area has become more desirable over time. That’s not always predictable of course. And that’s not something that we even thought about when buying. Quite to the contrary: with hindsight knowledge we were going about things rather naively. It surely wouldn’t have hurt had we been able to get the vast amounts of information as easily as they are available today when we started off at the end of the 1990s.
During the past 20 years we have experienced some unpleasant surprises in connection with our rentals as well. Nothing catastrophic. But still some things that had an unexpected negative impact on cash-flow and return. That’s why I’m so adamant not to push your debt level to the limit. I’ll describe our experiences in this are in a future post so you can weigh this into your own investment decisions.
Unfurnished long-term rental
But back to our first apartment. Fun-fact by the way; when we were due at the notary to sign the purchase contract we got mixed up between two streets with a very similar name and stood – while punctual to the minute – at the wrong address. That got us a hearty laugh from the way more mature and experienced seller when we turned up in the right place a little later.
We rent this apartment like most landlords do, unfurnished and long-term. At the same time, the apartment presents a potential fall-back for us. Should our financial situation deviate significantly from our plans, we could ‘down-size’ to the apartment, thus bringing down our fixed costs. On top of that the location of the apartment would enable us to go carless and save on costs for transportation as well. But that’s really a worst case scenario which we definitely don’t want to push on our great long-time renter. And since we’ve calculated very conservatively, this scenario should hopefully stay hypothetical.
Don’t base your decisions on tax advantages
About ten years after we bought our first apartment I started scanning the real estate internet platforms pretty regularly. I don’t really remember what triggered this. In the meantime we had made so-so experiences on the stock market and I think that the option of leverage drew me back into the real estate. Given our salaries there was an incentive based on taxes as well.
This goes with an important caveat, though: a tax advantage can be a nice add-on, but it should never be the prime motivation for an investment. We based our decisions for rental real estate on the locations and the expected returns versus the purchase price. And make sure not to assume anything too rosy, since as I said above there can always be unpleasant surprises.
Depending on how you’re planning your income streams and whether you want to rely solely on ‚passive‘ income, the tax advantage might vanish at some point. Maybe you’re earning a high salary during the accumulation phase and the tax authorities ‘sponsor’ the interest on your loan with almost 50%. Then you early retire and don’t earn a salary anymore. One stream of income might come from dividends our stock market gains that are taxed at 25% plus ‘Solidaritätszuschlag’. One from an old ‘Kapitallebensversicherung’ paid out tax-free. And the remainder from one or two apartments where your still paying off loans. In that case your personal tax-rate will probably at the very low end of the progression curve. Maybe you have to pay very little income tax at all. And there will be no return on taxes you haven’t paid.
It helps if you can wait
Anyway, while scanning the real estate portals I stumbled across a holiday apartment that was operated a spart of a hotel. Very charming, in a town that we had visited at the end of the 1990 when the first wave of restorations swept through the old grand watering places in the former GDR and project developers marketed the properties.
There was a peculiarity in this case since the apartment was listed by two agents, with a significant difference in price. What we didn’t know was that only one of the agents – the one with the higher price – actually had a contract with the owner. Since the lower price had ingrained itself in our brain, though, this psychological benchmark was quite helpful in negotiations. An additional advantage was that the seller wanted to sell fast while there was no urgency for us to buy. When buying real estate as an investment I would try to stay as rational as possible. Another opportunity will always come up. To fall in love with a property to the point where you just have to have it will most probably not result in a very good purchase price for you.
Leased out to a hotel
We took over the lease that came with the apartment. We could decide to deal with holiday renters ourselves or outsource this to a service provider when the lease is up for renewal. That’s something we will probably look into.
What’s attractive about the current model is, that it’s a type of net-lease. This means all running costs including maintenance are paid by the hotel. And typically there’s very little time involvement on our side. That would change when renting individually, even if a service provider took over most of the tasks involved. In the end it’s going to be a weighing-up of effort versus return.
Right, I just notice that talking about the first two apartments I already broke the 1,000-words barrier. I’ll just make the remaining two a second post. So that’s all for today.
Financial Independence Rocks!