Cash Chronicles took an extended break for the first time in a few years these past few weeks in order for me to focus on studying for level III of the CFA.
I felt good about my performance on the exam yet it felt a bit odd not writing for a few weeks. It may sound strange, but after so many months of being intensely focused on a goal, there is a bit of an anti-climactic emptiness I feel after it’s all over. It just tells me that it’s not the goal itself but the process which forces me to focus and improve myself and my habits is what I really get out of striving towards the next hill to climb.
The other task that has kept me intensely busy over the past few weeks has been the purchase of a multi-family home in New Jersey which I am also renovating. This was an idea that came about over the past few years which I will explain my rationale for below and hopefully add some value for those who may be interested in trying something similar.
Multifamily Real Estate to Save on Housing Costs
The first and most obvious reason to purchase multifamily housing was to save money on my own real estate costs while being able to house my growing family. For years I had saved money to invest by keeping my housing costs extremely low by NYC standards. As I have shared in the past, I did this through a combination of bucking the trend of most first time homebuyers, utilizing government programs and subsidies as well as choosing to live in a working class neighborhood far from the city center in order to save money which I later used to purchase investment real estate.
This took patience and a long term view. There were many times I questioned my decision while dead tired commuting at 6am on an uncomfortable train, but in retrospect, it was worth it. I was able to lower my housing costs initially to around 7% of my income and as I was promoted and received pay raises, eventually got it as low as 2% of my income. This is a feat I am proud of in a city where many people regularly spend 30%, 40% and even 50% of their income on rent. I managed to own while paying dramatically less. It’s also a testament to how you shouldn’t believe the hype about how large cities like NYC or San Francisco are impossible to live in. The overbearing big government in those cities create tons of legal loopholes in the housing markets that often get overlooked by middle class people who are often reaching for the aspirational wealth of the most fashionable neighborhoods to call their home.
Living in a cheap studio was easy when I didn’t have a child and didn’t need much space as I was working so much. When you have a family it’s a different story, partners may be willing to compromise but most don’t want to cram themselves into a small space if they can help it. So I was challenged to find a similarly cheap living situation which would reap the same advantages I had before but while providing for a larger family. Multifamily housing was the solution that combined the cost versus space problem for me.
In terms of the cost, a multifamily home reduces the overall costs and has the renters paying part of your taxes and mortgage. From the perspective of a landlord, we are fortunate enough to live in the New York metropolitan area, which has a housing shortage. This makes renting relatively easy. In my particular case, monthly cost of my multifamily home is about 4 times the monthly cost of my apartment but the renters cover about half that amount.
On a personal basis, I am also moving in with my girlfriend and her children. This is the reverse of the painful financial part of divorcing when costs such as housing, food and transport all increase because you are doubling them. We can share payment responsibilities together as well as help each other with child rearing duties. The quality of life improves on a financial as well as day to day work load basis.
Finally, the reason I choose New Jersey as opposed to New York is not as intuitive but has to do with home prices and taxes. A recent post of mine highlighted studies that pointed to how regressive the property tax system is in NYC. Homeowners with homes worth over $2 million tend to pay lower effective tax rates than someone owning a $200k apartment. This may be great for the high end homeowner but gets messy when it comes to renting.
Taxes and Prices
New Jersey has the highest effective state tax rate on real estate at 2.49%. Although no one I know likes paying more property taxes it does have an effect given that we are so close to the NYC market: the prices tend to be lower than for equivalent homes in NYC. The reason for this is the all in cost. Many people tend to look at prices in terms of the mo they cost that they can afford. In theory, people will be indifferent between paying $3500 a month with $1100 of that being taxes versus $3500 a month with only $500 being taxes, all else equal. In this case however, the home with the lower taxes will have a higher price, meaning more of that $3500 in my example is made up of the mortgage.
Lower prices mean a lower down payment as well, which frees up cash for improvements. On top of this, after many years as an NYC resident, I no longer will have to pay NYC taxes which are anywhere from 3% to 3.8% in addition to state taxes. All of this adds up to a bit more cash in my pocket for further investing.
Accounting for Your Property
As always, there are further complications when you are living in your investment. Revenues and costs for the investment apartment versus your section of the home have to be strictly delineated, you can’t simply write off your housing costs as a business expense. Rather the investments you make on the portion of the home that is rented will count as costs offsetting the rent you receive which counts as income. Improvements to your own part of the home will not be allowed to be written off as business expenses for your real estate ownership.
The one grey area here is for common areas for both you and your renters. I may be able to get away with incorporating improvements to these areas such as building a driveway which tenants can use or landscaping the yard which they have access to.
Location
As always with real estate, location is one of the most important factors. In many parts of the country, multifamily real estate likely isn’t worth the hassle. For example in Texas where I own other properties and homes tend to be much cheaper, multifamily real estate is only found in poorer neighborhoods. This tends to bring with it less reliable tenants and headaches. Not something I want to deal with.
We benefit from the location here close to a “superstar city” where high paying jobs across many industries are plentiful. This allows for a diverse renter market to choose from. I wanted a stand alone home as opposed to a row house, or Brownstone as they are sometimes called in NY so I would have to deal with any issues of the houses connected to my house. I also wanted a place that offered parking as well as public transportation with a reasonable commute time into NYC. It also had to be a decent neighborhood where I could send kids to school.
There are really only a few areas that offer all these factors in New Jersey close to NYC. Since there are swamp and marsh areas in New Jersey which further restrict buildable land, after areas near the Hudson River, the next options tend to be further out past Newark, which wasn’t ideal for me. In addition, much of the housing stock here was built as urban sprawl with single family housing in mind. Areas that tend to be older settlements with larger homes are prime locations for refurbishment and conversion of those homes into multifamily homes. Without revealing exactly where I am, these factors as well as my price point helped me decide on a target location which I expect to grow steadily in value in the coming years.
In fact I am starting to notice I have developed a niche strategy in terms of real estate. All my properties tend to be in good neighborhoods with good schools, a good renter pool and being located adjacent to very hot real estate markets. Each of my properties now lie within an hour’s drive of NYC, Austin or the San Francisco Bay Area yet avoid the sky high prices of those same markets, at least for now.
Conclusion
If you live in a city with a squeezed housing supply and want to own a home, multifamily housing can be a shortcut to get you there. Whether you want to own while lowering your housing costs or get help paying the rent while you save up to eventually own the whole home, multifamily real estate can offer you the best of both investing and owning at the same time for those willing to put up with renters.
I have to also give credit to the fact that this wasn’t an idea I came up with on my own. I heard one day on The Breakfast Club a syndicated talk radio show, that one of the hosts, Angela Yee, lives in multifamily housing in New Jersey and that the market here offered her the opportunity to own while reducing her own costs. The homework I did on the actual home and location were my own. If you are willing to put up with the hassles, this could be a solution for other housing strapped millennials as well.
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