11 Reasons To Buy An Owner-Occupied Rental Property

When the majority of people consider purchasing a home, they typically consider one of only three options: town-house, condo, or single-family residence. But for the savvy, and investment minded, there’s a fourth option worth considering: owner-occupied rental property.

With daily reminders of California's continued housing affordability crisis, consider the following 11 reasons why it makes sense to purchase an owner-occupied rental property:

1. Mortgage Advantages

Mortgage lenders typically classify properties into owner occupied and non-owner occupied, and they tend to give more favorable interest rates to people buying a property they will live in. With a duplex, “A mortgage company considers the two units as one property,” says Lucas Hall, head of industry relations for Cozy.co and founder of Landlordology. “And you can qualify for a lower interest rate if you occupy one of the units.” If you plan to rent out the other side, you might also qualify for a larger mortgage. Many lenders allow you to include a portion of the rent toward your income when qualifying for a mortgage. This allows you to qualify for a larger mortgage than you may not otherwise qualify for.

2. Appreciation From a Larger Basis

Consider your actual dollar return when comparing the purchase of a single family home for $750,000 (slightly less than the current median home price for Orange County) versus purchasing an owner-occupied income property for $1,000,000. Using a modest long-term annual appreciation rate of 3.00%, that $750,000 purchase appreciates by $22,500 annually, while the $1,000,000 purchase appreciated by $30,000 - 33% more than had you purchased the single family home! So, yes this is a very simple example. And yes, lots of other factors can affect the actual returns over the long run. But consider not all factors are negative - what if the appreciation rate is 5.00% (or more), note that your mortgage responsibility is significantly less given rents received, and we haven't even addressed after-tax returns...

3. Housing affordability

Using the same example above, let's explore the monthly payment for the $750,000 single family home versus the owner-occupied income property for $1,000,000 (this example assumes 10% down payment, 4.25% 30 year fixed-rate mortgage, PITI payments, and PMI of 1.00%). The total monthly payments are $4,684, and $6,245, respectively. NOW consider the rent received your rental unit. Again, for sake of simplicity we'll assume this is a duplex and the rental unit is a 2 bedroom unit. Here in San Clemente, the average rent for a 2 bedroom unit is $2,500 per month. So, your portion of the monthly mortgage is actually $3,745 - a staggering $939, or 20% less than had you purchased the single-family home!!

4. Springboard Your Investment Portfolio

One of my favorite quotes is "You can't save your way to wealth." If you want to amass wealth over the long-run you have to proactively make your money work for you. What better way but to have your home work double duty? First as your primary residence, and secondly as an income property which can provide numerous tax benefits, accelerated mortgage pay down via OPM (other people's money), immediate and long-term cashflow, supplement your retirement and/or investment income, and much much more.

5. New Tax Plan Beneficial to Landlords

The tax plan will likely drive increased demand for rentals because it will reduce (in many instances) the deduction for property taxes as well as lowers the limit on the mortgage interest deduction. That would hit all homeowners who itemize and especially those owners of higher-cost properties in expensive locations. That, in turn, would benefit landlords.

Home prices will likely continue to rise due to a severe shortage of homes for sale. If the cost of homeownership gets even higher, due to the tax bill and/or interest rates, it will be even more difficult for the youngest and largest generation to become homeowners. That means they will rent longer, and landlords will rake in the profits.

6. No Management Costs

Hiring a property manager can significantly reduce your rental income, and you'll still get stuck making major decisions about tenants and maintenance. If you live on-site, you can respond to problems in the same way you would for your own unit. You'll be familiar enough with the building to understand problems more quickly, and your mere presence will improve the likelihood that systems are maintained to a standard that will keep many problems from developing.

7. Tenants Pay Your Mortgage

Some two-unit buildings sell for the same price as a detached single-family home (yes, even in South Orange County), but will be less expensive to carry because the mortgage will be offset significantly by the rent you receive from your tenants. The savings you reap can be invested in more property, or saved for a down payment on your dream house.

8. Tax Benefits

You might already know that you get a tax write-off when you buy a home — you can deduct the mortgage interest you pay. If you buy a duplex and live in one side, you can write off only that side. But if you rent out the other side, there are additional write-offs. “You can write off all of the costs that take place on your Schedule E form,” says David Hryck, a New York, NY, tax lawyer and personal finance expert. “These could be fees accrued to rent the place out or even manage the property. All are completely tax-deductible.” But wait … there’s more. “The same would apply to any type of repair made to the rented half of the duplex as well as the unit’s utility bill,” Hryck says. “If you share expenses such as internet with your tenant, you can also write those off.”

9. Combine Depreciation with Mortgage Interest Deduction

Depreciation is a key tax advantage of rental property. It allows you to deduct a portion of the building's cost, plus the cost of capital improvements, annually from the building's income. In some instances, depreciation can completely shield rental income from taxation. The mortgage interest deduction is one of the chief tax advantages of home ownership. It allows you to deduct the interest part of your mortgage payment from your income. When you live in your own rental property, you are able to enjoy both tax deductions, each prorated to reflect the proportion of the building devoted to rental and personal use.

10. Combine Capital Gains or 1031 Exchange with Tax Exemption

When you sell rental property, you either pay capital gains tax on the profits, which are usually less than the tax rate you pay on ordinary income, or you can defer taxes altogether and do a 1031 exchange, also called a tax-deferred exchange, into another rental property. When you sell your principal residence, you are entitled to up to $250,000 if you are single, or $500,000 if you are married, in tax-free profits. When you own rental property in which you also reside, you can combine both tax advantages, also prorated to reflect the proportion of profits associated with the rental and with your residence. It would be possible, for instance, to take the profit and buy a single-family residence for yourself and roll the profit from the rental portion of the building into a purely rental property.

11. Options

Purchasing an owner-occupied investment property provides an almost unlimited number of options that the purchase of a single-family home simply can't compete with. From a net reduction on your mortgage, to greater tax advantages, increased capital appreciation (aka equity build-up), and prospects for cashflow. It's easy to see why purchasing an owner-occupied investment property makes sense.

Thinking of purchasing a home? Call, click, or visit us today to discuss your options and opportunities regarding owner-occupied investment properties.

​Pearson Real Estate Group

(949) 422-7923

info@pearsonREgroup.com