Real Estate Investing Q&A: Should I invest in a rental priced below comparable properties? What about revocable trusts?

Zillow real estate investment writer and long-term investor Leonard Baron, MBA, is answering questions from MintLife readers.

If you have a question about investment properties, cash flows, insurance, mortgage financing, homeowners associations, renting versus owning, foreclosures and more, drop Leonard an email.

Rental Property Deal Below Comparables

Martin of Seattle, WA asks:

I am in contract to buy what you’ve called a “fancy prize” rental property. It’s a condo in downtown Seattle, and I am getting a great deal on it compared to similar units that have recently sold.

However, as you note in your blog post, prizes usually are negative cash flows, and this one certainly will be negative. What are your thoughts on this type of purchase?

Answer: Regardless of comparable market pricing, a negative-cash-flow property will take money out of your bank account, probably for decades.

From a financial perspective, this makes no sense when there are properties on the market offering positive cash flow.

With a negative-cash-flow property, in order to get a fair rate of return on your invested cash equity, the price needs to increase enough over time to compensate for all the extra money you took from your bank or investment accounts.

If you are going to be slightly negative, that might not be terrible. However, with a fancy prize, you are probably going to be very negative. And, it will probably be worse than you expect.

If you are long-term holder, do you really want to continue to feed that prize every month for the next 20 years, hoping it will go up in value to compensate for the negative cash flow?

I recommend talking to a financial advisor to see if you might be better off investing your money in a well-diversified mutual fund that would provide better investment returns.

Or, you could find some non-prize, positive-cash-flow properties to buy.

Revocable Trusts & Asset Protection

Peter of Harrisburg, PA asks:

I’ve heard that putting my rental home into a revocable trust can protect my real estate in case I get sued. If this is correct, how do these work and what do they cost?

Answer: First, I’m not a lawyer, so I recommend seeking legal advice from an attorney in your local jurisdiction if you have liability concerns. I’ll walk you through some basics about trusts.

People can get too caught up in the topic of “asset protection.” The number of lawsuits against rental property owners is quite small in most areas.

The worse you treat your tenants – such as arguing with them, nickel and diming them, not repairing items or allowing the property to deteriorate – the more likely you will get involved in litigation with them.

So treat your tenants, who are paying for your retirement, like very important people in your life – because they are!

Revocable living trusts (RLT) offer no asset protection. They are used to avoid probate court and probate court fees, which can be significant in some states.

The cost for a RLT is usually between $1,500 and $2,500, and includes a health care power of attorney and will for any other missed assets. They’re a smart investment to consider as you age.

Other trusts – such as special or irrevocable trusts – may offer asset protection and/or tax avoidance strategies. But, they are for people with a lot of assets and a higher risk of liability.

Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.

Leonard Baron, MBA, CPA, is Zillow’s real estate investment writer, a San Diego University lecturer and real estate due diligence expert. As America’s Real Estate Professor®, his unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions.