Higher taxes on top of a high LTV can destroy your cash flow. Over the past couple of years, I have been concerned that rising property tax rates will eventually threaten the livelihood of rental property owners. As if to partially confirm this, I have recently been contacted by two different investors who are victims of property tax hikes that took them from a positive to a negative cash flow. In both cases we are talking about a doubling of the property tax bill in one single year. I personally experienced a near tripling of taxes on a rental property. My per month cost for taxes went from an initial estimate of $54.17 at the time of purchase to $125 per month the following year. The fact is no single entity on the face of the earth can affect your real estate investments the way that government can. Governments can add a significant cost of doing business via rising tax rates. It can change the rules in the middle of the game, force you to pay up or else, and only government, (especially local government), has the power to affect every single property owner in a given city, or county. Even bankruptcy won't rescue you from the clutches of the tax man. The general rule of thumb for residential property investing is that you should never exceed 80% financing on your income property. You should plan for higher taxes and keep your LTV at a reasonable level. While there are 90% and even 95% loans out there for investors, it can be dangerous to take out such loans as the risk of negative cash flow is much higher. Most investors and even home owners, should be very cautious about refinancing residential properties to pull additional cash out. A higher loan amount, combined with a large tax assessment could put you in the red overnight. If your strategy is to buy and hold, be very cautious about exceeding an 80% Loan To Value. Over-financing can cost you a whole years profits to compensate for a two month vacancy. If your rent rates have to be artificially high in order to cover loan payments and taxes, you may not be able to find a suitable tenant. Few investors can handle the financial strain of vacancies and negative cash flow for long periods of time. The issues facing our cities and counties in the 21st century are complex and appear to be beyond the knowledge and expertise of most local politicians. We must find new ways to manage the costs of government services in order to insure a supply of affordable housing in the years to come. Increasing property taxes has traditionally been a local governments answer to every budgeting need. If this continues, it could put investors in many cities out of business, and ruin the small investor's ability to provide affordable housing. For now, keeping lots of equity in your properties is the only real way you have to protect yourself from negative cash flow caused by rising property taxes. While it is exciting to think about taking tens of thousands of dollars out of your properties to use for tax free income, smart investors are very conservative here, and prefer to keep lots of equity for a rainy day. |
