Most of the activity in the tiny house market seems to revolve around individuals building their own to live in personally.
The original reason I began building the tiny house was that a friend and I couldn’t get qualified for a mortgage to purchase a 4-plex as investment property with our self-employed incomes. And as a former real estate agent, investment property has been on my mind for a while now.
And while tiny houses have yet to hit the mainstream, increasing density inside the city limits is already on a lot of people’s minds.
The only solution I’ve seen around town so far are the mixed vertical use developments (The Triangle and The Domain) and the folks that bulldoze older homes on large lots to put in town homes (see the Google street view for 1704 Justin Lane for example).
Those town homes are nice looking though out of character with the neighborhoods. Even so, they’ve stopped building them due to the credit crunch. The only other thing increasing density right now are the condo high rises downtown that are completely unaffordable for most people.
Before I get to any numbers, let me state that I’m not a CPA, attorney, etc so I can’t be responsible for anything anyone does with this information. Anyway…
For a tiny house there’s the typical rental return on investment most people are aware of. If you buy a tiny house for $15,000 + 8.25% tax and rent it out for $500 a month plus utilities on your own property, it looks like this:
$6,000 annual rental income / $16,238 purchase price = 37% return on your investment each year
If you have to rent land, maybe you pay $100 a month and get a 30% ROI. It’s win-win for the land owner too because they basically get $100 a month for letting someone have access to an unused part of their land. You’d probably want to put a separate meter on the electricity so you’d know how much to charge for shared utilities.
Understand that this takes the major risk out of investment property which is paying the mortgage during vacancies. Yes, your return is less, but you’re not out of pocket the minimum $1000 or so you’d have from a single family dwelling.
That’s the reason plexes can be safer and more profitable investment options – if one person moves out, the other 3 tenants are still covering the mortgage until you find another.
But then there’s tax depreciation. If you’re not as interested in the details, skip down to where I show the final potential returns.
Recall that this isn’t real estate so it depreciates much more quickly. IRS Publication 946 explains how to depreciate property. Our tiny house classification is as a trailer so we go to the classification tables (B-1) and see trailers are asset class 00.27.
Table B-2 is the classification based on use which I’d say is construction (15.0). Both classifications say the GDS recovery period is 5 years. GDS is the option you’d use under most circumstances (i.e. you’re using it inside the US).
For a 5 year depreciation, you have two basic options – straight line and percentage. You can depreciate at 200% or 150% rates. I’ll compare straight line and 200% here.
The straight line depreciation table is A-9 and gives you 17.5% depreciation the first year, 20% the next four and 2.5% the 6th. 200% depreciation (Table A-2) gives you 35%, 28%, 15.6%, 11.01% (2 years) and 1.38% rates.
Straight line depreciation:
Year 1: $2,841
Years 2-5: $$3,247
Year 6: $406
Year 1: $5,683
Year 2: $4,547
Year 3: $2,533
Years 4-5: $1,788
Year 6: $224
If you’re planning to keep the investment for 3 years and then sell it, you’d benefit from the percentage depreciation. If you want steady depreciation over 5 years, do straight line.
Let’s look at our ROI again with depreciation included:
Year 1 SL: ($6,000 rental income + $2,841 depreciation) / $16,238 sale price = 54% ROI
Years 2-5 SL: 57% ROI
Year 6 SL: 39% ROI
Understand that even if your tiny house is completely vacant for a full year between years 2-5, you’d still be getting tax benefits equal to a 20% ROI. Crazy tax system, huh? How are those safe investments looking now?
Here are the numbers with the 200% rate:
Year1 %: 72% ROI
Year 2 %: 65% ROI
Year 3 %: 53% ROI
Years 4-5 %: 48% ROI
Year 6 %: 38% ROI
Rental rates will vary from city to city. If you can only rent it for $300 a month, you’re looking at a 42% return (in a 20% depreciate rate year). But if you lived anywhere near downtown Austin, $600 or more would be completely reasonable giving you 64% ROI (and 79% ROI the first year of 200%).
Now let’s assume you have good enough credit that you can get a consumer loan with a 20% down payment of $3,247. For simplicity, I won’t include any fees such a loan might run you. Redo all those calculations above with an initial $3K investment and reduce the rental income by $250 (5 year loan on $13K at 6% interest). Obviously a longer term loan or lower interest rate would boost your return.
Even with a $250 payment, rental income of $300 a month would still give you a 118% ROI in a 20% year. Rental income of $600 a month would give you a 229% ROI. I imagine there aren’t that many 200% ROI opportunities in real estate right now.
Recall that worst case scenario, you pay all cash, have it sit vacant with no payment and still get a 20% ROI. As long as you could document a date for having put it to a business use, you should be fine.
All that said, I think tiny houses are one of the best opportunities for small time investors right now. If I end up being able to partner with the right folks so that we can ramp up production, it could be a great opportunity for larger investors too.