Behold the Dumbass. Heed me, O People, that thou mayest learn from my reckless gol-dang stupidity.
The first and last time I ran rental real estate was in a major northeastern city. Bought a run-down triple-decker with an illegal in-law apartment, fixed that puppy up, rented the units for five years, and condo-ed it.
Made a good bit of money, but when all was said and done and I’d crunched the final numbers, I discovered I’d’ve made right around the same amount if I’d just plowed the cash into an S&P fund. Cash flow was nice, but in hindsight, I didn’t need the cash flow as much as I needed the return. All that work and craziness—pffft.
So in my experience what’s true about a rental property is true about a boat: the happiest days in the owner’s life are A) when he buys it, and B) when he sells it.
Craziness? What craziness?
Being a landlord can SUCK. Having to plunge clogged toilets at 2 AM and such. And the worst of it was when we got sued. IRS treatment of rental income as “passive” is bullshit.
On being sued: we made a stupid mistake. When we bought that triple-decker we evicted everybody except the guy in the in-law so we could renovate the legals and raise the rents accordingly. We planned to boot the in-law tenant after the legals were rented, but at the time we needed the cash flow.
But we didn’t meet any of the tenants in person before we closed. Stupid stupid stupid. What we missed was that the in-law guy was the only white tenant. All the rest were black. One of them sued us for discrimination, which had never even crossed our minds…I mean, hell, again: we’d never met them. We settled for a ridiculously small amount of money, about two thousand bucks in free rent, after nine months of hostile and expensive legal wrangling ($6K in bills. At one point I had two lawyers working the case.) Mind you we lived in one floor up from these people and saw them every day. Fucking horrible. What we learned: pay close attention to everything; not just the financials.
Mind you, there’s something so satisfying about knowing you have an attack dog you can slip the chain off of whenever it’s in your best interests to do so. “Counselor, sic balls.” I LOVE lawyers, or at least the ones who work for me.
Like: a real estate attorney I worked with when I condo-ed out the very last unit saved me something like $1,200 with a single 15-minute phone call over a disputed term in a listing agreement…and the real estate agency he tore into actually called me to apologize for even demanding the money in the first place. I wish I could hang conversations on my wall.
“They forget who they work for,” my attorney said afterwards.
I mentioned plunging toilets at 2 AM. Why would anyone ever do that?
Because you HAVE to. Where we landlorded there are certain minimum habitability standards that you have to meet, and one of them is a working toilet. If the apartment’s not habitable, the tenant has the right to move into a hotel at your expense until such time as the apartment returns to habitability. An expensive PITA, yes? It’s probably not going to come up when the toilet’s temporarily clogged, but if a pipe breaks and the wall has to be torn open, it becomes an issue.
And when you’re dealing with an old lady who has no idea what to do when the thing clogs, and doesn’t even own a plunger, well…Do The Right Thing.
We found Section 8 tenants to be WONDERFUL. The checks were always on time, they always cleared, the tenants behaved themselves because they were afraid of losing their subsidies, and they took care of the rental units because the housing authority inspected annually. We screened them for fit, of course, and the ones we rented to were good people who just happened to be poor.
Crunching numbers to find the ideal rental property, at least in terms of return on investment, isn’t as difficult as you might think.
- Break your city down into neighborhoods. There are real estate listing sites that will do that for you.
- There are often public studies that list average rents on a neighborhood-by-neighborhood basis. Find those. Perhaps your property assessor’s office or the mayor’s office can help you find them. Otherwise, ask a rental broker.
- Find maybe the top 5 rentals for sale in your price range in each neighborhood, again through a listing site.
- Try to estimate rents, cost of maintenance, mortgage payments. Discount rents for empty-apartment AKA idle time.
- (Revenue – costs)/start-up cost = ROI.
- Rank neighborhoods by ROI.
That’s an off-the-cuff over-simplification but enough to you started. When you identify something you’re interested in buying, make sure you get a rent roll and crunch it before you pull the trigger.
But DO NOT REPEAT DO NOT make any mistakes in constructing your spreadsheet. God forbid a formula should reference the wrong cell, and you end up buying the falling-down ten-unit crackhouse because you thought the return would be better than the three-apartment house in the charming seaside town.
Sheesh. I’m out of the game and that thought still makes me break out in the poison sweats.
YouTube some inspection videos before you start viewing properties in person.
You should negotiate for ALL the issues the inspector finds to be FIXED by the seller before you move in, not just financially settled. Every single little one of them. If there’s a screen window spline that’s come loose, they need to fix it. If there are broken electrical outlet cover plates, they need to fix them. If the kitchen backsplash needs re-grouting, they need to fix it. &ct., &ct.
Trust me: you don’t want to have to deal with repairs yourself on top of the headache of moving.
If you’ve got a decent inspector he/she will go up on the roof looking for loose shingles and flashing and other damage, will inspect the foundation, etc. Every major structural component. The inspector may not be an expert in such matters—they often won’t be—but they’ll at least be competent, and you can always ask, “Do I need to bring in a specialist to take a look at this?”
Simple couple of points here, but consider these metrics when evaluating the purchase of housing…especially if you intend to live in one of the units of a rental property you’re buying.
- Avoided cost of rent. Sort of a left-handed ROI. Whether you own the thing outright it’s still helpful to know what percentage this asset is throwing off. You may want to move someday, and IMO this will be one factor to consider.
- Equivalent cost of lifestyle. Say you own your home outright and you’re ER. You should look at what your salary equivalent would be. In our case since we own our house outright and don’t pay federal or state income tax, our $48K annual budget suddenly balloons to the equivalent of something like $80K in gross salary discounted by income tax and mortgage cost. Again, an interesting metric to keep in mind.
Also, when I model our withdrawals against our SWR I’ll sometimes build the non-income nature of our current (non-rental) house into my various ROI assumptions (i.e., modeling range), such that even though the house is appreciating, since as a physical asset it reduces my ROI and in doing so makes certain iterations of my model appear more conservative. Goofy, yes, but still.
You’ve probably guessed by now that I didn’t like being a landlord. You end up responsible for a hell of a lot you don’t have control over.
So let’s define “easier” as the opposite of “harder” (duh, right?) and think of harder as A) taking financial risk, especially in the form of leverage, B) sweat equity as in literal physical labor, which you’ll invariably end up doing, C) legal/regulatory/liability risk, D) climbing an enormous learning curve, and E) having to deal with tenants. No particular order.
There are any number of ways to earn money that don’t require A, B, C, D, or E. Writing, consulting, taking on part-time work that’s closer to your passion even if it pays less, yard-sale-and-eBay, repairing and re-selling bicycles, building up an art gig, etc.
Sure, these are also businesses you have to build up from scratch, but you can unwind them whenever you want with very little effort and very little risk to your capital pool.
I can hear the objection, “Sure, but there’s so much more money to be made in real estate than in any of the work you mentioned.”
OK. Fair enough. My rebuttal? “High risk, high return.” Tell the people who got caught holding the hot potato in 2008 that there’s a lot of money to be made in real estate.
To be clear, I have no objection whatsoever to physical labor. It’s just that I’d rather be running or cycling than carrying cases of kitchen tile up three flights of stairs.
Photo credit: Mr Sock Monkey Teaches School by Nancy Denommee.