Sunday, February 17, 2013

Reflections of an (Ex) Landlord

It's been quite a few years since I was a landlord.  I don't miss it a bit.  All "hands on" landlords will have their share of tales to be told.  There was the time when I was faced with pursuing an eviction after a tenant failed to pay for several months and when the eviction hearing day came, the tenant called me up for ride to the eviction hearing.  And then there was the ex-Marine and his wife and kids who turned out to be my best tenants ever, despite their choice of pets - a couple of very large pythons... In fairness, they told me about these pets well in advance and after gathering their very favorable references, I proceeded despite my fair share of skepticism.  What can I say, they turned out to be honest hard working people, and I never, ever received a phone call complaining about a barking python keeping someone up all night or a python pooping in the neighbors yard...

Getting rich through rental real estate is something that looks great on paper... and it can be great in the right situation.  Just a simple illustration - say you are able to go out and get 100% financing for a home that is valued at $150,000 AND the rental income covers the financing.  In theory when the loan is paid off (typically in 15 to 30 years as mortgages go), you are left with an asset that you own.  If the value stays the same, you have found a way to have others deposit money in a "savings account" of sorts for you.  If the value of your property appreciates (for example, the value increases from $150,000 to $250,000), better yet, your "savings account" has grown.  So what could ever be the downside?  Let me count the ways...

1.  Location, location, location - if you ever do decide to pursue wealth through rental real estate, stick to this age old real estate axiom.  Unfortunately, real estate is often a case where "it takes money to make money".  If you are starting out and looking to buy "with little or no money down," the properties with the most flexible financing are likely to be in less desirable areas whereby you may be able to procure "owner financing" from an owner desperate to get out from under the responsibilities of property management.  Always, always go for the best location that you can afford - this means areas where the homes are predominantly owner occupied.  It is far better to take some money out of your savings and buy a property in a great location than to fall for a "no money down" deal in a bad location.

2.  Those repairs can really add up.  If you are not handy (or have a gullible friend), I would caution you against rental real estate.  Why the Internal Revenue Service (IRS) considers rental income as a "passive" activity is beyond me... if felt like work (earned income) to me.  My experience has been that labor is often more expensive than materials.  Today, you can easily spend $5,000 - $10,000 for a roofing job; if a hot water tank goes bad, the tank can set you back $400 plus another $400 for the labor to install it and remove the old one.  That positive cash flow can quickly disappear and it may take you a few months to recover from the financial hit (by which time a new crisis has emerged).

3.  Vacancies can kick your butt... but a bad tenant will kick your butt twice as hard.  Your "positive cash flow" can go south really quick if you have an empty apartment and consequently no rent coming in.  But, if you scramble and get a bad tenant, your situation may go from bad to worse - they may not pay, evictions cost money and it likely will cost money to collect a judgement (if they have any money to collect), and a bad tenant can wreck your building quicker than a pack of termites on steroids.

4.  It's lonely at the top.  While there may be some romanticism with being "the boss," and hopefully you will have good relations with others, don't count on others to have your back.  Your tenants may be friendly, but bottom line when push comes to shove, they represent their needs and best interests, not yours.  The bank or mortgage company is happy to take your monthly check, but don't count on them being your "partner" when things get tough.  That Realtor was very friendly during the sale, but they aren't going to come over to fix your leaky faucet (although they will be happy to list your property for 6% if you get tired of fixing faucets).  Fix up your rental property and you will quickly find out how friendly government can be as your upgrade may trigger inspections of varying rigor (maybe even fees to pay for the inspection) and potentially a nice surprise when you are greeted with a tax increase from the increased value of your property assessment.

5.  Yes, the tenant's are paying for your asset through their rent payment, BUT there's a long road before cashing in.  In particular, I will note the typical 30 year mortgage.  30 years is a long time.  How many people stay in the same place for 30 years?  What about relationships?  Rental property can be a big stressor on relationships.  Rental property requires time and attention; unfortunately, time and attention are very finite qualities and finding a balance between the demands of a property and the demands of family and friends can be tough.  It is hard to predict the time factor on your body when considering 30 years.  Buying a property at age 30 will look and feel much different than managing and trying to sell a property at age 60.  Also consider the 30 year mortgage - most of what you pay the first 5 years will be interest - you will still owe much of the principal balance after 5 years.  For example, on a $150,000, 30 year mortgage at 5%, your first payment is $805.23 of which $625.00 is interest - in other words, you only paid $180.23 towards your debt and you still owe $149,819,77!  (No, you didn't just pay $805 of it off...).  Given the uncertainty of life, whether it be relationships or health, don't count on lasting 30 years with a rental property.

6.  Real Estate is a bit like that roach hotel commercial - easy to check in, but not so easy to check out.  It is fun to shop - buying something always tends to me much more pleasant and easy than selling something.  Real estate markets can ebb and flow - you can easily get caught wanting to get out when market conditions are not in your favor.  Aside from the luck of the market, selling rental properties offers unique challenges.  For example, is it better to sell the property vacant or with tenants still in the building?  If your tenants are still in the building, what will be their level of cooperation?  (The sale of their home is a scary proposition).  If you vacate the property, it may be easier to show to potential buyers, but you will need to carry all expenses (mortgage, taxes, utilities) while the building is vacant.  Also, a vacant building may be a target for vandalism and theft.  Keep in mind that it will cost money (a lot of money) to sell your property... if you use a Realtor, count on about a 6% commission; if you do it yourself, advertising is expensive and either way, you will likely need an attorney.

7.  It truly is a business and the amount of record keeping might surprise you.  Completing a Schedule E  with your income tax is a given.  You also need to be knowledgeable about depreciation, not just the "building," but also personal property such as refrigerators and stoves.  Those "quick" trips count, but you need to keep track of them... reconstructing travel at the end of the year is problematic.  You will also need to consider a process for handling those little expenses that come up.  This includes keeping receipts.  A dedicated credit card for rental expenses may be a good suggestion to help with this record keeping.

I believe there are opportunities to be had with rental real estate.  There are 3 key ingredients - being the right person (skills and aptitude), buying in the right location and a willingness to dedicate time over an extended period (I recommend at least 10 years).  Best wishes to those brave souls with the tenacity to give it a go.  I am hopeful that this post will provide you some points to consider as your chart your path.  For the majority of others, I'm hopeful that this post affirms or reaffirms your choice to stay out of rental real estate.

No comments:

Post a Comment

Comments are appreciated. Please note that comments are moderated, but will generally be published if on topic and free from excessive profanity or hostility.