Buying rental property, it’s like playing a real life version of monopoly! I put the houses on the board and when the Scottie dog lands, I get big money!

The realty of being a landlord and owning rentals, not so much. There might be a Scottie dog involved, but it probably will be be an unapproved pet in one of your rentals that keeps the other tenants up every night with its yapping. Added bonus, odds are as a landlord, you can’t do anything about that unapproved dog. The tenant has rights you know, and you’ll probably have to cut off your nose to spite your face to get it resolved.

Being a landlord is filled with problems both with people and potentially financial. The bottom-line is that rentals almost are never worth the effort, especially if you don’t put a lot of money down.

I have often considered buying a rental myself in fact, but I just have no faith in people. I cannot trust people with my finances.

Do not be tempted by low interest rates. If anything, low interest rates should scare you, because if interest rates ultimately go back up 10 or 15 years from now, the equity in your property might be drained.

I’m from a family with rental experience. Everything from “My garbage disposal doesn’t work because my kid sticks his toys down there” to “the buildings on fire so I called you … not the fire department.” Even though it was my parents who owned them, the imagery of what people will do to your property is forever burned into my memory. I remember cleaning up a rental house where the children had stacked trash so high on the counter that they ended up flipping over the drawers to walk up them like steps to toss more trash on top.

Cincinnati is filled with neighborhoods (some good and some bad), and honestly I wouldn’t own a rental where I was personally willing to live. Far too often though, I find that those areas I would live in have high taxes and not high enough returns to justify getting involved. Trust me when I say, I’m the guy who runs the numbers. I have calculators, spreadsheets, and dozens of pages of paper filled with scribbles of numbers.

I think with most rentals in good areas of Cincinnati, it would be optimistic to get a 7% return with 20% down. I would also argue that there is much more give than take in that optimistic estimate.

Landlords:

  • Over-estimated what they make
  • Under-estimated their costs
  • Under-estimate how much time is spend on their rentals
  • Over-estimate their tax benefits
  • Usually forget that houses and apartments are “used up” every single year (roof, windows, furnace, etc.)
  • Usually only have major gains if the housing market is appreciating
  • Downplay that taxes, insurance, and maintenance costs increase every year
  • Commonly downplay how much opportunity cost they are losing with the equity/money they have in the rental

Let’s also not forget some of the other problems

  • You buy a $500,000 complex? If you bought it through a realtor or broker and it is the fair market value (through a realtor), you just lost $30,000 instantly (6% exit)
  • You are legally obligated and legally responsible to/for those tenants
  • If you get a bad tenant, they can wipe entire years of profitably out (and then some)
  • You are counting on appreciation, but housing could easily depreciate
  • That 3 a.m. phone call that there is no hot water (or that the roof fell in)
  • You want to avoid people? Going to have to pony up some serious dough for a good management company, that might wipe out your margins
  • You may receive worse financing if it is not owner-occupied
  • You should establish an LLC, that might not be insurable (check with your insurer)
  • You probably will need a lawyer and potentially an accountant
  • Rising interest rates = hurt your equity and overall profitability

I’m here to say, if you are young and don’t have more than 20% to put down on a rental, don’t do it. If you are determined to do it anyhow, run the numbers assuming the following.

  • Reasonable vacancy rates (be conservative)
  • Conservative maintenance costs
  • Factor in the cost of property management (this is a worst case scenario, but run the number anyhow)
  • Run the numbers assuming absolutely no appreciation
  • Factor in opportunity cost of your down payment (if you think you can get 5% return and you put down $20k, it costs you $1k a year)

Here is my view. The only way to get a good return is to own in places that landlords are hesitant to own, and praying for appreciation on your properties. That’s a lot of risk and creates a lot of “what-ifs.”

Odds are you will run the numbers and you will see only a tiny 4-10% return. I was up 12% last month and I’m currently up 10+% this month without toilets and tenants. Without transaction fees, apartment showings, LLCs, lawyers, without phone calls in the middle of the night, and without the overall headache.

If you are putting down 20% or less (and not buying in a bad neighborhood), I am confident you could beat that return in the stock market with just a little bit of knowledge.

Consider learning about writing cover calls, a conservative stock position that can easily net 10%+ a year.

In fact, cover calls are extremely similar to rentals without as much hassle. Buy 100 shares of a stock, sell a cover call and get “paid rent” every month (article to follow).

Just think twice before taking the rental plunge.

 

 

 

 

 

Tagged with:

Filed under: InvestingOwning a HomeReal Estate

Like this post? Subscribe to my RSS feed and get loads more!