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September 14, 2012

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Thank you for sharing the information! We will be getting a new house next year and considering to have our current house rented out. Your post give us a clearer view of what to expect as landlords should we decide to have this house rented.

Awesome! This is pretty spot on. I would only add that it takes certain personalities to do this job. First, you have to have good social skills. I find it especially helpful when you master a balance between being likable but also firm. This takes skill as you may get a question from a tenant and you need to respond back swiftly in the negative.

This is a timely article for me, as I am closing on my 9th rental property just slightly over 3 hours from now.

I'd say all your observations are spot on. There are certain times when lots of thing are happening and it takes up lots of personal time. You really need to be the kind of person who really enjoys dealing with real estate (almost like a fun hobby) to really make this work.

You are definitely correct about the capital required to grow, although I have been able to purchase my last 3 properties without any capital ultimately invested. It did require capital up front, but after completely fixing up each property, I was able to obtain financing on each one that fully repaid all the cash that I had used to purchase and rehab the property. I am not sure if I can repeat that model any more though...I am seeing fewer and fewer well priced properties to buy.

On a positive note, the Fed announced yesterday that rates essentially are going nowhere for a looooong time and they are going to pump a ton more money into the economy. This will eventually cause inflation, which will be good for us real estate investors. Also, the low rates are great for making acquisitions now.

Bogey

I enjoyed the article and feel like it has some very good information! I do have a few questions though.

With the current economic state and over the past 4-5 years or so with low unemployment, and all the other factors that have made life harder on people, would you say good tenants are harder to come by? Have you seen an increase in repairs due to negligence? I guess my main question is, if someone were to load up on property now because of the low interest rates, would renting be more burdensome now (in the quality of tenants) than in better times economically?

I have seen degradation in the character of people in my area over the past 5 years. I'm not sure if it's just me getting older and realizing it, or if it is really happening and its tied to economics.

JayB: I think screening the tenants is probably the hardest thing to do. I have 3 rental properties, and most of the people that are interested have poor credit. As a result, I have to look hard at each case. For example, if you have a criminal record (beyond just traffic tickets), then its an automatic NO. If you have been taken to court previously by a landlord for failure to pay rent, that's an automatic NO. However, if you have a steady job and your income can support the rent (typically about 1/3 your income), I will approve the tenant even though their credit may be poor.

"Passive" surely does not apply to rental income, unless one chooses to hire others to do all the work, thereby giving away likely all and more of the profit margin. Real estate investing is more akin to owning and running a small (or large--depending on the size of your holdings) business. Takes a lot of time and knowledge!

You have to know your own personality and your likes and dislikes because owning real estate is nothing like owning many other types of income investments.

I have only ever had one income property and it was a vacation condo. The tax benefits can be very good but you have to deal with people that you don't know and at times that can prove to be very annoying and frustrating. I obtained my rentals through a realtor, and realtors are only interested in getting their commissions. Sometimes I would have tenants that were longer term than just the normal vacationer. They were the worst. When they finally leave and you inspect your property you are often in for a big surprise. There can be damage from pets, even though your rental agreement prohibits pets. Some people just don't leave a place the way they found it, they are slobs and you get to clean up after them, repair any damage they have caused, and haul away all the trash they have left behind.

Fortunately my son now lives in the condo and as well as making many improvements he keeps it in wonderful condition.

Since I'm retired I don't have earned income that needs to be sheltered so I invest almost entirely in various types of bonds, and a couple of bond income funds. My income is either tax deferred or tax exempt, it arrives like clockwork on the day it is due and I don't have to deal with strangers, eviction attorneys, realtors, and slobs. Best of all, thanks to the dot.com bubble that I timed perfectly, my income from all sources is now 5 times greater than when I retired and the only work involved is reinvesting the income every month..

@JayB

I have only been doing this for the past 4-5 years so I can't say if finding good tenants is harder now than it was before but my suspicion is that it is not. I don't have much trouble finding good tenants because of the quality of the properties I have.

As to the economy lowering the quality of tenants I don't see that happening. In fact I see the opposite. Good people with decent jobs got trapped in a housing bubble that found them foreclosed on with their credit shot. Most still have reasonably good jobs that pay more than a typical renter. These people tend to be good quality tenants if you have a property that is high enough quality for them. Remember these were former home owners so they don't want to rent a dive duplex in a dive neighborhood.

MichaelK's comments about tenant screening are true. That is very important. I will be talking about tenant screening in a future column. This series will run for a number of months so I hope you will follow along as I will cover many different aspects of real estate investing.

FMF,

it looks like you finally roped Apex in to do some guest posts! Great job :)

Apex,

I loved the article and I am looking forward to the rest of the series. One topic I would find very interesting- how does a REITs index compare to actually owning the properties yourself.

I'm sure it doesn't have the full potential as the REIT companies have salaries and other overhead, but I know I couldn't take on owning properties right now so I am considering increasing my REIT exposure as an alternative.

-Rick Francis

Thanks for the follow-up MichaelK and Apex!

Your comments on tenant selection makes a great point. I'm not sure of the laws or whatnot for being selective, maybe that is something that could be mentioned in future articles. but I will definitely add the prior criminal record and past rent issues to my list of no-go's, if I ever decide to be a landlord.

It is encouraging to hear that there are still quality renters our there, I have heard a lot of horror stories, but nobody seems to tell the good stories.

Kurt --

You said:

"unless one chooses to hire others to do all the work, thereby giving away likely all and more of the profit margin."

This is not true. I have a manager built into my financials and I am still amking close to 10% even paying him. You just need to find the right deal.

Of course none of my deals are done yet, so we'll see if this holds up or not. :)

Noah --

He actually volunteered, so the credit goes to him...

@Rick,

Next week's column will touch on that, but not in a deep analysis type of way. More in the overview way you just touched on here.

There will be a column in a few weeks that goes over example finances for a sample property. A real property not a made up one. If you care to do so, you could do some REIT analysis and compare to those numbers. One important difference you will find is that REIT's like stocks are volatile. They can have very good and very bad years. So it would be important to compare very long term REIT returns and not just those from a few years.

@JayB,

I will address some of the laws to be careful of when I talk about tenants and tenant screening.

You are correct that there are plenty of real estate horror stories. That is why I wanted to tackle that concept head on in this first column. Rest assured I will have plenty of good stories to tell in the coming months.

Hi Apex,

Great article. My colleague and I were just discussing if investing in properties and renting it our was a worth-while effort since rates are so low. Looking forward for our future post on this topic.

A question to you and the readers who rent out single family homes, how many rental units are needed to make investment worth-while?

Regards,
CW

JayB asked :"would renting be more burdensome now (in the quality of tenants) than in better times economically?"

I think every market is different and it depends on the local economy, the property in question and who your target audience is.

My father has had rentals for ~30 years. He is having a hard time finding decent tenants in his city. He gets few calls from people who are often bad prospects (no job, no money, poor credit). But he rents to the low rent segment so attracts the low income crowd. However where I live I have not seen any problems. In fact our market is very tight and we had a flood of interest in our latest vacancy with several good applicants. But the house we rented is targeted at median income crowd and in a our county has below average unemployment. Vacancy rates in his city are double those in my city and their unemployment rate is 2% higher than ours (but both are not bad compared to national averages).

I am SO excited for this series! I am a young, aspiring real estate investor and I have bookmarked so many of Apex's comments, so I cannot wait for the wealth of knowledge which we be shared with this series. Thanks Apex and FMF.

I'm very glad to see Apex writing.

Excellent article. I agree with everything. Owning rentals is really a job.

I'm glad you included the bit about property managers. A lot of people think they can just hire a property manager and that doing so will take all the work away. Unfortunately its often not nearly that easy. I have some very good horror stories about property managers if you all wanna hear em. You really do have to manage the manager and pay them to manage their mismanagement. I couldn't have put it better myself.

@CW,

That's an astute question.

I think the answer depends on what your goals are. I can see a few options.

Maybe you want to supplement a normal income with a little extra income that gets better than average returns. In this case I would say you could try for about 3 properties and could make this work. You could certainly do more too but I would try to get to at least 3. Having only 1 property probably just isn't quite enough to overcome the hassle and overhead to make it worthwhile. It's also the case that with only 1 property you have higher vacancy risk because if your property is empty you have zero income.

Perhaps you want to start building something that could be a solid income stream in retirement. Then you could start with 1 or 2 now and keep adding, hopefully getting up to high single digits or perhaps 10 units. This would provide a very nice income stream in retirement even if the properties had decent leverage on them after retirement. If the properties were 100% paid for you could probably have even a few less and still provide a very nice income stream. And of course you can always grow it a little bigger if you would like the income stream to be a little more.

If however you want real estate investing to be your new career then you have a much higher hurdle. You will want to grow to many units somewhat quickly. I can't give you an exact number because I wouldn't know how much income someone needed to replace but my general rule is that to switch over to real estate investing full time you would need to produce net cash flow that was at least 150% of the money you need to replace. This would not be just salary but lost benefits as well (retirement funding, medical insurance, etc). The full amount of what you are losing plus 50%. The 50% is to allow for a buffer (things could get a little worse for a while) and to give you room to keep growing the business. You don't want to be at only 100% of needed income because if things pull back a little and you end up at 90% then not only can you not grow the business but you will be going backwards now. 150% is the number I feel is a safe switch over number.

Regardless of the path you might be thinking about, I would say start with one knowing that you should try to go to 2 or 3 and then see if you want to go further. It's easy to stop once you decide you are comfortable with where it is at.

My answer to the "how many" question is 5 free and clear properties, similar to a home in which the investor would be willing to live, per wage earner to be replaced. This was determined by backing into the result of the rule that a home should cost no more than 25% of ones income. 25% times 4 homes would be 100% of income and one additional home is required to account for vacancy,repairs and contingencies. My guess is your 150% would require 6 free and clear properties and there is certainly nothing wrong with that either.

APEX,
Every year do you take a depreciation on your properties? What are considered as expenses towards maintenance of rental Properties like HOA etc?

Really excited about this series! Thx for sharing.

@Venkat,

There is a post coming in a few weeks where I will go over the full financials of a property. Everything will be laid bare in that post.

Depreciation is a required expense. When you sell, the IRS will make you pay taxes on required depreciation whether you took it or not so there is really no option not to take depreciation.

Venkat - Almost everything is considered an expense. There are two kinds of expenses: Capital expenses which add lasting value to a property such as a remodel or a new roof, and general expenses which is pretty much everything else. Capital expenses are depreciated over a period of time according to schedules set by the IRS, so you get a certain deduction each year off of your income. General expenses are directly deducted. These include general repairs like painting, patching, and light bulbs, routine maintenance like gardening, interest from any financing on the property, property taxes, any management fees, and any indirect costs you as the landlord incur taking care of your property (including costs for travel such as mileage reimbursements). And of course the whole property is depreciated over a 27.5 year schedule. My first rental house, after being occupied for 11 months of 2010, incurred incurred virtually no costs for repairs, a small cost for a leasing service, and made about $5,000 in cash profit. However, because of depreciation and mortgage interest, the actual net profit was in the hundreds of dollars and the tax owed as a result was minimal. I am quite sure HOA fees would be deductible (or could even be paid directly by your tenant - which would have the same effect on your bottom line).

I'm convinced.

At some point in the series, I hope you'll give us a quantitative look at items 1 and 2. How much time do you sink into this business? What wage does that imply?

My parents learned this the hard way when we were young. They thought real estate was a sure thing, a great way to passive income. And while that can be true, it's really quite a lot of work.

My daughter used to be the office manager for an eviction attorney for many years. With some help from me, writing some software for her, she retired and now tele-commutes from home (in Maui) doing all of the billing and delinquent notices. The attorney she works for has 3 attorneys working for him and they are kept very busy. His office is in San Jose, CA and he has been in practice for a very long time. The last time I checked with my daughter a few years ago he was handling about 300 evictions per month, primarily for large apartment complexes. Some of the complexes don't do a very good job screening their renters because it's quite common for them to evict the same renter very frequently from different complexes. Thus it's a good idea to spend a little time and money on a comprehensive background check. The chronic evictees have more excuses why they haven't paid their rent than you can believe and in many cases they have to go to court and then, armed with a court order, have the sheriff put them and their belongings out on the street which increases the eviction cost substantially.

This is very useful information. I have always wanted to purchase investment property. I have always been apprehensive about being a landlord though. Being a landlord comes with a ton of responsibility that isn't really worth it in today's housing market. There are great deals to be found right now on investment property, but you are correct the housing market is going to be very slow to grow so it may not be worth it in the long run unless I am willing to wait things out for 30 years or more!

Sally Stretton

@Sally

You are correct that being a landlord comes with responsibility. However I think you may have mis-interpreted what I meant when I said it grows slowly. Real estate always grows slowly because it requires so much capital to acquire more property. I was not referring to the current housing market or future appreciation.

If you have always considered investment property please follow along during the next few months. I actually happen to believe that now is the best time to be a landlord in a long time and it reaps great dividends immediately. No need to wait 30 years for it to be worth it.

Everything depends on location and available jobs in the area.My properties are all inner city in an area where jobs have been devastate over the last three years.Good tenants are few and far between.

The housing crunch has caused both opportunities and headaches.opportunities for the professional real estate investor that is still expanding his inventory and headaches in the respect that wannabees that have no idea of what they are doing and screwing up the market.

In the area where my home are there a foreclosure on a number of duplexes owned by one outfit a few years ago.A new buyer came in and bought 19 of them at next to nothing.The problem is that they have no idea as to screening or pricing.They are allowing the bottom of the bucket to move in as rents far below the fair market value in the area. Now the cops are having to be there on an almost daily basis.This also hurts those of us that have vacancies there as our rents are higher and the neighborhood is deteriorating.The new owner WILL lose these properties before long,but in the meantime it screws things up and the it will take some time to change the reputation of the area.

The people that have moved into the units have caused both myself and other GOOD landlords to lose some of our good tenants.

I've been in this game for about 25 years and todays quality of tenant is about the worst I've seen.Good jobs are few and it seems that most folks are either flopping burgers or changing bedpans.My rents are depressed to early 2002 levels.The saving grace is that all of my units are paid for.Yet this year was costly with having to replace a number of driveways and having a water line break under a slab.

My advice for folks wanting to get in the game is that it's best to have at least ten units so the averages can work.With fewer a couple vacancies and a good trashing or two can destroy a landlord.Over the years I've seen this happen a number of times to wannabees with only three or four units.they not only lost their units,but their personal homes as well.

The secret to buying is getting a good price,using a local community bank that does not sell paper and paying off as quickly as possible.Some believe that they are better off using mortgage deductions to lower taxes.Not me.Why trade a dollar in order to get pennies back? there are enough other deductions that can be used instead.

I don't agree with the part that people shouldn't invest in real estate. Yes there are risks in this investment but with taking necessary precautions and with suitable care one can avoid losses in such investment.

As the landlord/manager of 5 rental units spread across 3 buildings, I applaud this post's accuracy. It's a spot-on description of the daily grind of real estate investing. It's a tough and demanding job. That said, I absolutely love it; I'd have 10 more properties if I could.

@Apex,

Thanks for the feedback. The goal is to eventually have a solid income stream for retirement. Looking forward for your future articles.

Regards,
CW

As a former RE Investor I failed and saw others failed - 1) not enough deals either due to too much competition or not enough marketing 2) no money which also hampers marketing 3) most dont know what their doing/ not enough education 4) partners, agents, closing company interference or just plained goofed things up 5)poor communication skills with homeowners, banks, closing companies, other investors 6)recession. There may be a few other things. I do not recommend being a RE investor 999 people out of 1000 will not make it. First year I made 86K, and after that it went to 20K, then 10K. Good thing I still had a 8-8 job. Dont borrow on credit cards it is not smart if you cannot pay it back. I have excellent credit and used it to some advantage but this is not the way to go.

@Steve,

Your numbers which outline the decline in your profitability are quite stark.

Would you be willing to answer a few questions about your experience?

1. Which years was this that you were investing in?

2. The first year when you make 86K, how many properties did you own and what types were they?

3. The second year when you made 20K what changed?
[For example, did you have short term loans where the interest rates rapidly increased? Did you buy a lot more properties which were cash flow negative? Did you start having lots of vacancies and tenant expenses? Something significant happened that decreased your profit by almost 80%. What was it?]

The reason I ask is that my personal experience over 4 years has been the exact opposite.

I too am curious about Steve's experience - and definitely interested to know what he was doing to earn $86k in the first year. He doesn't mention dealing with tenants or property managers, so I'm guessing he may have been a house flipper, which is definitely a type of investment that many fail at. But for all the reasons that Apex has outlined so well thus far, real estate investing can be very profitable and very stable.

@Jonathan,

As I look at his list of "issues" I think you may be right. They seem to revolve around buying, selling and financing properties rather than renting them. This article and series is clearly not about flipping.

It is important for people to realize that when someone is talking about RE investing that there are many different things they could mean by that. That's why I addressed very specifically exactly what I meant by real estate investing in my second column.

Flipping is a constant chase. Once a deal is done you are at ground zero once again. There is no residual income. There is no stability. There is no safety based on past experience. You have to go out and find a new deal, fix it up, and make the deal work to sell it at a profit. The market for that can turn quickly.

Some people are successful at that but this series is not about that. I can't really give any advice on that type of RE investing because I know very little about it. Only that any experiences in that type of RE investing are irrelevant to owning and renting.

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