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April 22, 2013

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With the vacation dilemma some ideas are that you can either buddy up with another landlord to cover for you or if you have family nearby who you trust are capable.

I have 4 rental properties and bought the first one 8 years ago. We don't use a management company and the weird thing is that we do tend to get calls while on vacation. However, it really isn't a big deal. We have contractors lined up and just coordinate a few calls and we are done.

Just a few weeks ago while on vacation out west we got a text about a refridgerator issue and we sent our appliance repair guy out and he fixed it. Our end of the incident wasn't more than a few text messages and one phone call. So you can do it if you have the infrastructure in place.

On the diversification front, I think this may be a mistake. I certainly understand the potential value of risk spreading but the reality is that you are going to be good at one or maybe two types of investment purchases. If you are good at finding 2-4 unit properties and fixing them up and renting that is a great speciality and I wouldn't want to learn all the different challenges with single family homes or appartment buildings. You will learn from each purchase and spreading across types seems like a mistake. Just like a business, find something you are good at and do it well. Too many businesses fail because they spread to thin and get into areas where they are not as knowledgeable. We know about single family homes in our areas. We know the prices by neighborhood, the rents, the target renters, the competition.... All that changes if we bought a 4 unit complex.

I agree with Erik's comments on diversification - there are valid reasons not to be too diversified in rental real estate.

From the article: "...could you financially withstand several months of no rental income and the cost of repairs that might not be covered by homeowner’s insurance...?"

In my opinion, if you are not in a position to handle a few months of vacancy and some repairs, then rethink rental real estate. It's a capital-intensive business. While I have not experienced any losses yet as a rental investor, I am confident in our ability to cover such an issue should it arise. Loss of rent would not cause hardship - even if we lost rent in all of our rental properties simultaneously, we would still be cash-flow positive each month. New roofs aren't generally "emergencies" and can be planned for. Major earthquakes on the other hand...we'll deal with that situation when it arises!

For the reasons suggested in the article, we are moving away from being a landlord in favor of being a lender. There are hoops, such as licensing requirements and regulations that must be closely followed, but overall, we've found it to be an easier investment in single family asset class. We still have about 30 rental units and finally ended up hiring an employee who is payed a salary to manage those units, after all kinds of head aches, including one house in a low income neighborhood had the copper stole from it twice.

I find these articles are usually overly simplified and written from a perspective of someone who usually doesn't really understand much about the business, probably never done it, with a quote or two thrown in from someone who has. They are written for the masses to try to tell them that it's not for everybody and not the same as a typical investment in stocks, which is true. That's exactly what my opening column in my Real Estate 101 series here attempted to lay out. It laid out some very specific reasons for people to think through rather than the cursory touch this article gives on it.

But as an article to give any real advice to actual landlords or people who are experienced doing real estate, articles like this are pretty useless. Their advice is usually tainted by their lack of understanding and their anchoring to traditional investments. They tend to think anything that deviates from what a standard 9-5 employee would invest in through a mutual fund is inherently dangerous. The bio for the author of this article says she is a personal finance reporter and her background for years appears to be in that field. That's why her perspective is off. What is correct from a personal finance perspective is not going to be a very good fit for what is good for real estate.

The hurricane on the east coast is a classic example. Really, a hurricane? The first thing these types of articles do is lay out an extreme example and then proceed to give false information even based on that.
First if you live in a place that can have hurricanes you better have insurance coverage for that. We have tornadoes here and I am certainly covered for that. Second if you are a landlord you better have an insurance policy that covers lost rents. Mine all do. This is basic landlord stuff. But this author doesn't seem to be aware of that.

Second the idea that having 300K of a 600K portfolio invested in real estate is a lack of diversification is also a lack of understanding of business. You diversify because you are an outsider and don't know enough about the businesses you are investing in to understand the risks. That's why you don't buy just one stock, etc. But as a business owner, you don't diversify. Everything you have is in that business. Farmers don't diversify outside of farming, construction companies don't diversify outside of construction (and they usually focus on niches of construction), Heck even employees don't diversify outside of their "business". Employees know one trade and work one job for one employer, talk about lack of diversification. This is how everyone operates. You only diversify when you are putting your money in other people's hands because you have lack of good knowledge.

The greatest modern investor (arguably) has said exactly that: "Wide diversification is only required when investors do not understand what they are doing." - Warren Buffet.

I wrote about that topic in my real estate 101 series too in the post entitled finding your niche. I do not agree with the concept of wide diversification. Diversification is over-rated. There is great benefit in becoming very good at something and sticking to that. The Jack of all Trades concept is for a different era. No one goes to a Jack of all Trades when they want something done well. We all want specialists who are experts in their fields. As a Jack of all trades you are competing with specialists in every area you enter and are at a disadvantage to each one of them. Diversification of things you are personally involved with operating and controlling is a weakness, not a strength.

Apex --

"These articles are usually overly simplified and written from a perspective of someone who usually doesn't really understand much about the business, probably never done it, with a quote or two thrown in from someone who has."

I think this statement summarizes most mainstream media personal finance writers as well.

@FMF

That's why I come here for the real good stuff. ;)

@FMF - "By the time I'm done investing in rental real estate, I want to have my properties diversified by type of home (single family versus multi-unit), area of town (north, south, east, west), and type of renter (larger families, young professionals, etc.)"

Has either Apex or me convinced you to rethink the idea to diversify to different types of properties? We haven't received an update lately but if your 2-4 unit buildings are doing well and you know the market and what makes a good next purchase then I'd stick to it.

You aren't really operating at a loss if you have a paper loss from depreciation. That really helps offset some of the taxes on rental income. Also, you forgot to mention that it's not considered earned income, so there are no payroll taxes on it. That makes a big difference versus self-employment income.

Erik --

I'm saving up for an update. As you know, things move slowly sometimes in real estate. :)

My strategy really is this:

1. Buy at a good value.

2. Get a place that needs some work that currently only has moderate rents (this helps with #1).

3. Fix up the place so it's very nice.

4. Increase rents to the appropriate level given the nice-ness of the place.

Within this criteria, I'm willing to look at almost any type of property -- single family, duplexes, multi-units, etc.

That said, I do like the 4-unit buildings because you can spread a lot of fixed costs over many units. However these aren't in great supply these days, so I can't focus only on them or I'll be out of business.

Apex said: "They are written for the masses to try to tell them that it's not for everybody and not the same as a typical investment in stocks, which is true."

Yes exactly. Thats what I think the entire point of the article is.

I think Apex said it best, and that's why I come here for the good stuff too :-)

I also agree with Apex and Erik about specializing, not diversifying. My three houses are all in the same neighborhood, which makes it easy to visit them all at once. I targeted a specific demographic that has worked well for me -- no major problems and no tenant turnover since I bought the houses three years ago.

Keep a large emergency fund and don't be cheap to pay professionals to fix problems (that's part of what the tenants are paying you for!), and repairs are no longer a hassle or a risk. I manage my houses myself, and don't spend more than an hour or two every couple of months. I would imagine I'd spend MORE time managing a management company to do the same thing!

I am almost through my first year of owning a rental investment property. So far everything has been going well and I haven't run into any of the "bad" real estate issues.

@FMF:

You'll naturally narrow that. We have really specific deal criteria and neighborhoods we'll look at. It saves tons of time, and it's better to be an expert on a few neighborhoods ultimately, but we started broader like you.

I am of the opinion to own an estate rather than spending money on rentals where you don't own a property and end up paying a fortune for nothing unless you have no choice to.

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