Ready To Be A Landlord

[AzCactus]

For anyone who is owns real estate that they rent out---when did you know you were ready to take the plunge?

For example-Was your first home paid off?  At least six months of cash for mortgage due to vacancies? Homes only 20 miles from your present home?  Only Foreclosures, etc?

 

Thanks in advance for the guidance.

 

[redhots]

In 2012, Buffett talked about buying single family homes.  That resonated with me.  I looked at real estate 10 years ago and couldn't make the numbers work.  So I found a Realtor and looked around.  Real estate was down, rates were low, and the numbers worked.  So I bought a couple of rental properties that are within a 1/2 hour of my home  (Fannie's HomePath properties that were in foreclosure).    I liked the idea of borrowing at low rates for 30 years.

[Jurgis]

In 2012, Buffett talked about buying single family homes.  That resonated with me.  I looked at real estate 10 years ago and couldn't make the numbers work.  So I found a Realtor and looked around.  Real estate was down, rates were low, and the numbers worked.  So I bought a couple of rental properties that are within a 1/2 hour of my home  (Fannie's HomePath properties that were in foreclosure).    I liked the idea of borrowing at low rates for 30 years.

 

If not a secret, which state/area? What is the "numbers worked"? What's the rental yield unlevered? What rates did you get on mortgages (IIRC rental mortgages have higher rates than owner-occupied)? Did you have to renovate? Self-renovated?

 

I was thinking of buying RE in Florida after crash. Waited too long. I'm in MA and numbers definitely don't work here.  :-\

[Morgan]

In general, I wouldn't recommend investing in real estate unless you're going to buy a duplex and have the tenant pay the mortgage, or are going to make it a full time gig within a reasonably short time (2-4 years). Frankly I don't think it is worth the effort to have less than maybe 10 units considering how much money you'll likely be making. You're not big enough to get much in terms of economies of scale until you have 50+ units at least.  We're at ~80 units with our little company and until we had 40-50 units I was doing almost everything myself or had occasional help with renovations. Now I do much more managing and work with a crew of guys to get things done. Needless to say, my back is happier.

 

As for making the plunge, you just have to find a property that works financially and then do it. Don't force the numbers to work. It will be obvious that you should buy it. I'm in northern West Virginia and RE investing works here. From preliminary research multi-family investing appears to work in Cleveland, Columbus and Detroit, but not Pittsburgh. I haven't looked elsewhere. Overall it's a good business to be in. I took 6 weeks off a few months ago and kept getting paid while I was away.

[redhots]

This in Seattle.  My goal was to make money on the monthly income assuming I could keep it rented out and have some money left over for maintenance and vacancy.  I want to keep it long term and I hope for appreciation. 

 

The first house I bought was $280,000.  Interest rate is 4.25%.  (going rates were ~3.9%...)  The HomePath properties could be bought with only 10% down so I borrowed 90% and since they are coming from Fannie there isn't any mortgage insurance.    I pay ~$1500 a month for  principal, interest, taxes, insurance (PITI) and I started renting it for $1950.  (now $2100).

 

When I first looked at rentals the monthly couldn't cover the PITI.  I don't want to put additional money in on a monthly basis.

 

The house was in pretty good shape.  I did some cosmetic work myself and hired people to help get it rented.

[Jurgis]

$2100 on $280K property is not that bad. Good luck.

[hillfronter83]

$2100 on $280K property is not that bad. Good luck.

+1

 

I looked at it in 2011 and didn't see return very attractive. In fact, I rented a townhouse worth $400k for $2600/month. Here is the math: Property tax $6800, Home owner fee $5000. So if you pay 20% down, your interest and insurance will cost about $13500. The profit is about $5900, without deducting repair/vacancy/broker, on $80k downpayment. I would rather buy REIT. This is in NJ and property tax really hurts.

[bizaro86]

I bought a bunch of RE in 2009-2013, and sold more than half in 2014 as prices here were high. IMO buying RE makes sense when the return you will make assuming reasonable repairs/vacancy expenses and no appreciation exceeds a reasonable stock market return. Advantages are leverage and potential to buy under market value, which gives a margin of safety. Of course, leverage is risky, and because RE investments are sometimes larger than stock investments, people often get very concentrated. Ask yourself, how would this investment due in a bad recession in my area.

 

 

[Mephistopheles]

I have a question about RE investing but didn't want to start another thread. With leverage, like 20% down, it's possible to get a great return. But you have to pay off more and more of the loan every year, so your return on equity declines over time. Is it possible to reconcile that somehow? I know they used to have interest only loans pre-crisis, but I doubt it's possible to get those nowadays.

 

A friend and I have looked at properties and which would produce great leveraged returns but on an unlevered basis it's not worth it.

[Guest Schwab711]

I feel like the issue with rental properties in general are the lack of liquidity and low returns (even with 20% down). Most banks require 25% down for rental properties/2nd houses and you can't write off your interest expense as easily (though you can write off some charges). So 4x leverage. Most rents are ~5% of principal in my area or they are high-risk neighborhoods (congrats redhots). Rent sensitivity is 1*leverage and FV rent can be quite volatile due to heavy weighting on local employment/crime conditions. Also, rent growth is quite lumpy.

 

I'm from WNY so I assume my asset appreciation outlook is much different than most. Reinvestment risk is introduced with possible need for "new cash" vs a one-time investment for REITs. I don't think RE investing makes sense unless your expected stock returns are < no-appreciation RE return, you can find a balloon payment mortgage (I only), you see a logical reason to E(appreciation) with market liquidity (in the face of rising interest rates), and/or E(repair costs) are low and E(rental yields) are significant.

[orthopa]

I feel like the issue with rental properties in general are the lack of liquidity and low returns (even with 20% down). Most banks require 25% down for rental properties/2nd houses and you can't write off your interest expense as easily (though you can write off some charges). So 4x leverage. Most rents are ~5% of principal in my area or they are high-risk neighborhoods (congrats redhots). Rent sensitivity is 1*leverage and FV rent can be quite volatile due to heavy weighting on local employment/crime conditions. Also, rent growth is quite lumpy.

 

I'm from WNY so I assume my asset appreciation outlook is much different than most. Reinvestment risk is introduced with possible need for "new cash" vs a one-time investment for REITs. I don't think RE investing makes sense unless your expected stock returns are < no-appreciation RE return, you can find a balloon payment mortgage (I only), you see a logical reason to E(appreciation) with market liquidity (in the face of rising interest rates), and/or E(repair costs) are low and E(rental yields) are significant.

 

WNY? Nice, I live in Clarence, are you still in WNY?

 

I have thought about real estate also as my father in law is in agent and has ~15 units. He has done ok but is by no means wealthy and is nearing 60. He has been doing it for ~30 years also. I'm sure his capital base was small and no idea on his return over the that time.

 

I think the issue with RE too are all the frictional costs. Taxes every month (very high in my area). Turnover with tenants can cost you money. Damage costs by tenants. Last fall when we got 7 feet of snow in WNY my father in law had to find a way to clear a big parking lot with 7 feet of snow. People were price gouging big time to clear the snow as a loader/bobcat was needed and Im sure some with rental properties paid a couple months profit because of that. Then when you sell you pay 6% etc etc.

 

The 1031 exchange is attractive but if you have a couple properties you are trying to unload it makes it hard to transfer all of your equity. Not liquid enough for me. 

 

 

[bookie71]

At least 50+ % of the tax free exchanges that i have seen in my practice over the last 50 years wish they had taken the cash and paid the taxes.  Mostly because as the time limits get close they picked exchange properties that didn't make sense.  You have to be very disciplined to make it work right and willing to pay the taxes IF you don't find ideal properties.

[frugalchief]

For what it's worth....my career is in residential property management.  I'm a Broker and manage approximately 100 single family homes (including about 5 duplexes).

 

I've found many RE investors too optimistic about owning rentals.  Being in the business, I deal with all the crap.  Investors have to prepare for the worst but hope for the best.  I'm a realist.  My best clients come after our initial consultation when I straight up tell them to expect tenants to park their cars in the yard, kill the grass, change motorcycle oil on the carpets, and have to paint/replace flooring after each tenancy.  I prepare them for the worst.  They budget and save the profits for the expenses "that may come" (but never had, to that extent).  When it's a perfect move-out, my client is sitting on cash and is happy because they are less stressed.  Of course, I still advise them to hold cash so if something unexpectedly happens quickly (HVAC needing to be replaced, tunneling for plumbing issue, etc.) they have the funds available.

 

The biggest mistakes my clients (owners) made/make:

• High Leverage - many clients are "landlords by default."  They couldn't sell their homes when they moved so we ended up renting them.  With this, many bought those homes with 3.5% - 5% down (FHA or Conventional).  I know for members here that is not "the plan."  But, when something like that occurs, the rents minus our fees and budgeting for vacancy and repairs cost the owner hundreds to thousands per year out of pocket.  It goes with out saying that money is made at the buy.  Of course, they never think that initially since it isn't meant to be a rental.
  
• Low cash levels - b/c of the above happening, most clients don't have emergency funds or budgets - no plan, fly by the seat of their pants.  Therefore, when I have to replace an AC, carpet, paint, etc. they usually want to pay with a credit card or do everything possible NOT to have to do it.  I also tell them that if they don't have liquid cash on hand to pay the mortgage for 3-4 months while the unit is vacant they shouldn't be in the business.
  
• Not using a good property manager - so I might be bias here, but I believe this is true.  If you don't know what you are doing (Landlord/Tenant Laws, Association of REALTORS leases and other docs, etc.) you need to hire a professional property manager.  I've been in the business for 5 years, and with legislative updates every two years there are requirements you need to stay up with - or you can find yourself in a lot of trouble.  I advocate for a professional who runs a small business, small portfolio or rentals with a small staff (1-3 people managing 100 units....this is me).  I firmly believe this is the most profitable model for the investor as the property manager can pay more attention to their rentals and tenants.  I've been able to retain a higher percentage of tenants when working with a smaller portfolio (<100) than a larger portfolio (>250).  This comes because I can interact and give more attention to tenants (they don't think the "landlord" is out to get them, even though I'm firm but fair) and I take care of issues quickly and correctly.  Retaining tenants (no leasing fee, no vacancy) saves a ton of money.  Nothing costs an owner more than a vacancy.  My job is to help my owners lose less money.
  

[AzCactus]

FrugalChief-Your opinion is worth a lot especially considering your profession.  Thanks for taking the time to shed some light. 

[frugalchief]

No problem.  I wrote that when I was in a rush while on vacation this weekend.  A few more things I'd add that I've witnessed/experienced:

 

[*]Patience is key - most of us here are value investors.  When buying rental properties you have to evaluate them and buy only when the price is right.  Don't let your money burn a hole in your pocket - there are more buyers in the RE market who will pay top dollar than you think.  Let them make the mistake.  Sit and wait for a deal to come.  Most deals are foreclosures and short sales. Do what you can to pay cash too.  Nothing hurts like a vacancy and paying a mortgage.  Limit your downside.

[*]Trulia & Zillow vs. REALTOR - please, please.....do not use Trulia or Zillow to give you values (whether sales price or rental price).  These are always (in most cases) far off from the true value.....and most of the time too optimistic.  Have a REALTOR run comps for you on both sides - sales and rental.  If your market uses a MLS system (multiple listing service) it takes no more than 5 minutes for the REALTOR to get good comps for you.

[*]A REALTOR who is a Property Manager - this topic really pisses me off.  I'll keep my soap box short.  Find a Professional Property Manager (NARPM® - www.narpm.org - is a great source to find one in your area) to give you comps on rents.  I've had many clients come to me after being sold a home by a general "sales" REALTOR and say, "My agent said the home would rent for X."  Then I have to say, "I'm sorry, it won't rent for X, it will rent for Y (Y = lower rent)."  The problem here is the REALTORS who aren't in the "rental market" don't know.  I'm not knocking them down, because I'm the opposite - I don't specialize in the "sales market."  My niche is rentals.  So make sure you get very accurate figures and stay conservative in your estimates of rents.

[*]NARPM® - This is the National Association of Residential Property Managers - I'm a member of this organization and very involved in my local NARPM® Chapter.  We are Professional Property Managers who take ethics, education, industry knowledge and volunteerism seriously.  We can earn designations (RMP® & MPM®) which help show our involvement in the industry, education, and continuing to better ourselves.  So make sure you find a Professional to manager your properties.

[*]Stay local - don't buy a rental in a different city or state.  Buy something in your market (if you are a long-time citizen of that town/city).  RE is a tangible asset and fun to look at and touch.  You can also help keep a close watch on it and/or be hands on during make ready's etc.

[*]Have tons of dry powder - I've only spent 5 years in the business, but I feel like I've seen it all.  Have 3-6 months of rents in cash on hand PER unit (duplex = 2 units, single family home = 1, etc.).  Something will break down - that I can guarantee.  I had an owner (lives in California) - their home flooded one night during a very heavy thunderstorm.  Home wasn't even in the floodplain.  It was from run off from topography from across the street.  Had to gut most of the home.  All in all, $18,000 in repairs like that let alone the 3 months of vacancy for repairs, letting the tenant out of their lease, etc.  Evictions can get bad too depending upon how your JP courts are.  Looking at probably 2 months lost rent, vacancy, make ready's are typically a few thousand b/c the tenants trash the place.

 

RE investing is tough.  Patience is a must and the long-term mentality.  Hope it helps.

[bizaro86]

• A REALTOR who is a Property Manager - this topic really pisses me off.  I'll keep my soap box short.  Find a Professional Property Manager (NARPM® - www.narpm.org - is a great source to find one in your area) to give you comps on rents.  I've had many clients come to me after being sold a home by a general "sales" REALTOR and say, "My agent said the home would rent for X."  Then I have to say, "I'm sorry, it won't rent for X, it will rent for Y (Y = lower rent)."  The problem here is the REALTORS who aren't in the "rental market" don't know.  I'm not knocking them down, because I'm the opposite - I don't specialize in the "sales market."  My niche is rentals.  So make sure you get very accurate figures and stay conservative in your estimates of rents.

 

I would go so far as to say that you need to be able to estimate rents yourself. I wouldn't buy a stock where I didn't have an idea what the earnings were, and I certainly wouldn't buy a rental property where I couldn't estimate the rents within $100/unit/month with high confidence.

 

I think RE investing is very much like value investing. The money is in the purchase. If you can buy something at a strong rental yield, below its current fair market value, dealing with the day-to-day BS will work itself out.

[AzCactus]

Do you guys have rough formulas you use?  One example, off hand would be a 10% gross yield.

 

So in the mortgage was $100,000--than rent would be $833/month. 

$833*$12=~$10,000.00/$100,000=10%

 

I know that between taxes, repairs and vacancies the net would be lower.  However, I am looking to get an estimate of a realistic yield. 

[frugalchief]

Do you guys have rough formulas you use?  One example, off hand would be a 10% gross yield.

 

So in the mortgage was $100,000--than rent would be $833/month. 

$833*$12=~$10,000.00/$100,000=10%

 

I know that between taxes, repairs and vacancies the net would be lower.  However, I am looking to get an estimate of a realistic yield.

 

I always tell investors to pay between 50-75 times the monthly rent if they want to cash flow well.  The higher the multiple, obviously, the lower the return.

 

Down here (San Antonio) most homes rent for 1% of their fair market price monthly.  $1,000 monthly rent means home is worth around $100,000.  The higher the value of the home ($200,000 +) the % drops.  i.e., my home is worth $200,000, but would rent for $1,850 max.  I find that in most areas around here.

 

The typical investor (not value investor) makes the 12% annually gross, but after expenses makes maybe 6%. (haven't computed so it's a guess).  These people aren't cash flowing much if anything, depending on the mortgage payment.

[Pelagic]

Frugalchief has made some excellent points, thought I'd add a little from my own experience working in real estate.

 

-Beware the temptation of leverage. A lot of real estate deals look great when you are purchasing the property with leverage, and since it's so easy to get and use why not. Easy access to financing is like picking up girls at the bar after a few too many, they all look good. Does the deal make sense if you're not using leverage, if yes then it's probably a pretty good deal.

 

-Real estate transactions are like a fresh kill on the African Savanna. If you're the lion and you went out and found the deal, rest assured there's a mixed lot of industry professionals scavenging for their share too. You can go out and buy a couple million dollars worth of stock for a couple bucks through just about any of the major brokerages, if you spend that much in real estate you're going to be paying in the tens of thousands to the realtors, lawyers, home inspectors and other professionals involved. Assemble your "team" first, let them know you want to invest in real estate and that you'll stick with them and provide more business if they keep their costs reasonable. Have your team lined up before you commit to a purchase, they should be able to help you find a good deal. 

 

-Be willing to get your hands dirty. If you're paying out of pocket for repairs and to have someone else do them that quickly eats into your profits, especially if you only have a couple units. As you scale up its easier and more necessary to have someone else do the little stuff.

 

Take a value investing mind set to real estate and try to keep the costs under control and you'll be fine. Many people jump into real estate because its easy to do and everyone else is doing it without taking a hard and pessimistic look at the deal they're getting. If you still think it's a good deal when you project in vacancy and below market rents and thieves stealing everything from the place, including the kitchen sink  >:( then you might be on to something. Buy with a margin of safety and build a margin of safety by finding good tenants that add value to your investment.

[ATLValue]

Thanks for the posts so far, this is a topic I've been thinking about recently as well. I have a few questions and would love to get some outside opinions:

 

1) Does anyone have a preference on buying condos vs. single family homes. Apart from the additional HOA fees I have heard that condos tend to underperform the broader market but I'm not sure if this was just specific to the area that person was familiar with (Hartford, CT area).

 

2) What is the right amount of leverage to put on a rental property. 25% with a year of cash to cover vacancies, repairs and other expenses seems reasonable to me but I would love to hear more experienced real estate investors opinion.

 

3) Say you have accumulated a portfolio of 30 apartments, how easy is it to sell that portfolio? Is there an active market for portfolios like this?

 

4) At what point does the investor start being able to fund their investment properties with commercial mortgages on the portfolio vs. individual mortgages

 

5) Have people had more success working with smaller regional banks than larger banks?

 

Thanks in advance!