Buying rental property: How to get rich with rental properties
I have two second cousins who serve in the military — both brave young men I am proud to call my family. We don’t always talk much, though. The age gap can be a roadblock and those boys are always traveling around, serving overseas and living on bases in order to fulfill their military duties and finish school.
Still, social media makes it easier than it used to be, and emails are a quick and painless way to stay in touch. So I wasn’t surprised to receive an email from my cousin, Michael, asking for advice on his future financial goals.
So, what’s the deal? As part of his military compensation, Michael will soon start receiving $2,124 per month for housing and wanted ideas on how to parlay that money into long-term wealth.
But it wasn’t random; he contacted me for a specific reason. He and his wife are toying with the idea of buying a property to live in temporarily, then rent out. And since he knew I own rental properties myself, I’m pretty sure he expected me to support this idea wholeheartedly.
Boy, was he in for a surprise.
Too Dumb to be Afraid
It’s not that I think he’s too young. Truth be told, my husband and I bought our rental properties when we were just a few years older than my cousin (at ages 25 and 26). It’s been almost nine years since then and we’ve learned a lot in that short amount of time, including the fact that we were not prepared to be landlords when we first started out.
I’ve said it before and I’ll say it again — when we bought our rentals, we were too dumb to be afraid. We were too young and inexperienced to understand the many things that could go wrong, and what those things really meant for us. Simply put, we were ignorant.
Asking the Right Questions
So when my cousin asked what I thought about his aspirations to be a landlord, I had a ton of questions to ask — the same questions I wish someone had asked me before I got started. After a short introduction email, here are the questions I sent in reply:
- What is the average price for housing where you live?
- What is the average rent where you live?
- Why do you want to buy a house?
- How long do you plan to live in Maryland? One year? Five to ten years?
- Would you plan to keep your rental property for the long term? If so, what is your plan to manage it from a distance?
- Would you get a 30-year loan?
- Would you hire a property manager? Have you factored that cost into the equation?
- Do you have considerable savings to take care of home repairs?
- Do you have the money to pay for multiple repairs and vacancies all at once?
- Do you have a down payment? Do you plan on paying PMI?
- Have you factored property taxes into the equation? How high are taxes where you live?
After talking through instant message for quite a while, I got answers to most of those questions. First, they planned on living in the house for a few years and intended to rent it out after that. He hoped to hire a property manager to manage the home while he moves elsewhere in the country. And since he could qualify for a VA loan, he didn’t need to worry about paying private mortgage insurance (PMI).
However, I could tell he hadn’t considered many of the other factors I mentioned — including a savings cushion for those inevitable repairs.
“No, I don’t have the savings currently,” he told me, after some prodding.
The Truth About Being a Homeowner
Kristin Wong recently asked whether homeownership is still a good measure of financial success and examined why the appeal of owning a home is currently on the decline in some groups, including Millennials.
“Ownership is a sign of financial stability and freedom, but it seems like a lot of people are questioning the rush into that,” she wrote.
In my opinion, waiting it out seems like a good idea.
I spent my 20s watching shows like “House Hunters,” “My First Place,” and “Property Virgins,” and believing every word. While entertaining, they would have you believe that the housing market always goes up and that there are no bad investments — only good, better, and best.
That was before the housing crash of 2007-2008, a time when people believed that real estate could never go wrong.
Now we know better.
Where Things Break Down
But fluctuating real estate prices aren’t the only reason homeownership isn’t attractive for everyone. Let’s talk about repairs.
Over the course of eight years in real estate, I’ve replaced a roof and two air conditioners, paid nearly $10,000 for interior and exterior drainage and sump pumps to be installed in the yard of a property with a water problem, and repaired $6,000 worth of damage left behind by a tenant.
Most of those repairs were paid for from the profits I brought in from our rental properties or insurance, but not all of them. Unfortunately, being a landlord (and a homeowner) means shelling out some of your own money for repairs from time to time.
The fact is, things break. Often. And as a landlord and homeowner, it is your sole responsibility to fix them when they do.
Far too many people rush into homeownership without realizing the financial implications of doing so, and it is generally to their detriment. Most experts recommend having an emergency fund of three to six months to take care of unexpected expenses, including home repairs.
But landlords need far more than that. Owning rental property generally means having multiple furnaces, air conditioners, and roofs to take care of, and more money to go with it.
Sometimes Your Best Route is to Think Long Term
After nearly scaring my cousin to death with all of these issues, I gave him the best advice I could muster.
“Rent the cheapest place you can while you’re young,” I said. “Put all of your money into savings and investments and don’t look back. One day, when you have the money to own a home, and perhaps rental property, you can reassess.”
“Sometimes progress means taking it slow,” I added.
That advice may sound funny, but I’ve found it to be true.
When I was 25, my thoughts on making progress in the wealth department were entirely different than they are now. In those days, progress meant taking huge risks and making moves. Progress meant doing something and making things happen — not just waiting to let things happen to me.
But now that I’m older, I realize that the opposite approach usually works best. I don’t regret buying our rental properties or becoming a homeowner, but I also realize that I wasn’t prepared at the time. We would have been better off if we had more savings ahead of time, for example, and done a whole lot of research. Instead, our success can mostly be attributed to luck … and good timing.
The truth is, sometimes progress is boring. Sometimes the best thing you can do for yourself is literally nothing, except to see where life takes you and make the best decisions you can with the information you have at the time.
One of the best decisions you can make is to keep saving because, as we all know, having money means having options — the option to stay put and rent, the option to buy a home or even to become a landlord if that’s what you really want to do. Especially when you’re 25 years old, the more options you can give yourself, the better.
Are you building wealth by taking risks or are you taking time to plan your investments more carefully? Has your idea of making progress on building wealth changed over time? Do you regret any of your financial decisions?
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There are 52 comments to "Buying rental property: How to get rich with rental properties".
Great post!!
See, I feel that buying rental property while young is better (unless you are saving to buy better quality rentals) because like any investments you have more time to make those mistakes and rebound then use those mistakes and expertise you hopefully acquired to continually improve the process to gain the maximum return.
I bought my house at 25 and have been renting it out for a year (and renting out the detached apartment on the lot for most of the 5 years I’ve owned the house). I’m 30 now and eagerly looking forward to buying a second property by spring of 2016. I learned so much from the original process which will hopefully save me money and earn me more money on the next go-around.
If I didn’t do this while I was “young” I wouldn’t ever do it because the risk and the fear gets higher the older you get (one of the reasons I don’t want children). If he can physically afford to do it now (it’s not putting him in immediate straits), and it’s something he’s researched and is willing to commit to, I’d tell him to go for it and worry about the things that pop up later, while preparing now for things to pop up later…because they will.
My property insurance company gave me 6 months to replace my roof within 2 years of first owning the property. It cost $8000 but it worked itself out (in the form of a 2 year interest free deal from a home improvement store). Just like you mentioned in your article about advice you’re glad you never listened to in regards to having children, if it’s something you want, and you are well aware of the risks (and do the things to best hedge yourself against those risks), do it, and do it while you are young.
Rental properties in my opinion cannot be compared to typical market investments. I truly feel that you have more control over how successful it is:
– Raising rents (to take advantage of demand)
– Lowering rents (to keep good tenants)
– Choosing good tenants
– staging
– marketing
– DIY
– industry connections
– using long-lasting anti wear n tear building materials
– purchasing quality fixings with warranties
– location
– overhead costs (ex: paying off mortgage, shopping insurance)
It’s not as much of a game of chance that it’s made out to be. You can physically track for the most part the failures and successes of rental property owners based on how they utilize the above factors. You just don’t have the same control with most investment vehicles, and that’s why investing in mutual funds (for ex) does feel a little like being a floating duck…bored out of your freakin mind. Not to mention the little life skills one can learn from renting property, depending on how engaged they are in the process.
I agree with you in some ways and disagree in others. There are some huge differences between my situation and his. For example, our first home (which is now a rental) only cost us $103,500. The same type of home in his area would cost 3 times more. And obviously, the more money you spend, the higher the risk. His mortgage would also be much higher and therefore more difficult to cover during vacancies.
Second, he doesn’t have any money saved for repairs and that is a recipe for disaster.
On the other hand, we are way ahead because we bought rental property so early in our lives. We are already nine years in at this point, and we are only 35 years old. But, like I said, we got lucky in a lot of ways. We didn’t have any major repairs until we had the money to pay for them.
I don’t think you’re disagreeing with what Holly said at all. You’re saying that you should do it, if you’ve done your homework and you’ve run the numbers and you can hedge risks. She’s saying that you shouldn’t do it unless you’ve done the homework and you’ve run the numbers and you can hedge risks.
You’re saying it’s not a game of chance if you’re prepared. She’s saying it is a game of chance if you’re not prepared.
I’m not a landlord yet, but I will be within the next couple of years, and you’ve definitely given me food for thought! Thank you!
I thought the basic housing benefit was a take it or leave it – that is, if you didn’t spend the full amount on housing, you only received what you actually spent.
In that situation, it completely changes the decision calculus, and buying a property may then allow your cousin to build up savings than renting a cheap apartment would.
I’m not sure about whether he has to spend all of his allowance. I do know that rent and housing are very expensive where he lives.
The point is, renting instead of buying would free up more money to save for the future. Buying a home to live in (and eventually turn into a rental) will cost him in ways that renting won’t- for things like repairs, upkeep, etc.
I agree with Tim’s point – to maximize the value of your cousin’s allowance – where it is essential to know whether it is a use-it-or-lose-it scenario. Renting a cheap place and then losing the rest of the allowance is likely less optimal than buying a more expensive place and using all of the allowance.
Please do the follow-up research for your post, including whether/when VA loans are eligible as rentals.
My cousin says that it is NOT use-it-or-lose-it. It is part of his compensation and he can save it or spend it. Currently, he is renting a place for around $1,800 so he gets to keep the difference.
It appears that it is against the rules to use a VA loan for a rental. That means he would need to take out a traditional loan and pay PMI, which just makes the entire situation more risky and expensive.
Presumably, if you buy a personal residence with a VA loan, and after some number of years (when you are relocated) you convert it to a rental, they wouldn’t call the loan due…I have no knoweldge of this specifically, but that’s typical with, for example, FHA loans.
It’s not “use it or lose it”, but it is a housing allowance that will vary depending on what part of they country they are living in.
Or, if they end up living on base, then they lose it completely.
To jump in here,two points. First, I agree with Holly in general. That being said, if this young main lives anywhere between fort Meade and DC God’s sake purchase property. Now, now, now!! DC prices may flatten but they always rise. Even in the housing bubble, and having renters who trashed my home, I sold my suburban DC home for over double what I paid for it in five years. And if he believes that he will return to the DC area as part of his career, he may not be able to afford a house the second time around. The comedies about congressmen sharing homes are actual fact.
NOw, as to the other, he cannot purchase a VA loan with the purpose of owning rental property. He can, however, as a military person who is stationed in another area, rent that home out while he is in Fort Leonardwood Kansas, Okinawa, Germany or wherever he is stationed as a reasonable solution. And since he is in the military that could be quite awhile. Military and us foreign service types do it all the time because once we’ve been in Europe for six or seven years, we need a home to return to. so the va loan is not a problem as such.
My apologies — I was confusing the basic housing allowance with the overseas housing allowance. The OHA is use it or lose it, but the BHA isn’t.
Just because he does not have that “repair savings cushion” now dose not mean he should not buy. Before ruling out that option. He should see if he is able to save that sum of money while he is currently living in the house. Depending on how long he will be stationed there and how much his current expenses are it may or may not be possible.
Many people in the military invest in real estate by using their VA loans. One officer told me that every time he changes station he buys a house where the payments are less than his housing allowance and when it is time for him to change station again he refinances, gets his VA loan back, rents out the place and does it again in the new city. Someone mentioned that you cannot buy a place with the VA loan with the intention to rent it out. That is true. What the officer did is the legit way of doing things. Although, I know many soldiers that purchase property with their VA loan move out a few years later and rent the place out. The bank/VA only questions you if you will live there when you are financing. If you pay the bills on time no body will question if you are living there or renting it out. I don’t know how by the book your cousin is but those are things to consider.
I also live in the DC area but on the Virginia side. And yes this area is expensive.
when I moved to the area I lived with a roommate. The price of renting my own place is the same or more than a mortgage so I decided to buy my own place with my VA loan. Now I have the option to rent out the other bedroom and have her help me pay my mortgage.
Around that time I loved the home shows too, especially Trading Spaces and the flipping shows! At that time it made sense for me to buy a place where I would be happy living and that I could fix up. That made sense at the time, but now with the market cooling (we’ve yet to have a crash here) and a kid, we’ve decided to settle down. Living well within our means has always been a theme though. At first for renos and savings, then weddings and cars, and now paying off our only debt: the mortgage.
I would have gave the same advice. If you want to own rental property, build up your saving reserves, almost as a giant emergency fund, with a certain amount of it dedicated for each house you want to own.
On top of the emergency savings, you will need the money to buy the house (down payment, closing costs, initial repairs, etc.)
That’s pretty much the only way to protect yourself from the inevitable. My wife and I own rental property and we know that Murphy’s Law is in full effect. Something will always break…things you didn’t even know could break will break.
We have our emergency fund divided into personal and each rental home. It’s all in the same money market account, but it’s divided on paper.
As far as buying your first rental home, like you said, invest and save diligently until you can afford it. If you know you’re 5 to 10 years away from the purchase, you can afford to invest in some higher reward, higher risk investments, like aggressive index funds, aggressive ETFs and possibly some growth stocks.
There’s my two cents on the matter, though it’s probably more like 15 or 20 cents! Great article!
In own 11 rentals and this is a real good article. I happen to be an aggressive investor and I don’t mind taking risks buying real estate, but you can’t buy any property and expect to make a fortune on it.
One advantage to buying rentals is if you can get a great deal it usually makes your investment a positive one. It takes acting very quick or buying a home that needs some work to get a great deal.
I think the key to building wealth is saving and building investments. Many people do not calculate the maintenance and vacancies into their rental properties before they buy. Those can account for at least 20% of the rents and many times more.
If you buy rentals with great cash flow, below market value you should be in decent shape. That is not always easy to do.
About a month ago there can an opportunity to buy a rental property. I got super excited, started doing the numbers, and after about a week, we decided to not go through with it. Although I was willing to take the risk, my husband said he didn’t want to be stretched too thin. I’m glad we made that decision.
Great post!
I will note for both your cousin and other readers. Getting a VA loan means that you are not allowed to rent out the property. I wish I could find where I read that statement–I believe it was in my loan agreement. A quick google search shows that the borrower must occupy the home or be within close promixity. Multi-unit properties look to be an exception. The article I found about it is here: http://www.valoans.com/va_article?id=345
Here’s my issue with Rental Property: My father got very into the Robert Allen plan in the 1970s, where you bought 20 properties, held them for 5 years, sold off 15 and using the profits, paid off the first 5 properties. In a market with increasing home prices, this sounds like a plan.
Unfortunately, Rental Properties require renters. We had renters that totally trashed homes where the Cleaning Deposit would never cover the cost. When renters would get behind on the rent, they were almost impossible to evict if they could come up with some money. My brother and I become essentially free labor for the upkeep of these homes doing repairs to walls and fixtures, painting, laying tile, etc. Already a vastly losing proposition, if these task had to have been paid, it would have been much worse.
I would look long and hard at ever starting this as an “investment”.
I beg to differ with some of the opinions above for a subset of people out there.
If you are a professional or on a professional-like track with your career, then do NOT get into Rentals. It will distract your life for a small amount of money. So, if the formula for you is “work harder at work and get promotions after promotions, leading to making $10K to $50K more in the next 10 years (annually)” then do NOT get into rentals now.
I did the exact thing above and waited until I had the money, more time, good pricing in the RE market, and then jumped in with both feet. I have 7 properties now purchased within 3 years and I am maxed out with it. Everything is fully paid for and everything is feeding into the cash flow.
I would NEVER have imagined doing it at 25 or 35 since I was thick in the middle of feeding my career and it was a good thing.
The list of qualifications are great, but most important of all is ROI Computations. Do the ROI and a lot of it will JUMP OUT at you. I have built my own ROI model that I adjust every 1-3 months depending on changes per property (upgrades, updates, repairs, cleanup, bills etc), and keep my numbers accurate.
Finally, once you get to the 1st property, do NOT wait to get it into an LLC or Corporation or Trust. I am finally doing the Trust route since every route is NOT fool proof at all.
Good luck y’all…..
Kenny
Suzanne makes a good point about the VA loan.
I have a first-time homebuyers loan (also through USDA Housing, like a VA loan), which means I can’t rent. I’m in a spot I have to refinance the house after a divorce. In doing so, I’ll free up equity for home repairs through a refi. A refi and repairs means three things: I can rent the home later if I choose to move or upgrade; I can more easily sell the home after updates; or I can live in the home more comfortably after updates & repairs.
BUT – I’ve been working out this plan for a couple years!
Anyway, that’s a bit of an aside. But, it’s true what you say about the home repairs, etc. There’s always something. So, definitely, do the homework, sort out the options and be prepared to work through things that come up – either financially or emotionally.
BAH in the states is not use it or lose it. It is an allowance. So use what you can for housing and pocket the rest tax free. You only lose it really when you live on a base.
A great way to invest in real estate, without the hassle of buying a house or condo and renting it out, is to invest in a REIT fund. There are lots of different kinds of REIT funds.
You can also buy stock directly in a REIT company.
If he lives off base, his housing allowance is all his. It’s up to him if he spends less, exactly or more than that.
I just turned 26 this summer and my husband & I are getting the keys to our first home soon. While we don’t know how long we will be here yet, we found an ideal property at a great price point & it just made sense. We plan to rent it out if/when we move. Being military, our BAH should cover our mortgage and utilities just fine. The house we bought was a foreclosure and we are going in with positive equity.
For me, real estate is a long term thing. We thought about this for a while until we decided to not pass up on a good deal with a long term investment and a fantastic interest rate. It also helps knowing rent in our area is a hot market and would easily cover our mortgage if we end up that route.
As an add — we have a VA loan which requires the purchased property to be your main residence for the first six months. It can then be a rental property, and you can get multiple VA loans as well.
I have at times bounced back and forth between wanting to be a landlord and not.
I think what cured me of the ill was in my late twenties watching my own landlords have to deal with a string of bad tenants, including one that smoked indoors and was also secretly keeping a dog (both against the rules, so she left her windows open, in the winter, driving up my landlord’s heating bill and inevitably our rent), one that skipped town, and one that was on drugs who they had a heck of a time evicting. This was in a very nice neighborhood, btw. I decided that between this and my not being mister fix-it, the cards were stacked against me.
That said, I did rent the cheapest place I could find (within reason, still wanting a safe neighborhood), socked $$$ away, and then when my wife and I got married and bought a house, we had a nice emergency fund to take care of the things that inevitably came up. We took the long view of buying a place we knew we’d be happy with for a long time. Twelve years later, we’re still here.
I think this is a great post! The advice you offered was spot-on and I hope these fine young men benefit from your hard-earned wisdom.
I would like to clarify one point: “I spent my 20s watching shows like “House Hunters,” “My First Place,” and “Property Virgins,” and believing every word. While entertaining, they would have you believe that the housing market always goes up and that there are no bad investments – only good, better, and best.”
I confess, am an HGTV addict. I am also aware that what I’m watching is ENTERTAINMENT. I’m okay that the shows/producers package stories/situations in order to tell a better story. What concerns me is your take-away that HGTV’s Message is there are no bad investments. There have been scores of HGTV episodes where people are dealing with short sales and foreclosures. HGTV reflects what is going on in the current economy. Don’t forget that a number of programs are based in Canada, which is a quite different market.
Ten years ago, a lot of people (like yourselves) believed that Real Estate was a one-way ticket to wealth. Any study of RE history would illustrate that it is, was, and always shall be an up-and-down cycle, as is the stock market. Blaming HGTV for your admitted lack of knowledge (then) is unfair and inaccurate. “They would have you believe…” should perhaps more accurately read “I chose to believe…”.
FWIW, I don’t like any of the shows you referred to, but not because they are packaged. It’s because I can’t stand first-timers with no savings and a big sense of entitlement whining that they “need” SS appliances and granite countertops. Sheesh.
Growing up I see my uncle owning 10 fourplex and retiring comfortably at age 45 from a city job so owning rental property was my way to an early retirement. What I fail to realize was that my uncle was always at the rental units fixing this and that 90% of his free time outside of the 8-5. When I ask him why he retire so early he said he’s too tired to work anymore….I myself own 2 condo units that are having a 50% cash flow but that’s after enduring a year of out of pocket expense to pay for the mortgage and tax and Hoa after a fire at the entire complex. The positive to the fire was I got 2 brand new units that are now giving a great return. I had over 12 months of emergency money so I was able to handle the fire just fine. I’m 37 and had own the rentals since I was 30. I’m not going to buy anymore and my advice to someone who want to be a landlord is to make sure your home finance is solid and you are willing to be a handy man otherwise it’s really tough to make money in rentals unless you want to risk 30 years of your lives waiting for the appreciation.
like your uncle I owned 25 properties over 26 years and I learned its hard work. I retire slowly sold the rentals before the crash and cash out. and just did flips one at a time until last year. I taking a break a long one. lesson always have reserve cash for repairs and keep your personal expenses low and plan on double for any repair work and do most of it yourself.you made your money when you buy and buy in good areas people want to move in for flips or rentals if you have to sell. I aways bought the worst house on a good street and learn to be a good landlord. join a local real investment club and ask for help. good luck
Landlording is a business like any other–it requires labor, capital, and the assumption of risk. People wanting “passive income” probably should be looking at bonds and dividend stocks.
I think that if I was going to do a rental property, I’d do it like my sole proprietorship. I’d have separate accounts, and after an initial outlay (down payment plus an emergency/startup fund in a separate checking/savings) I would have a plan in place to pay everything out of that separate account and transfer profits to myself quarterly or so. I can’t stand the thought of not even knowing for sure if I’m coming out ahead or not.
I love the questions and think they are very helpful, but if you are basing a decision on real estate on the fear of a bubble, how does not also apply to the same investment advice you provided? Most of us got equally burnt by the stock market crash–and for me, that crash hurt me a TON more than the real estate bubble. For those that foresaw the stock market crash, they were able to luck out by withdrawing money beforehand and putting it back after it hit bottom. I began my investment plan 3 years before the market crash and would have been so much better off if I had stuffed my savings under my mattress and waited to buy until the stocks stopped dropping. The reality is that every investment has risk–you need to acknowledge the risk and plan as best you can, but act anyway.
The income for rental property doesn’t always take care of the bills and one expends money, but investors expend money anyway when they put that money in the stock market/investments. It seems there are two possible methods: a person can save as much as possible and place it in investments or stocks OR a person can buy a rental, have to pay for repairs here and there, taxes and insurance each year, and have the renter help toward paying off the place. It seems the rental, if done smartly, can really help a person along.
I keep playing with the rental option in my mind, though I’ve been doing the more traditional plan (stock market). Thank you for all the food for thought
No, phoenix1920, “most of us” did not necessarily get “burnt by the crash”. An investment plan generally means 1). Well balanced and 2). Long term. That means you don’t go running for the hills when the market dumps, you buy more and stay balanced. Panic is not a long-term investment plan.
I didn’t sell anything and ratcheted up my saving/investing after the crash. As a result, my investments are worth a TON more than before. Same with real estate. Unless you are forced to sell, who cares what your house is “worth” on paper? Oh, yeah, real estate prices in my area are beginning to exceed the peak prices of ’07/’08. I’m FIRE now, and “luck” had nothin’ to do with it.
Sorry for the semi-hijack. I just couldn’t let this one go unremarked upon. Lucky, my left toe.
I think you completely missed my point, which was that there is not really a difference in the risks of real estate and investments. BOTH are long-term investments and both can go up and down. (And one does have more control over real estate, if done smartly)
My investment plan is one based on the S&P 500 index, which I favor because it has incredibly low fees. And yes, this is a long-term investment, but I could have profited greatly if I had decided to sell right after the market began its crash. While the market has recovered, the market’s value dropped more than half and it took 6 years before it recovered. Even my house, when the bubble popped, did not lose half of its value and here, the real estate market has equally recovered.
However, the market crash DID affect a lot of people. I know many people at work who were hoping to retire before their investments plummeted–most had to postpone retirement, but some could not because of health reasons. Likewise, those who put their money into college investment plans for their kids had a problem because when investments plummet, what can you do? Ask your kids to hold off on college for the next 6 years? My assets dropped as well during the crash.
If you were not affected at all during that time, I’d love to hear in what you invest
PHX – What I primarily took issue with was your use of the term “lucked out”. Just a few quick thoughts:
– An investment plan based on the S&P is NOT a balanced plan. And not all S&P Index Funds have “incredibly low fees” per se. It’s important to do your research.
– In the examples you cited, you’re overlooking something important. In either case, you will not be using all the money at once.
– In the case of retirement, if I had to retire during a downturn, I’d take out as little as possible to get by, leaving the majority of the principal to recover over many years. As things improved, I’d take out a little more to spend on the things I missed in the lean years.
– In the case of college, again you don’t pay all four years up front. Personally, I’d probably try to pay as little out of the 529 as possible while the market was down. I’d use a combination of loans and other savings until the market improved. I might even spend the first two years at a junior college close to home and then transfer to a four-year school.
– Finally, I said my investments cover a very broad spectrum. Since I didn’t sell anything, I didn’t lose anything, because I am a long-term, balanced investor. Same with my RE holdings. The markets (and my accounts, by extension) have rebounded way past what they fell to at the downturn. If you’d sold then as you pined for in your OP and failed to jump back in at exactly the right time, you’d still be behind with no one to blame but yourself, not the markets.
– In other words, it’s not as much about what you BUY (assuming a low-cost, diversified portfolio) it’s how you BEHAVE. Again, luck had nothing to do with it.
I think your advice for his situation is certainly one route to take, I think renting something very cheap and putting the extra in savings is a great plan.
I think if a couple other items were in place I would highly recommend the owner occupied housing this way they can get a taste of some of the cautionary items you mentioned. If it were a VA loan, I would either want them to have a large down payment or large house emergency fund.
All in all I think based on his answers you gave the correct advice;)
“Most of those repairs were paid for from the profits I brought in from our rental properties or insurance, but not all of them. Unfortunately, being a landlord (and a homeowner) means shelling out some of your own money for repairs from time to time.”
All of the money is your own money. Any that’s not spent goes to your pockets, so any that is spent comes from your pockets. If you’re paying more in repairs – in the long term – than you’re making in cash flow, you probably bought the wrong property. Also, it is very helpful to think in terms of cash flow and return on investment (with the investment being any money spent prior to the cash flow beginning – typically, down payment, closing costs, initial fix-up costs) rather than “profit” since, as you point out, expenses can eat up even past profits in a hurry.
I actually don’t see it that way at all.
One of the great things about owning rental property is having someone else pay the mortgage on our properties for the duration of the loans.
I feel fortunate that we did, by some miracle, buy properties with positive cash flow. And some years have been better than others. For example, we spent quite a bit of cash on repairs last year but almost nothing during the 3 years up to that point.
On the other hand, the ups and downs don’t really matter that much to me. All I care about is the end result.
For as clear as Boglehead-style investing seems, I really cannot understand why the average person would want to go through the potential nightmare of dealing with rental properties. Not that I would have nearly enough cash to even put a down payment on one, but my experiences with roommates has been enough to dissuade me from ever wanting to get involved in this industry.
Even places that screen potential tenants can’t account for the disgusting and bizarre things that people do to rented houses and apartments. To give just a few examples from my life: a roommate dislodged a sliding door from its track and shattered the mirror on it, a drunk roommate turned the AC up so high before he passed out that it froze our pipes (in ARIZONA!), one former roommate left so many bags of trash and plates with rotting food on our balcony and around our apartment that the complex management came by and yelled at us, and a roommate punched a big hole into his own door and left dried blood on it/the carpet. Even leaving aside these instances of catastrophic damage, you have to take into account the regular wear-and-tear that people put on appliances out of laziness.
For me, this type of undiversified, unknowable risk (not to mention the potential legal headaches, depending on your location) is just completely unacceptable. I would take an equivalent investment in an REIT over a rental property any day of the week; I would be even happier with an REIT index fund like VGSIX to diversify between residential and commercial real estate. What reasons do you have for choosing to invest in these properties rather than an REIT or REIT fund? If it’s just a matter of savings for your brother, it may be good to start him off with REIT investing first rather than diving into being a landlord right off the bat.
I have to say your experience is a bit extreme. I have owned a 6-plex for several years and apart for one cranky tenant, all the others have been kind and considerate. It’s not a fancy place, either. What appears to make a difference is the fact that we take of the place ourselves, are timely with repairs, and DH is really handy. He’s also gruff at times so no taking-advantage-of-the-landlord thingy. I play the “good cop”:)
We respect them and they respect us. Simply good human relations.
We were military and we did exactly that…..and I would never recommend it. The home we had overseas was always rented to military, and although complicated by the fact that it was overseas it wasn’t too bad of a headache. Military renters have been level headed, competent, capable renters who can handle things and then send me the bill. But after 10 years when we sold, financially it was pretty much a wash. No big win, but no loss.
Our stateside property was another story. I’m shocked at how easy it is for some people to not pay their rent, to leave in the middle of the night, to destroy property and not care. Selling it off (finally) what has been a nightmare property, and taking a big financial hit, but need to unload the stress and not close enough to deal with things ourselves. PS Good property management companies cost. Between renters and the government (they couldn’t send us an email, and we had moved overseas, next thing we had a court order because they hadn’t been able to contact us about an issue that wasn’t our fault which resulted in a fine) it has been a huge stress.
But we are lucky enough that we could handle the downs, and we’ve learned……
Rental property can be a blessing, or a curse. I have had bad tenants, and great ones.
It’s all a matter of proper screening, and recognizing what a great tenant looks like in terms of income and credit score.
We gave very similar advice to a newly married cousin and her West Point grad husband. They were working with a broker in about year 2 of the housing market decline. The broker was trying to convince them prices were near the bottom and they would soon have equity in the home. We advised them against purchasing. They were relocated about one year later and the market had dropped substantially. Had they bought and kept the home as a rental I believe they might still be upside down in their mortgage.
Holly, great article. As a 25 year landlord, I would also recommend that buyers have a reserve to handle breakdowns (a line of credit works also).
The easiest way to get into rentals (my opinion) is to buy a distressed house to live in, fix it up, and rent it out in a year or two, instead of flipping. Then, buy another house. Repeat. You then have the knowledge of knowing the home you rent out has been upgraded (perhaps new roof, hvac, etc.) But, can you handle owning rentals? You need to be old/experienced enough to have a hard heart to be a landlord. Will you REALLY be able to evict the crying mother, holding a baby begging for another month to pay when you try to collect rent? You had better be. Because the worst renters have all been to “deadbeat” university, and know the tenant laws better than you, and they can smell a “sucker” for a sob story. Give them any mercy, and you will go bankrupt-they need to be evicted without a second chance. If you are offended in any way by what I just said, you are not cut out to be a landlord. For those who aren’t offended, you have a fighting chance at success, and it is worth it.
Great article. We would like to own rental properties sometime in the future. We’ve thought about a lot of these things, but I think we need to get it all down on paper and evaluate the business plan. We’re in our 40s, so I don’t think we have a “too young” category. But with three kids, we need to work on our savings. I do know we have a lot of good homes for sale in our area that would make great rental properties and we don’t want to move out of this area anytime soon. We would, however, like to get a property management company to work with us.
I’m pretty certain you actually gave your cousin bad advice. He indicated that he would be staying at the home for a few years, and that his BAH would be $2124. Since that is based off of the average expenses (and it IS money that he would not receive if he was living on base)-having him rent means that you’re essentially throwing away a percentage of that money on…rent.
Let’s say he’s spending $1000 on rent instead of $1000 on a 140k home-half the allowance, which is probably a reasonable estimate. After 2 years, that’s going to be $24,000 dollars-most of which will have gone toward interest/tax/insurance, so he’d probably end up with about 5K in equity at the end of year two. Plus the possibility of either an increase or decrease in property value.
The alternative, renting, means that he will be guaranteed $0 in equity, and no possibility of either a gain or loss in property value. You have essentially advised him to NOT take a risk to attempt to build wealth. You definitely should have actually showed him how to run the numbers to understand the value of home ownership itself even without the possibility of renting the home at some future date (and you certainly shouldn’t have discounted the possibility of selling the house at a future date at a profit!)
Now, if the rent is ~20% less than the mortgage, and the two year time frame is definite (in the military it rarely is), then renting might be more attractive, but the longer he stays in and gets BAH to pay for the house, the lower that rent discount needs to be before he’s losing money.
That said, I know people who have built highly functional rental portfolios in exactly this manner, allowing them to really retire when they retired from the military at 20 years. They would say that the time frame is irrelevant-what is relevant is that you’re using a benefit of your service to build long term wealth that will last beyond your enlistment period.
Holly I like the advice. I’m 30 and own two rental properties and think they are the best investment you can make. BUT, I acknowledge I’ve had a good experience so far. There’s not a be all and end all. Sometimes it makes sense to wait, especially if you haven’t gone through all the numbers yet.
Millenials aren’t under-represented as homeowners because the majority doesn’t want a house, it’s because so many of them can’t afford it in the current economy which was discovered when someone actually surveyed the age group rather than just looking at statistics.
If you can afford the down payment, and the rent will cover the mortgage and all other monthly expenses, buy the house, assuming you can hold it long term. Most people underestimate the potential gains long term through the real estate leverage. Let’s assume a low historical return on real estate of 3% per year. Most people put a down payment of 10% to 20%. Let’s assume 20%. Based on your down payment, you are earning 15% per year.
My boyfriend and I have one rental property each. I got a condo when I was 24 and he got a house when he was 23. Best thing we ever did. I rented the condo out to an amazing tenant (knock on wood), headache free so far and it’s been a little over a year. Condo was brand new at the time with minimal maintenance. My boyfriend got a house, rented out the top to a very nice family and we currently live in the basement of the house. We are renovating the basement and are planning to eventually move out and rent it out to another tenant.
The trick is to ask the potential tenant for 1. credit check report 2. proof of income and first and last. Always meet the tenants in person first and have a small chat to get to know them a little bit. First impression is key, your gut feeling will let you know if they are right!
It helps that my boyfriend is a contractor and is rally handy, so any maintenance he does himself. We plan to keep the house until we retire, at which point the mortgage will be long paid off by the tenants and we will rely on rental income for retirement living.
Living in the basement of the house allows us to continue to save for another property because the mortgage and 70% of the utilities are being paid by the tenants, therefore we have very minimal expenses.
I submitted an article to GRS about our venture with full details but they never got back to me.
I would fully recommend to invest into real estate early because it’s a long term investment. The key is to plan ahead – have the downpayment ready along with a buffer for unexpected costs for maintenance. Also, research what the rent costs in your area using sites like rentalcompass.com
Seriously? No disrespect but this seems like a case of “I screwed up so this system won’t work for you either”. How much do you really expect your cousin to earn by sticking his money in savings or CDs? Does he know enough about the stock market to invest there? The best financial education your cousin will get is my diving in after studying up. Even if he only makes $1/yr off his properties after repair, someone else is building him EQUITY. Cash flow is king, but equity is queen. I know COUNTLESS people who are investing in real estate and will be walking away from their full time jobs soon. I am one of them. Regardless of if the market heats up or cools down. I am glad I never listened to those with bad experiences…I would have a whole bunch of money sitting in the bank barely beating inflation. The stock market crashed a few years ago…is that a bad investment too? Please do your cousin a favor and tell him there are TONS of ways to get started in real estate and build a nice portfolio. Tell him to do his homework (join a site like bigger pockets) and learn to live on 50% or less of his income. Then, when he is ready, to begin investing and learning from his mistakes. Being afraid of failure will never bring financial freedom. Just my two cents…