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Author: EsM30 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 4898  
Subject: Buying first rental property Date: 11/14/2012 9:45 AM
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I'm looking into buying my first rental property and just thought I'd post here. With interest rates so low, I've just refinanced my house into a 10 year loan and took out $40,000 of equity. At < 3% interest (and tax deductible) it felt like a no brainer.

Initially I was just planning on investing the money in stocks, but for a long time I've been interested in purchasing a rental property. This seemed like the perfect opportunity.

I'm looking at a duplex less than a mile from my house selling for $70k. It's an older neighborhood in a decent suburb. Taxes are $4200 a year.

One of the units is currently rented for $600 a month. The other is a bit smaller and upstairs but it should be able to rent for $500 a month.

I plan to do all the maintenance myself, which should help my profit picture. There are a few exceptions such as the furnace and things that need to be done ASAP.

Any thoughts? I still need to more precisely work out the numbers, but back of the envelope calculations seem encouraging. I don't want to plan for any price appreciation, so this has to be profitable over time just through increased equity and positive cashflow eventually.
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Author: KennyO Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4684 of 4898
Subject: Re: Buying first rental property Date: 11/14/2012 1:16 PM
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Cash flow is what kills small businesses, which is what you are as a landlord, so that's a permanent front burner item. Looking at doing something about the furnace is a good step at this time. Do things like that before winter converts inconvenience into emergency. Look closely at any other biggies as well, especially at the water heater, the roof and the major appliances, if you supply those. Look for anything that might pose a liability risk like broken or heaved sidewalks, damaged/rotted porches and decks, re-key locks between tenants and check that doors and windows are in good repair and secure. Make a phone list of your preferred repairmen and service companies and keep it handy. Vet them before adding them to the list. If you go out of town you may want to give that list to the tenant. I have.

Get familiar with landlord/tenant law in your area. There are some surprises in there for those who haven't been on the owner side before. Browse back through this board for some unhappy tales with good lessons. Happily, with rare exceptions, nearly all those tales could have been avoided with due diligence. There are standard lease forms that you should use. Stationery stores, if any are left, are where I used to get them.

Above all, do not plan for 100% occupancy. Be prepared for some vacancy between tenants for any number of reasons, some predictable and some not. I plan for 75% and consider everything above that to be gravy.

Good luck and I hope it goes as well for you as it has for me.
KennyO

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4685 of 4898
Subject: Re: Buying first rental property Date: 11/14/2012 2:22 PM
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Hi EsM30,

Any thoughts?
Definitely...

I've just refinanced my house into a 10 year loan and took out $40,000 of equity. At < 3% interest (and tax deductible) it felt like a no brainer.
Bad move, unfortunately. The amortization costs and cashflow risks on that 10 yr FRM put you at a very significant handicap as a first-timer landlord. As KennyO says; "CASHFLOW IS KING!®"

As a first-timer, living in a lower-priced region, you'll likely ignore this advice, but; GO BACK AND REFI AGAIN TO A 30 FRM.
(Unless you are an aggressive saver, in which case take a 5 yr ARM and bank/safe-invest the monthly savings to offset the fairly low risks of any rate increases in the distant future.)

I plan to do all the maintenance myself, which should help my profit picture.
Do you make nothing in your regular profession? Or do you earn less than the local handyman rates?

If you can have your maintenance done for less than you are worth doing what you are paid for, save your money and book better profits by paying the cheaper outsourced maintenance.

I don't want to plan for any price appreciation, so this has to be profitable over time just through increased equity and positive cashflow eventually.
Increased equity is not profits... its merely the gradual accumulation of your net worth in one particular asset bucket versus others. Smart real estate investors keep their equity balances minimized in their real estate (which has a minimal appreciation track in the best of times, and is likely flat for a decade into the future from here... but which has outstanding yield/income growth.)

Also, while "CASHFLOW IS KING®" it is not the same as profitability. Cashflow is the combination of actual profits *AND* equity flowing through your books... its like drinking a latte', where equity is the milk and profits are the espresso.

REAL profitability is actual profitability... the stuff that is not simply shifting money from one of your own pockets to the other, but actually increasing your overall net worth over net time.

The long-term after-tax rents/yield left over after the carrying costs of ownership, minus any depreciation recapture, is your actual profitability. That sounds complex... but take a moment to wrap your head around it, as this is your "True North" compass heading. You definitely want to navigate your short term on cashflow (did I mention "CASHFLOW IS KING®"?) which includes getting your butt back to your lender & getting your amortization burden stretched back out 30 years... *AND* the longterm focus is actual real profits.

Luck!
Dave Donhoff
Leverage Planner

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Author: rita205 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4687 of 4898
Subject: Re: Buying first rental property Date: 11/14/2012 6:56 PM
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Do be aware that you'll be charged higher interest on investment property, and probably will have to put down 20%. That's what I learned recently with my first investment purchase. So the 3% rate you got for your refi may not be available to you on the investment property.

Rita

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Author: n8larson Big gold star, 5000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4688 of 4898
Subject: Re: Buying first rental property Date: 11/14/2012 7:34 PM
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I plan to do all the maintenance myself, which should help my profit picture.
Do you make nothing in your regular profession? Or do you earn less than the local handyman rates? If you can have your maintenance done for less than you are worth doing what you are paid for, save your money and book better profits by paying the cheaper outsourced maintenance.

Common fallacy! This is not how it works!

What you make at your day job only matters if you either (1) have to take time off from your job to do rental property maintenance (RPM, for now), or (2) your day job is scalable and you do as much of it as you want, with every hour translating to additional money at the same rate. Unless you meet either of these conditions, it's very incorrect to think that an hour spent on anything outside work should be valued the same as an hour spent at your day job. The "value of time" with respect to outsourcing RPM is a different one for most people than what they earn.

To the extent that you can do your RPM work on your own time, either during actual evenings and weekends (or if an emergency arises that requires RPM during work hours, by making up lost work time on evenings and weekends), it's the value of THAT time that you'd compare to what you pay a handyman. As an average, the range of $10-15 an hour covers what most people's time is ACTUALLY worth, based on how they behave. If you can find a handyman that does good work for less than that, it makes more sense to pay them. If they charge more than that (say, 4 to 5 times that, as is my experience) it makes sense to do the work yourself, assuming the quality of work is equal.

As you said in the OP, some kinds of work are easy, and some best left to the pros. Basic plumbing and electrical repairs and upgrades are, in my experience, where the HUGEST savings are in doing it yourself if you can do them reasonably well.

Point: Unless you spend the time that you're NOT handymanning actually doing something that pays you more (after taxes) than you pay the handyman, you'll "book more profits" by paying yourself, tax free, to do that work instead of paying someone else.

-n8 (son of a handyman)

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Author: KennyO Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4689 of 4898
Subject: Re: Buying first rental property Date: 11/15/2012 4:16 PM
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Also, while "CASHFLOW IS KING®" it is not the same as profitability.

I'll wholeheartedly agree with that. I'll also assert that positive cash flow is a condition for profitability. Cash flow determines financial survival. When cash flow goes negative your financial survival depends on 1) the resources that you can use to cover expenditures or 2) on your ability to unload the investment before your backup resources run out.

KennyO

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Author: EsM30 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4690 of 4898
Subject: Re: Buying first rental property Date: 11/16/2012 10:12 AM
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Thanks for the responses, it will definitely give me some things to think about. I understand you're an expert so I will have to think about your comments in more detail, but I'd just like to comment on a few things.

Bad move, unfortunately
I will have to think about this some more. I am not totally convinced. I do not foresee a cash flow issue. Even after refinancing to a 10 year, my mortgage is less than 20% of my net income. When I did the refinance, it was with the intent of investing the cashed out equity into stocks.

Do you make nothing in your regular profession? Or do you earn less than the local handyman rates?
I am a salaried employee and don't make extra income by working more hours. It isn't a tradeoff. I wouldn't do this with 20 units, but as long as I can manage it with one I plan to.

Increased equity is not profits... its merely the gradual accumulation of your net worth in one particular asset bucket versus others.
I understand that and maybe I wasn't clear. If I can determine that the property is cash flow neutral or positive with ALL costs taken into account, then the equity is actually the money moved from the renter's bucket to my bucket. This is where I have to do some more calculations with various assumptions. I really just meant I want to be conservative with my calculations and will only do the deal if it is profitable even if the property value never increases.

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Author: StockGoddess Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4691 of 4898
Subject: Re: Buying first rental property Date: 11/16/2012 3:10 PM
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Do you have what it takes to be a landlord? I know a few. Get to know one, take them to dinner, talk about the worst in tenants. Here's a quiz:

1. Tenant is a mother, with kids, hasn't paid rent in 2 months, it's just shy of Christmas - could you evict her and sleep well at night?

2. Tenants are family, dad is out of work - can you evict them?

3. Tenant's neighbors have complained of strange men coming and going all times of day and night - you suspect prostitution or drugs. What do you do?

4. Tenants do $4K in damages above their deposit and it'll take a month of solid work to put it back into shape - if you hire it done. Four months doing it yourself. What do you do? We're talking head-sized holes in the walls, broken doors, filth everywhere an inch thick, broken windows, chewed-up windowsills, dog and cat pizz on the floors

5. Prospective tenants - nice old man and wife - say landlord is selling. They don't seem to have his name, though, my goodness. Their house is spotless. Take a chance, or no?


ANSWERS (not all MY situations, but all real-life situations)

1. Yes. If you hesitated at all, don't do this.

2. Yes. As a matter of fact, you went out to dinner last night and saw said father with a woman not his wife, and he paid you $300 of the back-rent to be quiet about it. (this really happened). Take the money. Evict anyway as he owes $2K.

3. You call tenant, tell her you know what's going on, tell her she vacates the property in 3 days or you'll call the cops. Apartment is empty 3 days later. No forwarding address. Re-rent.

4. Hire it done and go back to work. Not.worth.it.

5. I used tax records to find the owner. Tenants were being EVICTED. Ran credit check - worst thing I've ever seen, evictions, judgements, liens, bankrupcy - guy had an actual credit score of 406 in a 300-800 range. They looked and sounded like fresh-baked-cookies churchgoing ma and pa. They were every landlords' worst nightmare. Better a biker who pays his rent than a schoolmarm who does't...

You need a plumber, an electrician, and a well-rounded handyman you trust and can call at the drop of a hat. Ability to run credit and background checks. Info on how to evict. Those credit checks saved my backside more than once...

SG "my 2 cents..."

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4692 of 4898
Subject: Re: Buying first rental property Date: 11/16/2012 3:39 PM
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Hi Evan,

I will have to think about this some more. I am not totally convinced.
Its pretty simple on a net worth effect basis;
a) each dollar sent to your real estate equity (due to voluntary acceleration, or amortization) gives you the benefit to net worth (ignoring liquidity risks) equal to the after-tax rate of mortgage interest,
b) the same dollar, if kept out of the equity, earns a net improvement to net worth equal to its after-tax copounding growth, minus the after-tax cost of mortgage interest (plus liquidity/safety benefits.)

I do not foresee a cash flow issue.
Cash flow problems only become problems when they weren't foreseen.

I am a salaried employee and don't make extra income by working more hours. It isn't a tradeoff.
That's fine... but your liesure time still isn't "free." If you enjoy handling simple maintenance issues (frankly, I do sometimes... in a bizarre way, I sometimes enjoy the uncomplicated sweaty tasks that don't need special tools or skills & make me get physical for a while... as opposed to my cerebral desk-jockey job,) then there's a compensation of liesure hobbiness. On the other hand, there will be tasks that could be done & over with in 30 minutes by the right person with the right tools, experience & supplies, that will take you all day & 4 round trips to Home Depot to resolve. Don't fool yourself into thinking you're "saving money" simply by not stroking a check to a pro handyman.

I think the 50,000 foot critical perspective is that;
Landlording is a business

Treat it that way from the outset, and every step along the way.
You'll have more fun that way.

Luck!
Dave Donhoff
Leverage Planner

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4693 of 4898
Subject: Re: Buying first rental property Date: 11/16/2012 3:41 PM
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PPS.... lest there be any doubt at all;
I wholeheartedly believe that directly owned residential rental real estate is THE HANDS'-DOWN BEST longterm growth & inflation-offsetting investment strategy that exists at present.

You're looking the right direction!!!
Dave

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Author: activeREinvestor Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4697 of 4898
Subject: Re: Buying first rental property Date: 12/25/2012 3:10 PM
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This can be as complex of as simple as people want it to me. If you run it as a business and you show a taxable profit while keeping the LTV low there are not too many risks. I say, not too many in that the risks should be things you can handle.

Cashflow keeps you in the game. Not trying to maximize the debt levels is a good idea. If you want to push the edge, make sure you keep ample cash available for the unexpected.

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