Real Estate Investing #10: Myths and Presumptions
May 4, 2015
People tend to make assumptions the second they hear that you own rental property and, for those who aren’t knowledgeable, many of those are wrong.
1. You’re rich. (Correlated: You will be rich tomorrow if you just got started today.)
2. You’re always making money, usually hand over fist.
3. It’s easy money, and profitable as hell.
4. Landlords can charge anything they want.
Obviously we’re not rich. Far from it. I certainly intend to be but this is one part of a long term plan to get there, this isn’t the end all be all.
The point is to make money but it’s not easy and not an overnight get rich quick scheme.
There is a risk and a truckload of expenses involved: I took on a mortgage, with all the associated home buying costs like closing costs, realtor fees, inspection and appraisal fees, and a higher interest rate because it’s not an owner occupied property.
And whether or not we have renters (aka income), I’m still responsible for all taxes, damages, repairs, and association or other fees every month. My profit is AFTER I pay all those bills, if anything is left.
Profit margin is dependent on two main factors: fixed expenses and rent. I’d love it if I could engineer a 50% profit margin but the only “control” I have is on the expense side. It’s down to what decisions I make when buying. The price point has to be low enough with a high enough property value so that when the mortgage and all the other costs are added up, they are less than the amount of rent I can charge. And I can only charge what the market will bear. If rents in the neighborhood or region are $1200/month for a 4 bedroom, 2 bath single family home, and I’m trying to charge $1500/month for a comparable property with no distinctive features worth $300 more per month, all because my expenses are $1400/month, guess who’s got 2 thumbs and is SOL?
Or say your expenses are lower and you can still make a small profit charging market rates – if you get hit with multiple repairs, month after month, even small ones, you’re still looking into an ever deepening hole.
You’d better have some slush fund saved to keep covering your expenses during times of vacancy, and any rental income budgeting sheet worth the paper it’s printed on includes a minimum assumed vacancy percentage, because just try crying to your bank about how you can’t pay this month because the rent was paid late or your property stood vacant.
Believe me, they’re just fine and dandy taking the house along with whatever money you’ve already sunk into it if you were fool enough to believe that you didn’t need to pony up more cash out of pocket from time to time.
I didn’t get into this intending to lose money but as an investor you have to know the basic risks you’re running, and yes, losing money is absolutely a real risk.
Yes, you have to be prepared to have losses with a rental property and to be able to cover those losses in the moment. The silver-lining to losses on rentals comes at tax time when you can demonstrate that you lost on the investment, offset your income, and get a bit of a tax break. HOWEVER you simply c an’t count on this happening, and you really don’t want to be bleeding money every year to maintain your rental. (Unless you really make a LOT of money are are simply “investing” in real estate to offset more lucrative gains, which is what a lot of “slumlords” are doing.)
Before I started renting out rooms in my home I talked with a colleague who owned a two-flat. She lived on the second floor and rented out the first. She told me, with a smile on her face, how she usually lost money every year on paper due to the property maintenance and upkeep not being covered by the rent. As an on-site landlord with a full-time, well-paying job, this was ideal for her. So, being a landlord can make you cash-flow poor on a regular basis, but hopefully pays off at tax time; just don’t count on it.
Maybe I’m being dense but how is losing money on paper not actually losing money in reality? It feels a little to me like people who don’t want to make more income (either higher wages or OT) because then they have to pay more in taxes. Yes but, if you have to pay more taxes that’s because you have more money! Just because you don’t get to keep all of it doesn’t mean you don’t keep any!
You’re not the only one. I’m also not clear how losing money on paper is different from losing money on reality unless the rental income is not fully reported.
Everybody I know thinks real estate is the path to riches (i.e. being a landlord). While I know that it can be very lucrative, it is also hard work. I never hear about anyone losing money if they keep the house for a long time and continue renting it out but I hear ya about having a slush fund for vacancies. My ILs have a rental apartment that’s been vacant for 1.5 years now and was trashed by the last tenant who wanted to move out before the lease was up.
The only people from whom I’ll accept that POV is people who have been and continue to do it and make money over the long term – most everyone else just makes shallow assumptions.
I know several landlords first hand and that has taught me that it is NOT a money making proposition! In fact most people know I just break even.
For that reason, I don’t think I’d be cut out to be a landlord. I’d rather just invest my money, less hassle.
This is, in some ways, an expensive experiment! I’m hanging in for the long term and learning what I can.
Rental biz is tough. I’ve done it for over 35 years and it’s as challenging as it has ever been. Not only are there the challenges you outlined but when you get to the “end of the rainbow” and decide it’s time to sell….The tax consequence is simply “breath-taking”. Remember all of your depreciation is added back in and then added to your capital gains…and when the Fed is done… then the State get’s their cut. I have done the numbers with the accountant on a couple pieces of property I have owned for a long time and it is simply frightening…..
Well now I’m a little leery of staying in it for the long term.
[…] Revanche holds forth on the myths of the landlord biz. It’s an interesting post with points well […]