Monday, June 29, 2020

Do You Want Something You Can Put Your Hands On?

Do You Want Something You Can Put Your Hands On?

Should I Buy a Rental Property to Fund My Retired Years?
This is definitely a “Top 10” question I hear in my practice.
During my 20 year career, I have seen countless clients buy and own rental properties and my conclusion?  Don’t do it.  Don’t do it.  Don’t do it.
Now, don’t misunderstand.  I have some clients with 20 properties or more who treat being a landlord as a full-time job.  Normally these kinds of property portfolios consist of very low-end housing.  They can make significant money.
I’m talking about the retiring couple who buy a rental, usually a few years before retirement.  Their rationale?  “Once we retire, we can just sit there and let the checks roll in. Not only do we get the rent but we are also building up equity in the house.”
I’m going to tell you a story about Billy and Sally.
Billy and Sally were good, hard-working people who were responsible savers.  A few years before retirement they watched a show on TV.  In it, the host showed them how easy it was to create income from properties.  “It is a tangible asset,” he proclaimed.  “You can put your hands on it.  It’s not like other investments.  You own a real piece of real estate which has tremendous cash flow and growth potential.”
Billy and Sally were immediately sold.  They began to peruse Zillow.  It seemed like there were opportunities everywhere. They didn’t want anything fancy.  Just a basic home for a renter.
After a month of researching, they made an offer on a house.  It sold for $200,000.  They used a good portion of their savings for the purchase.  They were thrilled they owned the house without a mortgage.  Of course, Billy had to cash in some of his 401k, but it was worth it to him (don’t do this).
The home was in a nice, quiet neighborhood.  Billy and Sally were proud of their purchase.  It was incredibly comforting to know they owned another home, outright.  No matter what happened to them financially, they always had this house.
Now, of course, the house was not in perfect shape.  It definitely needed new floors.  The last owner must have owned big dogs.  They continued on to the rest of their to-do list:
Paint, inside and out
New, small patio off the back entrance.
Replace the leaky water heater.
New curtains.
Some basic landscaping.
Replace several fixtures.
As Billy and Sally were still working their own full-time jobs, these weekend projects took nearly three months to complete.  But, finally, it was ready to rent.
In deciding rent they looked at other rentals in the neighborhood. They wanted to be fair so they asked for $1400 a month (way too low).  Amazingly, the first person who saw the house wanted to rent it.  What great news!
The tenant was currently renting another place and he had to stay there one more month according to his lease.
Billy and Sally were surprised that the new floors, paint, and patio didn’t really mean much to the renter.  He was just looking for the right amount of space and at least two bedrooms.
So, here we are, six months in.  The house is rented and their dream of endless income was becoming a reality.  (Billy suddenly realized he had to cut the grass.)
Three weeks in, they got a call from the tenant at 10:00 at night.  “My toilets don’t work,” he complained.  “I need this fixed ASAP.”  They had a plumber out right away  ($500).
A week after that, the air conditioner stopped working and Sally had to get a repairman out there.  ($200)
Two months after that, the renter was late on his rent.  Billy and Sally felt very uncomfortable threatening the tenant.  They certainly didn’t want to mess with foreclosure.  Luckily, the renter got them the money a week later.
Two months later the property tax bill came in:  $3,000.  Insurance: $1000.
Two months after the house was rented, they learned that the renter had an emergency back home (in New York) and had to leave immediately.  Billy and Sally had to start looking for a new renter again.
A few more minor things needed fixing that filled up their weekends.  “This is a pain,” Billy commented,  “We shouldn’t have gotten a place all the way across town.  Sally’s friend, who has a rental, utilizes a property manager.”
It seemed so simple and they were tired of dealing with the headaches.
They found a good property manager who requested 10% of the rent for his services.
Billy and Sally now really had it made.  They didn’t even have to worry about the stress.
Let’s do some quick math.
Cost from savings:  $200,000
Monthly rent:  $1400 (minus the 6 months to get it filled-  $8400 total first year.)
Upgrade Costs:  $10,000
Taxes/Insurance:  $4000
Landscaping (Billy gave up doing it himself)- $600 a year
Random maintenance and repair- $2000
Property Manager:  $1680/yr.
Let’s look at their year one profit.
$8400 rent
-$200,000 that could have been making money in his 401k (-$10,000 conservatively)
-$10,000 upgrades
-$4000
-$600
-$2000
-$1680
———–
-$18,880 (loss)
Now that isn’t entirely fair.  The first year is tough.
Let’s look at year two.
$16,800 rent  (assuming it’s rented the whole time).
-$10,000 opportunity cost (money that could have been invested)
-$4000 (taxes/insurance)
-$600
-$2000
-$1680
———–
-$1480 (loss)
I hope I’ve made my point by now.  Billy and Sally would be lucky to break even.
Of course, there are exceptions.  But 90% of the people with whom I meet suddenly realize owning a property isn’t as easy and lucrative (or fun) as they thought.
I’ve also found that these landlords never increase their rent.  “Ms. Bowers is such a sweet lady.  She’s been there for 8 years.  We hate to raise her rent.  She started at $800 a month and we never increased it.”
Even more often, the rental ends up getting occupied by a down-on-their-luck family member or child, who agree to pay the property tax and insurance (but that’s it).
I hope this makes sense.  The alternative to all of this?  Passively invest your money into a diversified portfolio of stocks and bonds. You’ll almost certainly make more money,  and you don’t even need to deal with that darn rat infestation!
Be Blessed,
Dave

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