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Considering Becoming a Landlord - Advice?
Old 09-11-2015, 07:59 PM   #1
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Considering Becoming a Landlord - Advice?

Hi all,

I have been considering becoming a landlord. I live in a new (~7 years old) condo building on the north side of Chicago in a popular neighborhood. I bought my unit in April of 2014 at a very good price since it was bank owned. Similar units in my building have recently sold for 12+% more than I paid.

Some units have recently come for sale in my building, and I've been thinking of buying one of them and renting my unit out. If I were to rent my unit out, my conservative "cash on cash" return would be 7% (cash flow return on my total money invested). This excludes any principal paydown and value appreciation. I feel, though, that the 7% return is really more than 7% because it is technically "after-tax" so it is higher than a comparable 7% return in an equity holding.

The unit I am considering buying is a little nicer, and more expense than my unit was. Of course, I like it because it is nicer, but I am also looking at this from an investment standpoint.

I am considering purchasing the unit (say at $250K).

If I were to put 20% down or $50k down, my net monthly increase in monthly payments (over my current place) would be about $300/month. If I were to put 5% down and pay PMI, my net monthly increase over my current place would be about $400/month (with PMI quoted at about $100/month from my mortgage broker).

My *very conservative* estimate on what I would positive cash flow from renting my current place each month is $300, which is roughly a 7% cash on cash return.

I am considering pursuing this but am curious to hear your thoughts:

1) Is it wise to pay the $100 PMI per month so I can only put down $12,500 instead of $50,000? Assuming I could earn 7% on the additional $37,500 ($2,625), I would still come ahead $1,425.

2) Put down 20% ($50k) and avoid PMI and essentially the additional $300 in extra monthly living costs would come from my rental unit's cash flow.

I honestly think #1 is a good move if I can keep the PMI fixed at $100/month, but it really is dependent on how RE values pan out in the future. #1 and #2 are really only "good moves" if values continue to increase slowly but surely. Of course, no one will no the answer, but if values tank then neither idea is good. I also could eventually move out of this second unit one day and rent that one out as well.

I am also attracted to this whole thing because of the idea of becoming a landlord, and a condo unit presents an "easy way" to become a landlord, because I am not handy and it would require little maintenance vs. owning a house or a duplex.

Thanks in advance for your thoughts!
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Old 09-11-2015, 08:09 PM   #2
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A 7% cash on cash return is not near enough.

Have you added in 10% for property management? How about 5% for vacancy? Can you even rent a unit in that association?
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Old 09-11-2015, 08:26 PM   #3
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I see the viewpoint that 7% is not "enough" given the additional work that comes along with it. In the sense that, one could invest in an index fund and earn that. However, keep in mind this is year 1 return, so returns will only increase each year, and, the sequence of returns is fairly guaranteed compared to the stock market.

I wouldn't need a management company since I would do it myself. It would require little work (mostly just paperwork, see above) since it is a small 800 square foot condo. Although, I have factored in $100/month maintenance reserves each month which is more than enough given how new the place is.

Lastly, no vacancy factor. I wouldn't have much trouble renting the unit. It is in one of the most desirable neighborhoods of the city in one of the most desirable buildings (two blocks from Wrigley Field).


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Old 09-11-2015, 08:39 PM   #4
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Are you calculating tax savings in your number That is the big appeal to RE in my opinion....

If your tax bracket is already low, RE does not make sense to me...
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Old 09-11-2015, 08:44 PM   #5
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I believe the 7% is after tax.

If I understand the tax impact of real estate investments correctly, the tax advantage or savings comes from the fact that most deals cash flow negatively so you are able to deduct the loss from your wage income. Is this correct?

If so, my monthly cash flow would be about $300, but after deducting out depreciation for tax purposes, my net income is almost $0 (basically break even but still cash flowing since depreciation is a non cash expense). So, since I break even, basically $0 flows through to my reportable income or loss for tax purposes. So the 7% is understated, since that is an after tax return, it is really higher, if i understand the code correctly.

Admittedly, I have some learning to do on the tax impacts but that is yet another reason why I am interested in this.


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Old 09-11-2015, 09:42 PM   #6
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Are you calculating tax savings in your number That is the big appeal to RE in my opinion.....
I have 24 rentals myself that generate a solid 6-figure income from them, after all expenses. Never include tax savings, never include depreciation or appreciation. Never do a negative cash flow unit.

With big rewards is big risk. One bad tenant will kill several years of profit. Understand rental property before you buy any.

Assume expenses will be 50% of rents, then pay your mortgage. What is left is cash flow.

You will not be able to buy a rental with 5% down, you need 20%+ for non-owner occupied property. A lender will not loan money unless you can afford both mortgages - without any rental income. A bank will not count rental income until you have two years of it.
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Old 09-11-2015, 11:14 PM   #7
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Why do you want to become a landlord? Well, obviously, you want to make some money, but why did you rule out other options such as starting your own business or investing in the stock market (active or passive style). I'm not recommending such alternatives, just merely encouraging you fully understand why you would like to take this path to $$ as opposed to others.

As for me, I am lazy and hate to deal with people. I'm burned out on responsibility of any and all kind, so I am a passive inventor in the stock and bond markets.

Keep in mind that real estate can be a big headache with no tenant or the wrong tenant. Also, be sure you understand the magnitude of the entry and exist costs. Just finished selling 2 houses and buying another house, so still licking my wounds...
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Old 09-12-2015, 12:52 AM   #8
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I have 24 rentals myself that generate a solid 6-figure income from them, after all expenses. Never include tax savings, never include depreciation or appreciation. Never do a negative cash flow unit.

With big rewards is big risk. One bad tenant will kill several years of profit. Understand rental property before you buy any.

Assume expenses will be 50% of rents, then pay your mortgage. What is left is cash flow.

You will not be able to buy a rental with 5% down, you need 20%+ for non-owner occupied property. A lender will not loan money unless you can afford both mortgages - without any rental income. A bank will not count rental income until you have two years of it.

Wow.... if you are making that much then why are you not retired now


Yes, I agree that it should cash flow without taking into account depreciation... I was just asking how he was calculating...

I also agree that it would be hard to get a loan... my DW has two friends who are either divorced or getting divorced and both have talked to me about buying a house and renting it out and living off the income... now, these are women who make little to no money... but they seem willing to put 100% of what they have into a rental property.... I just say that is nuts... like you said, one bad tenant who tears up the place can cost you big time... and since they do not have any reserve or any other income they would be hosed...

I think if you want to get into RE you need a critical mass to make it worthwhile... one or two houses seems like a lot of work for not much reward... having more gives the ability to go without rent for a month or two on a property and not have to pull money out of pocket...
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Old 09-12-2015, 07:02 AM   #9
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Assume expenses will be 50% of rents, then pay your mortgage.
This. Also, follow the 2% rule and you will be fine. Your unit doesn't even come close.
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Old 09-12-2015, 07:05 AM   #10
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Wow.... if you are making that much then why are you not retired now
It's sort of a mystery to me too... I have had some rental property since 2000. I was finally able to buy more in 2008, after trying to buy more since 2005. I purchased a 4-plex every year, from 2008-2012, until I had five.

Each 4-plex required a large down-payment, and some fix-up costs. ~$100K+. Each year, my investment account was back to where it was the year before. In late 20013, I purchased a flip for $128K, which I sold 3 months later for a ~$28K gain. A partner and I each made $28K. And my investment account bounced even higher.

So it wasn't until sometime in mid-2014, when my investments finally came back to my investment account (and I was paying taxes...) that I started looking at my finances. It was a "holy crap, I can retire" moment .

Analyzing the numbers, I was generating 3-4x my annual spending with my rentals. It still doesn't seem like all that much, as much of my NW is in RE equity. I keep paying off mortgages, and my cash flow increases, but the investment accounts do not add up as fast.

I wanted to be at least 55, which was only about a year away, in order to make sure that SS would not likely change after I retire. So I randomly set an age of 56 to retire, which was a about 18 month's out. But I wanted to get the next years bonuses that were only a few months away from turning 56, max out the 401K, pick up another year of pension, etc.

About that same time, I was labeled a disabled vet, and receive a small pension and free healthcare. So it is even better than my projections.

So now it is a mental thing. I set the goal, now I want to make the goal. I have ~$30k more annual cash flow now, than I had a year ago. I am on target to pay off one more mortgage to get me another $12K by the time I leave work.

It is much more difficult that I thought. Like being in a cage, with the door wide open. Work is not that difficult, it is the captivity.
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Old 09-12-2015, 08:12 AM   #11
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I'd be curious to see the deal types you all are closing on if you're able to follow the 2% rule. If I were to follow the 2% rule, that would imply I would collect about $4,200 in monthly rent off my ~$210k condo, and cash flow $2,700 month or about $32k a year on my initial 20% down for a roughly 60% cash on cash return.

Is that a joke? I find hard to believe anyone gets those returns. Or am I understanding the rule incorrectly? If one is to profit this much from a real estate investment, I think one would be pursuing more value add type deals (fixer uppers, distressed properties, etc).


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Old 09-12-2015, 08:30 AM   #12
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If one is to profit this much from a real estate investment, I think one would be pursuing more value add type deals (fixer uppers, distressed properties, etc).
2% is just a rule of thumb, like any other formula. 6x the gross rents is another. 15% ROI is a third one. 50% of rents goes to expenses is a fourth. If a property is close, then start looking at the details.

That is exactly what you do. Buy distressed properties. All of mine were foreclosures, at one point one sold for $430K and I picked it up for $200K, plus ~60K of work. It brings in $53K in annual rent and is paid for. Another bought for $269K with $10K of work also brings in $53K.

My flip was sold as new construction in 2005 for $245K, purchased for $128K in 2013 (eight year old building). Sold for $200K after $15K of additional investment and a few weekends of work. It was back on the market, 100% finished and clean, 20 days after I bought it. I post all these stories on my own blog.

In order to do this, you have to understand real estate. Buying retail (i.e. MLS) is a losers game in becoming a landlord.
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Old 09-12-2015, 09:21 AM   #13
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It's sort of a mystery to me too... I have had some rental property since 2000. I was finally able to buy more in 2008, after trying to buy more since 2005. I purchased a 4-plex every year, from 2008-2012, until I had five.

Each 4-plex required a large down-payment, and some fix-up costs. ~$100K+. Each year, my investment account was back to where it was the year before. In late 20013, I purchased a flip for $128K, which I sold 3 months later for a ~$28K gain. A partner and I each made $28K. And my investment account bounced even higher.

So it wasn't until sometime in mid-2014, when my investments finally came back to my investment account (and I was paying taxes...) that I started looking at my finances. It was a "holy crap, I can retire" moment .

Analyzing the numbers, I was generating 3-4x my annual spending with my rentals. It still doesn't seem like all that much, as much of my NW is in RE equity. I keep paying off mortgages, and my cash flow increases, but the investment accounts do not add up as fast.

I wanted to be at least 55, which was only about a year away, in order to make sure that SS would not likely change after I retire. So I randomly set an age of 56 to retire, which was a about 18 month's out. But I wanted to get the next years bonuses that were only a few months away from turning 56, max out the 401K, pick up another year of pension, etc.

About that same time, I was labeled a disabled vet, and receive a small pension and free healthcare. So it is even better than my projections.

So now it is a mental thing. I set the goal, now I want to make the goal. I have ~$30k more annual cash flow now, than I had a year ago. I am on target to pay off one more mortgage to get me another $12K by the time I leave work.

It is much more difficult that I thought. Like being in a cage, with the door wide open. Work is not that difficult, it is the captivity.

I can see your fatal flaw.... putting in a time goal .... What if you won 30 mill lottery tomorrow... I bet you would not wait..... so then the question is what lottery level do you need?

With the number of properties you have your NW in RE must be pretty high... that is not going to go away.... you seem to be cash flowing at a much higher rate than your spending.... I would not just look at one account to make my decision....

I do not have the asset level you do.... and even though I have taken off this last year, I will be going back part time to supplement my income.... I still have two kids to get through college.... but I do not mind... work is easy and being a temp has some huge advantages.... as long as you do not need a steady paycheck it is great... the one big one to me is that they do not try and make you work LONG hours since they have to pay for every one you work....
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Old 09-12-2015, 09:27 AM   #14
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This. Also, follow the 2% rule and you will be fine. Your unit doesn't even come close.

Do not know where you are, but I doubt there are any places around here that rent for 2%.... 1% is the norm....


Decided to look it up and found this....

The 2% Rule: Fact, Fiction, or Feasible?
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Old 09-12-2015, 11:08 AM   #15
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If you were to apply the 2% rule here in the SF Bay Area (SF or Silicon Valley), the 3 bedroom 2 bath 1200 square foot 60 year old rancher would rent for $20,000 per month.
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Old 09-12-2015, 11:21 AM   #16
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Yeah...average rent for a 4 bd 3 ba SFH in the neighborhood where I have my rental is $1425. I bought at the very bottom of the market on a short sale for $180k. I am cash flow positive.

The house I currently live in sells for ~$170k and rents for $1200, in a completely different part of the country.

I've lived in 6 houses in 4 states in the last 11 years and have never seen the 2% rule being even close to feasible. I'm happy if some of you can get >1% in monthly rents, but let's not act like this is common and easy to achieve.


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Old 09-12-2015, 12:06 PM   #17
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If you were to apply the 2% rule here in the SF Bay Area (SF or Silicon Valley), the 3 bedroom 2 bath 1200 square foot 60 year old rancher would rent for $20,000 per month.
Probably true, but that would not be a good investment. Likely negative cash flowing.

A 6x the gross rents formula, which is a good rule of thumb, would yield a .72% of purchase price every month. In the end, it is about cash flow, and return on your investment. The same as the stock market.

As you get further from .72%, 1% or 2%, you start to run the risk of losing money. Most people underestimate vacancy, property management costs and maintenance.

Neighborhood classification is also key. In a D class neighborhood, you better make sure you get a 20% ROI or a 12%+ cap rate. In an class A neighborhood, you can get by with less. There will be less maintenance. a 6% cap rate is common in A neighborhoods.

After 'getting into the business' with little education, most landlords do not have a clue how to screen tenants. Or what neighborhood classification is. Or even what they need to do, or how to recognize a bad tenant. So they have higher vacancy, higher management and higher maintenance expenses. And they lose money.

Do not think for a minute that a 'professional' property manager will save you. They make the most money when you make the least. A financial adviser is CHEAP compared to a property manager. A PA will take ~1% of your asset, and that is all. A PM will take 10% a month, plus a month's rent to place a tenant. Compare that to the amount of equity you have in the place.

As in anything, a rental is not a get rich scheme, although many people do get rich quick. Buying a McDonald's franchise is another great way to strike it rich, or lose everything.
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Old 09-15-2015, 11:58 PM   #18
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In one word "Don't".
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Considering Becoming a Landlord - Advice?
Old 09-16-2015, 05:28 AM   #19
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Considering Becoming a Landlord - Advice?

I've been a landlord for many years. - Lets just say
1) the tenant decides not to pay - have you investigated the rules and cost of eviction in your area. Will you need the rent to pay a mortgage?
2) the tenant calls at 2 am with a broken pipe
3) the tenant causes a ruckus and you get complains
4) the tenant has a fight with her lover and kicks in doors and destroys the place.
5) the tenant brings in a pet or several
6) the tenant sister complains about a faulty light switch and you go there to learn her bulb was burned out...

If your answer is that won't happen because.... Or I'll call a plumber....Then don't do it because you don't understand what it can be a landlord. I have had every one of those things happen in addition to having a tenant leave a three minute message with nothing but profanity.

If you can put up with the aforementioned, are handy with a hammer and a paintbrush then it can be a great way to diversify.


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Old 09-16-2015, 10:58 AM   #20
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I'll add another risk: HOA restrictions.

To the OP, are you sure your HOA covenants will allow this? And if they do allow this, be aware it could change in the future.

My Dad's condo association, also in the Chicago area, put strict restrictions on rentals in place. They basically required all new rentals to be family only, and they put a grandfather window of a few years on existing non-family rentals.

Just giving you something else to worry about along with the list directly above. To me, Landlord=Worry.
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