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Adding rental properties a good ER plan option?
Old 06-22-2013, 12:29 PM   #1
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Adding rental properties a good ER plan option?

Thinking thru my ER plan, expect 5 more years of working, would forum members recommend using some of cash on hand to buy rental properties as way of adding to monthly income? At ER I'd be 55 and could manage some maintenance work/rehab. I've read some positives but also talked to some who had bad renters, no payment, damages, hard to evict. Also I know in the past the plan would be to liquidate properties when older and expect property value increases, but not sure in current market I could assume future value increases, how to model? Are rental properties a good option or is keeping cash invested better ER plan? What is best income alternative for the 55-65 years?
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Old 06-22-2013, 12:43 PM   #2
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I managed/owned rental properties as a career.
But I have since sold most of them off as I am in ER.
If you are going to consider them as part of your retirement income,
I would personally stick to only properties that will attract hi end tenants
& properties that will be in almost maintenance free/top condition either now or in ER.

As we age, it gets harder to "fix em up".
I only have a small group of single family & duplex rentals left....
& that is what I am doing with them now, getting them all in top shape & in places where I get the best tenants.


Probably the greatest weakness of newbie landlords is in the area of screening tenants
& now the credit bureau laws make it more difficult to get good information....
if you plan to pursue this investment, screen like crazy & be very cautious. JMHO>
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Old 06-22-2013, 02:41 PM   #3
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We have no wheres near NWLandlady's portfolio. Our four rentals (mostly duplexes) are in our university community so very stable population. With one exception, our units do not have students and are in the upper 25% of rents in the area. I would certainly say "AMEN" to all of NWlandlady's advise.
When you are buying do not let the realtor bully you in to buying what is not a good value. You will be the one stuck with vacancies and low returns. Personally, I would not bet on the market providing anymore than inflation in principle value growth for at least the next 5 years, unless you are in a market with very low vacancy rates and underhoused, like the Dakota shale fracking market.
Higher end tenants generally do have a much greater sense of property value and will be far more respectful of your property. This is a generalization so it does not mean you do not have to screen screen. There are undesireables at every economic level.
Good luck
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Old 06-22-2013, 03:09 PM   #4
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All investment has risk, rental is no different.

I see my city will still be booming in the next couple of decades, with diversified industries. And my rentals are generating way more yield than CD, after budgeting for vacancy and repair. They are all close to downtown. I started beginning of last year. So far I am very happy.

I will hold my rentals for 10 years, which will be my retirement time.

I am not sure about the plan after that. I can sell them. Or find a PM to manage them. Currently, I manage them myself. DW is not working, so she can handle any issues.

Maybe I will retire into one of them, as they are all in very desirable part of the down. I like where I am living now, but it is way too big.
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Old 06-23-2013, 06:16 AM   #5
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If you have cash on hand and financing isn't an issue, have you looked at any smaller commercial properties? The economics are generally a little better. It can take longer to find tenants, but they tend to stay longer and are less needy.
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Old 06-23-2013, 07:15 AM   #6
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+1 My mom has a small commercial property that I manage for her and the principal effort is renegotiating the lease every so often, but we are lucky to have a long term tenant (30 years and it doesn't appear they are going anywhere). Given what they pay in rent I am surprised that they haven't offered to buy the building but I suppose they have better uses for their capital.
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Old 06-23-2013, 08:43 AM   #7
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I am definitely using rental properties as a primary means of funding retirement. I call it building my own pension.

I bought my first place in December 2010. I now have 9 units which are almost all smaller & newer townhouses. I went with townhouses so I wouldn't have to deal with outside maintenance and newer ones so they would be more appealing to tenants and less inside maintenance. They are all in Twin Cities 2nd/3rd ring suburbs so they aren't in low income areas.

I'm a Realtor so it was probably easier for me to find deals.

As others said, it's important to have your processes set up to screen for tenants. The one chance you get to get someone good is to set high standards (like a minimum of 3x income to rent) and good background checks. I use an online service and I personally call their current/past landlords and current employers. That seems to be working as I've never had even a late payment (knock on wood).

I did buy with all cash. If you use leverage you can possibly get a better return but with conservative cost estimates I'm getting a 9.5% return right now. In addition, with the rebound in home prices they would sell for substantially more than I paid.

The one caveat is that real estate prices are up significantly (at least in my area), bank owned & short sale listings are down and there are more investors in the market. It's getting really hard to find any deals that come anywhere close to what I was seeing 1-2 years ago.

I could go into much more detail in laying out a good process but this is already long.
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Old 06-23-2013, 12:44 PM   #8
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At ER I'd be 55 and could manage some maintenance work/rehab.
In that situation, perhaps you should just get a part time job. You'd probably have more flexibility from an employer giving you time off for vacations, etc. than you'd have from tenants.
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Old 06-23-2013, 04:32 PM   #9
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Hi,

Quote:
Are rental properties a good option or is keeping cash invested better ER plan? What is best income alternative for the 55-65 years?
Single family homes form about about 50% of our investment portfolio (depending upon how you measure) and I am happy with it. However, I think the only person who can answer your question is you - via lots and lots of education. I think buying your first investment property can be likened to buying a single stock with the same amount of money... in that it is best if you did a similar level of due diligence. (ie more risk than say buying total stock market/total bond market at 60/40 as no diversity)

There are far more experienced and successful landlords than me on this board and on forums such as biggerpockets.
Real Estate Investing Forums | BiggerPockets.com

Also here is an excerpt from a poster that I saved. I looked for half an hour but can't find the original source - apologies. But I think it is worth including in that these points won't necessary apply to your situation, but it would be a good idea for you to get to the stage where you can understand if they do or don't.

Lumpr wrote:
Quote:
I invest in income properties. The properties I own are mostly multi-family, but a few SFH (I’ve looked at some commercial property, but that is a whole different ballgame). Overall, I think rental properties can be a good way to create wealth, BUT it isn't an automatic sure thing. I'd reckon around 90-95% of the books on real estate investing are complete nonsense (not counting academic finance texts). I'd recommend checking out John T. Reed's Real Estate Investing Books. His books are self published (so there are some typos, etc.) and his writing style isn’t appealing to some people (think of having a beer with a high school football coach who is absolutely sure his way of thinking is the right way). However, he is a straight shooter and definitely not someone who over promises.

Here are some quick thoughts from my experience:

1 - You cannot count on any appreciation (in real terms) in the value of income property beyond what you can do to increase rents in excess of inflation. Income property is valued based on rental income, thus any appreciation must come from either (a) actions you take to increase rents or (b) unpredictable market dynamics (e.g. new factory in town, gentrification, etc.). You cannot count on dumb luck.

2 - You need a robust model (they are not that difficult to conceive or build). Your model must account for (a) management expense regardless of whether you hire a property manager (your time is money too), (b) vacancy, (c) maintenance, which must including deferred maintenance items not just day-to-day repairs, lawn care, snow removal etc. (you’ll need to replace the roof, water heater, carpet some day), (d) property taxes, (e) insurance, (f) professional fees (tax prep, evections, etc.), (g) advertising, (h) utilities if landlord is responsible for them and (i) cash reserve. If you really want to get fancy you can layer on the income tax effects on top of that, but I’d suggest you view this as gravy.

As a generally rule of thumb, when I’m eyeballing properties (i.e. pre due-diligence), I estimate expenses (not including any financing) to be 45%. This is generally fairly accurate, but at the end of the day you must perform your diligence before you are fully committed.

3 - I generally look for Cap Rates north of 10% (I’ve gone as low as an 8% Cap Rates, but that is the exception not the rule). In my area, most rental property is listed at a price that results in a 5-6% Cap Rate and most realtors will chuckle when you tell them you are looking for a 10% cap rate and tell you it doesn’t exist. They are full of nonsense (and that is putting it nicely). Now during some market conditions it is difficult to find a 10% cap rate and in others, like now, it isn’t (at least in my area). FYI, compute a cap rate by dividing (a) gross rents less non-financing expenses by (b) the purchase price (including closing costs).

The important thing to keep in mind is that real estate is a very illiquid with high transaction costs, so chasing marginal opportunities is not worth it. If you buy at an insufficient cap rate, you’ve pretty much ensured that you’ve made a bad investment absent dumb luck.
Just my 2c... not a No, Not a yes... but be very educated.

PS: I don't follow much of the above: I don't have any multi-family and my demographics are different... but I could not have written a better overview/gotchas post.
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Old 06-23-2013, 05:03 PM   #10
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While rental properties isn't for everyone, I find that it is a way more desirable way to be self-employed even if you have to do your own maintenance. You don't have to work long hours and you set your own time. Even with 30 SFs, we can go weeks without a single maintenance call and we rent to low income tenants. Now will tenants damage your properties and will you have tenant problems? Of course, but it comes with the terrirory.
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Old 06-23-2013, 06:45 PM   #11
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I am still a newbie landlord and have made plenty of rookie mistakes. Plus as an absentee landlord who has to hire a property manager, my expense will always be higher than those of you who live near your property and can do much of your own work.

Lumpr advice I think is really sound especially on the importance of the cap rate. Probably the only mistake I haven't made is insisting on a cap rate above 10% on my purchases. Now as turns out because the rents I've actually been able to receive are 10-20% lower than I thought, and expenses a bit higher only one of my properties has a cap rate over 10%.

Now because prices have appreciated the properties I did purchase have been a good investments,and the 4 Plex that I bought and sold in 6 months only cost me a few thousand dollars, even after selling expenses.

But one can definitely over pay for houses and just like stocks and dividends, you should really concentrate on the income stream and not count on appreciation.
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Old 06-23-2013, 07:03 PM   #12
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But one can definitely over pay for houses and just like stocks and dividends, you should really concentrate on the income stream and not count on appreciation.
+1

We look on our properties as a source of rental income that will, once the mortgages are gone, fund a large part of our retirement income. Like dividends, we hope that over the longer term they will also provide some protection against inflation (although that is not guaranteed and there will likely be periods of over/under performance).
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Old 06-23-2013, 08:52 PM   #13
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Thanks to all, a lot to think about. I was surprised by some facts like expenses were such a large piece of rental income. Definitely need more research and detail planning before seriously considering. Also never considered commercial properties before maybe better if I can find one with existing business.
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Old 06-23-2013, 08:54 PM   #14
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but they tend to stay longer and are less needy.
+1

My father began investing in real estate in the 1960's and when he died several years ago, I inherited promissory notes. He found the maintenance of rentals to be more than he could keep up with as he aged, so he began selling the properties and owner-financing them.

Long story short, I am not a fan of real estate. The property is the least of the problems, it's the tenants. The crop I inherited are needy, self-sufficiency isn't in their vocabulary, and like to blame all their problems on someone or something else. My stomach is in knots each time one of them shows up on my caller ID. I find it a very stressful, unpleasant way to make $$. While I'm very grateful for the income, I'd never have done this on my own with my own $$$.

I foreclosed on several of them right after the mortgage crisis and sold the properties outright at a ~50% loss on each. The remaining occupants are slowly realizing that I'm not my dad and I'm not quite as quick to believe their many (often entertaining) stories.

YMMV of course, but I'd talk to other landlords in your area and get some of their experiences. We have a real estate investors club in our area and I have been a few times. If I were going to continue down this path, I'd go more often. I'd think this would be a great place for you to make some connections. I found ours on Meetup.org.

Good luck to you. I wish you the best tenants and most infallible properties.
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Old 06-24-2013, 12:07 AM   #15
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We've been doing rental property since the 80's - that , and a healthy amount of LWBM, has resulted in our being in pretty fair financial shape compared to our peers. OTOH, we are pensionless, have only the health insurance we pay for, and our SS monthly checks are very modest. No Roth IRA for me.

Do consider that when you are ready to divest of the properties the buyers may not be there, or willing to pay the price you would like. Not like deciding to sell your stocks - it can take months or years to divest.
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Old 06-24-2013, 05:45 AM   #16
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Thanks to all, a lot to think about. I was surprised by some facts like expenses were such a large piece of rental income. Definitely need more research and detail planning before seriously considering. Also never considered commercial properties before maybe better if I can find one with existing business.
30% of gross rents is a good number to benchmark for expenses on a residential rental. Commercial is slightly less
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Old 06-24-2013, 11:25 AM   #17
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30% of gross rents is a good number to benchmark for expenses on a residential rental. Commercial is slightly less
30% is also the value we used when we were evaluating rental opportunities last year. Not exact for every property but it does allow a rough scoping if the property will generate an acceptable cap rate.
While I absolutely endorse the post on using cap rate for guiding the buying decision, it is important you gain a sound understanding what the competitive cap rate in YOUR market is. While realtors can give you an approximation, I recommend you get actual comp sales from the last six months and using the 30% expense allowance and the advertised rental income on the sold properties to determine the "real" cap rate.
The one area where I got surprised was the property insurance premiums. As you get more units, you will find the insurance company will push you to a "commercial" status that bumps up the coverage cost. Also, know that any property larger than a triplex will push you to a commercial policy. My insurance company recently reclassified triplexs to commercial as well.
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Old 06-24-2013, 12:10 PM   #18
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30% of gross rents is a good number to benchmark for expenses on a residential rental. Commercial is slightly less
30% is low in my opinion.

If you spend any time on www.biggerpockets.com (the biggest real estate investor website) you'll see lots of posts advocating a 50% rule. Now that assumes you are using a property manager and I do think it's probably lower for single family. Still I budget for 41.7% on my current properties and that's with me managing them.

Here's what a typical place of mine looks like -

Rent $1,050/mo = 12,600 gross income

Expense projection -

Vacancy (5%) - $630
Accounting/Legal - $100
Insurance (Landlord rider) - $140
HOA Fee - $2,160
Repairs - $800
Taxes - 1,336

Expenses + Vacancy = 41%

Net Income - $7,434/year
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Old 06-24-2013, 12:21 PM   #19
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Thanks to all, a lot to think about. I was surprised by some facts like expenses were such a large piece of rental income. Definitely need more research and detail planning before seriously considering. Also never considered commercial properties before maybe better if I can find one with existing business.
I'd definitely start small and emphasise quality. There's no fun in being a slum landlord. Here's what I've done and it has served me well:

Fifteen years ago I bought a two family in a good neighbourhood for $329k. It's close to a big college and hospital and with good transport links to the city center. I live upstairs and rent out the ground floor apartment. I can keep an eye on the place and also easily deal with any fixes required. I get $1200/month rent ($14.4k/year), but I'll put it up to $1400 when the current tenant leaves. She's been there for 5 years and is a great tenant so I give her a good deal.

The house is currently valued at $550k and I've used the rental income to help pay off the mortgage so I'm now mortgage free. My deductible expenses on the apartment are $4k (taxes, insurance, maintenance, water etc), leaving me with around $10k annual income. But you have to be prepared to spend money on your tenants and the apartment to keep it up to standard. I went the route of a two family to minimize my costs and as the rental has only one bedroom i rent to singles or couples only which keeps things simple.
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Old 06-24-2013, 02:48 PM   #20
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30% is low in my opinion.
Fishingmn. Thanks for sharing your numbers. Whether it is 30%, 41.7% or 50% will depend upon many factors (the major point being - that you shouldn't assume anything close to 0%):

Value of the property;
Rent;
Age;
Single family, duplex, multi-family;
Initial condition: Was $100k+ just spent on a renovation? or is it just serviceable as a rental with deferred maintenance.

For me, the key to my education so far has been to take these "rules of thumb" and try to understand all the inputs and variables behind the "rules of thumb". Better yet, be able to create a spreadsheet model. How valuers estimate maintenance expenses is pretty formulaic - ie depreciate different items over different periods of time.

So I think I have the worst case generally covered, but unfortunately, the unknowns/future estimates probably dominate my returns.
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