Rental Income

[Adventuregirl]

Hello all!
I'm looking for experiences with rental income. My S/O owns a condo and I own a house. We want to consolidate living spaces and we're trying to decide what to do with the condo, sell it for a nice little profit, or keep it and use it as a rental while selling my home and using the procedes to purchase another home more suitable for us.
The condo won't be paid off for quite a while (he's had it just over 2 years) but can be rented for more than the mortgage, fees, ins, without a problem and could provide a source of income in ER. :
I don't know much about landlord law or the tax implications or the PIA factor and will do plenty of research into all. I'm hoping some of the members knowlege and experiences with rental property will help us decide what would be the best choice, keep or sell?

Thanks!
Adventuregirl

 

[wabmester]

The PIA factor is huge. I had to evict one tenant from a property I owned in CA while I lived in WA. Talk about pain.

Also consider that now that interest rates have started to rise, there's a good chance that houses will see their peak valuations this year. Not a bad time to sell. (I'm selling one of mine.)

 

[brewer12345]

Adventuregirl, aside from the PITA factor, one way to look at this is to examine what your returns will be if you rent out the property versus what you would eran with an investment of similar risk and no work (i.e. stock, bond, REIT, etc.). A good place to start on figuring out what your return might be is here: http://www.goodmortgage.com/calc_investment_property.htm

Personally, I have looked around me in the past two years and found that there is pretty much nothing near enough to me that I would want it that would be cash flow positive. If it ain't cash flow positive, you don't want it.

 

[Nords]

Re:  Rental property is still real work.

This seemingly simple decision has the potential to be more than just a rent/sell issue. In fact, to most guys this looks like an emotional minefield. If the "consolidation" goes well, will the condo ever be needed again? Would selling the condo seem like an irrevocable relationship commitment to one-half of this merger? If selling the condo is potentially too much of a strain on the relationship, then renting is an easier answer. OTOH it might be an expensive proposition, but nothing's too expensive for consolidation bliss!

In any case read "Investing in Real Estate", 3rd edition or later, by Andrew McLean & Gary W. Eldred (Eldred has taken over the new editions). It doesn't acknowledge the emotional aspect of being a landlord but it will give you the information you'll need for a sound business analysis. Pulling in more rental income than the mortgage looks attractive but it doesn't account for the pitfalls of landlord (not the primary residence) insurance, liability insurance, major repairs/renovations, vacancies, blissfully ignorant tenants, slow-paying tenants, malevolent tenants...

If it's only an issue of assets, then this one should be sold into the peak of the market. Six months from now will be a tough time to sell (holidays, cold weather, & kids in schools) and who knows what interest rates will do to the market a year from now. Don't try to sell at the top.

Before your "consolidation" turns into something that the IRS might view as "filing a joint return", you could each sell your primary residences for a pile of tax-free cap gains that'd be a great foundation toward a new home & household.

If you're looking to buy again, I'd try to find a home with minimal equity and a low-interest fixed-rate mortgage (of course with no PMI). That works great if you're sure that it's the house you'll be living in for decades, and over the long term (from this high-valuation start) it'll probably appreciate at about the rate of inflation. Or you could put your "consolidation profits" into long-term CDs at over 4%, which is a very difficult cash-flow return to achieve even with the best of tenants.

But if your work/lifestyle has any risk of being mobile for the next decade then I wouldn't assume the additional risk of buying. You might be trapped into becoming landlords before you really want to...

 

[John Galt]

I am mostly a "former landlord" now. When I was more
active, people would say, "But isn't that a lot of work?"
Of course it is, but so are most other ways of making money.
Alas, there are few (if any) ways to make any real money without some work and brainpower. Taking
advantage of idiots comes to mind. But, I digress........

John Galt

 

[unclemick]

After 15 years of landlordship(duplex) with good tenants and making a modest amount of money - I'm with GDER. Even when it didn't happen, I always had Murphy on the mind - especially on vacation. I knew plumbing,electrical, A/C would 'happen' at the worst time possible. Never did - a few inconvient times when I'd rather be doing something else yes. So I'm landlord free and happy to be so.

 

[yelnad]

We own some rental properties and they are very hard work. There's always some sort of upkeep to do...not to mention the fire started by a tenant's candle that practically destroyed our Victorian 3 unit. Just this week we had to deal with a water heater that blew. When they call, you must answer, no matter what the hour.

We live in a bedroom community of a major university, so that comes with the good and the bad. There's always a tenant willing to pay premium rent (for a premium space, of course) and we're far enough away from the university to only attract graduate students or young professionals. Of course, the good tenants always move on to buy houses in a year or so, but my husband is a realtor, so we make money off them there, too.

Typically, I would say that most single units aren't worth the trouble. There's not enough "profit." But double and triple units are more work and more turnover. Yes - like you, I laughed outloud when I typed "profit." Every extra penny goes back into one of our properties, or into a new one as we build our portfolio. I guess we'll never truly retire since my husband has no desire to ever give this up. Luckily, he does most of the work himself and enjoys it.

 

[wzd]

I have had small rental properties and currently own a 20 unit property. I got it by using a 1031 exchange from a 4-plex, (which was traded/bought out from a partner).

I would say that the larger properties offer an economy of scale and would advise looking around at "commercial" residential real estate. "commercial" just means 5+ units in this context. Usually real estate agents specialize in commercial so look around until you find them. Look for a while, look at the numbers they give you, and compare it to your single family rentals. I think that the numbers, even when taken with a grain or two of salt, will interest you. The catch will be coming up with the 25% down that is currently the standard. If you have enough equity in your other properties you can EXCHANGE them for a bigger unit (NOTE: EXCHANGE, NOT Sell/buy - read up on 1031 issues before starting!)

My take on it: single family, duplexes, etc. are for the sweat equity, wealth building years. They are work, and I feel that I have earned the right to be lazy. The larger complexes have the advantage of being TOO MUCH WORK. This then forces you to look for ways to hire it out. You have options from hiring a property management company (beware if you do - you still need to keep on top of it and can't just ignore it) to hiring a tenant or two to be resident manager and/or maintenance. Keep the payments as rent discount only (and require that they live their as part of the employment) and you don't have to work about withholding income taxes.

I think that the PITA factor for the 20 unit is less than for the 4-plex for the above reasons. Even so, I often consider finding a property manager...so that I don't have to spend one or two mornings a week working on it. Guess I really am getting lazier!

Wayne

 

[John Galt]

Excellent post by Wayne. I have owned almost every
type of income property. The "economies of scale" on larger buildings are real. I especially liked his comment
about "being forced to hire" management. That is
exactly the way that I looked at it. You might have to look a long time to find a "cash cow", but they are always there for those who work hard and can
recognize them. Anyway, I agree with the entire post.
Exchanges offer additional benefits, but complicate
the transactions somewhat. Then there are
"3 way exchanges" etc. Gosh, if only I was 20 years younger........................

John Galt

 

[John Galt]

Hi GDER! It is a lot of work which is why I no longer participate.
But, if you are working toward ER, or want to only
semiretire, it's a good way to go. I was semiretired
for 5 years up until 1998. If other things hadn't
come along, there is a good chance I would have
been involved. However, I have a heavy bias in
favor of real estate. I do agree many should stay away
from it. For example, if you are very averse to confrontational situations
you would not make a good landlord. Never a problem
for me

John Galt

 

[John Galt]

Well, GDER, it is fair to say that I couldn't have ERed
without real estate, and certainly real estate is not everyone's "cup of tea", nor should it be. BTW, those
infomercials are pretty true to life IMHO. I liked real estate because I understood it and had some control
as opposed to investing in common stocks (full
confidence in myself - all others are suspect).
Anyway, there is a pile of money to be made but
someone else will have to make it. I am on the
sidelines.

John Galt

 

[wzd]

I don't care how you slice it, it definitely sounds alot like work to me and that is definitely a four letter word in retirement. It wasn't my idea of fun and it definitely isn't easy money. If I needed the money, I'd just keep working until I had enough to really truly retire.

Yup, it can be a bit of work. Thats why I said

sweat equity, wealth building years

My friends have sold their properties, not wanting the work and not wanting to delegate it. But since I retired a few years earlier than I planned to, I am willing to work a day a week. Reluctant, but willing. In another couple of years I expect I will find a property management company. Yes, they won't do it as well as I would like them to, but I have learned how to deal with that. I find that the key to delegating or hiring out is to ask the question how much better would I do, in dollars, and to compare that to the time I would spend. I find that I choose the time more often than not lately. The ER choice is definitely different than the choice I would have made in the accumulation years. I'm not completely on the sidelines yet, but I sure am headed there.

Wayne

 

[wzd]

The "economies of scale" on larger buildings are real.

Thanks for the comments John. Also to elaborate on the economies of scale, I get $550 rent on a unit I paid $55k for. Looking at houses I know are for rent around here, I would guess that you can get $1300 rent on a $200k house. Maybe someone can put in some other current single family house rental rates vs. prices. But the $550/$55k is my actual rate and price.

It is amazing however, that things I would not have batted an eye about 5 years ago are now a PITA. I no longer even think about cleaning/painting an apartment myself... I sit on that sideline and ask my maintenance guy to do it!

Wayne

 

[unclemick]

Once a year, I toss my UDR 1099 div(apartment REIT) into the paper pile for taxes. If it weren't for the SO, I'd probably be a renter. BUT we know a few people who do well in real estate/rentals and love it. ?different strokes?

 

[trumpeting_angel]

I am of the disposition that I like to have some control over things, or at least some influence over how they come out.

When I inherited some money and decided it was high time to figure out the best way to invest, I discovered that the best way to invest involved exerting EXTREMELY little influence over the investments. In fact, the less, the better. Don't do something, just sit there, a la Bogle. Index, rebalance if necessary, and just sit there.

AND that we can probably expect lower returns over the coming couple of decades, per Bernstein.

So I looked around, and asked a lot of questions here, and went out and read Investing in Real Estate (bought it used from Amazon), took other McLean and Eldred books out of the library, and decided that real estate was one way for me to earn some significant returns and have some hands-on influence over the course of my investments. (In addition, of course, to my $650 hobby stock adventure at Sharebuilder, now at $748.)

In fact, I've been posting much less here because I've been busy reading about real estate, perusing the MLS, calculating ROIs, and looking at properties. And making an offer (6 offers came in 3 days after it went on the market. I came in second.)

I'm sure that in the months and years to come, those of you willing to listen will hear stories of my PITA tenants. I intend to choose carefully, per McLean/Eldred, and follow through ruthlessly. Hiring a property manager if I can't muster up the necessary ruthlessness.

I've decided on a multifamily, given the economies of my(modest) scale. It's harder to get positive cash flow with a single unit. There are some numbers, Adventuregirl, to add to your calculations. Homeowners' insurance will skyrocket, you should figure in 5% vacancy, and various authors will suggest various ratios for maintenance and repairs. Do lots of math before you decide you'll have positive cash flow! But it might be a good way to build some equity in the long haul, and begin building your net worth in real estate.

Good luck! on both the "merger" and the real estate tycoonery!

Anne

 

[John Galt]

HI Anne. I think you are on the right track vis-a-vis
real estate. Makes me a bit envious as my day is done.

A quick story. About 30 years ago I owned a 3 unit
with 2 partners (I usually avoid having partners. this
was an exception). We bought the building knowing
there was a dispute with a tenant. The tenant never
paid us any rent, so the 3 of us decided to pay a visit.
When the guys picked me up that night, I came out of the house
with a baseball bat. They thought that was a hoot!
Even though we eventually took the tenant to small claims
court, we never got our money. That was one of only 2
tenants where I ever lost any rent money, over 30 years as an off-and-on
landlord. Pretty good record.

John Galt

 

[wabmester]

Nobody has mentioned one thing that scares me a bit about real estate: liability. Now that you're retired, you assumably have lots of assets. Do you really want to worry about a renter or a contractor tripping on a stair and going after your relatively deep pockets?

Crank up your liability insurance if you take this route.

 

[John Galt]

You are correct about real estate and liability. It's a risk but so is living.

John Galt

 

[Saver to Spender]

Nobody has mentioned one thing that scares me a bit about real estate: liability.   Now that you're retired, you assumably have lots of assets.   Do you really want to worry about a renter or a contractor tripping on a stair and going after your relatively deep pockets?

Crank up your liability insurance if you take this route.

Put it in a Limited Partnership (aka Family Limited Partnership if you have a wife and kids and want to keep it in the family). Nobody will sue you once your lawyer explains the "charging order" concept to them. This isn't a do-it-yourself thing if you don't understand the tax and law ramifications of setting this up, so get a CPA and lawyer involved to explain the pros and cons and to set it up the correct way.

 

[John Galt]

You don't need a lawyer's help unless your situation
is complex. Just buy plenty of good insurance. Then,
if you ever get sued, their attorney will handle it.

John Galt

 

[Martha]

In the years my husband was a landlord he had only one really bad experience. He bought his first buidling, a tri-plex.
One of the apartments was occupied by a "collector" who had newpapers and other trash piled all over. As part of the purchase, he required the owner to have her moved out and the owner clean her apartment. That went just fine. However, the owner, right before closing on the sale, rented the apartment to a woman and her children, with no deposit and he didn't even collect the first month's rent. The landlord at closing paid the first month's rent out of his pocket. My husband didn't know that and thought the landlord had done his job and simply had rented to someone new.

This tenant was a nightmare. She never paid any rent, though she kept promising to do so. Although the trash was cleaned out by the prior owner, the apartment was in bad shape and needed repairs. The new tenant wouldn't let my husband in to work on it. The neighbors complained about noise and kept calling my husband and the police. As my husband's lawyer, I started an eviction action for failure to pay rent, and all the other problems. In Wisconsin, if a tenant says she contests the eviction, it is set for trial. The tenant contested the eviction and the court wouldn't set it for trial for two months. The tenant filed complaints about the condition of the property and had the county test for lead paint. The tenant claimed no rent was due until the apartment was fixed up. The county found lead paint and demanded my husband repair peeling paint. He still had not even been in the apartment since before closing on the sale and the tenant still wouldn't let him in.

Finally, we get to the trial date. The tenant called the court right before the trial was to start and said she was in labor at the hospital and having a baby. She wanted a continuance. None of us believed her because she lied all the time. The judge said he would do the trial by phone. We did the trial. We won an immediate eviction order.

It turned out she really was in the hospital having a baby.

Nevertheless, we enforced the eviction order.

Years later, my husband is still mad at her and the seller. I never really was mad at her. She was doing what she needed to do to survice, just as we did what we needed to do.

When all of this was going on, we went and saw a movie, Pacific Heights, about a tenant from hell destroying an apartment with the landlord unable to do anything. We still hate that movie to this day.

 

[JOhn Galt]

Hello Martha. Good story. I never really had a "tenant from Hell", but had a few give me trouble. I always worked it out. The tenants who never paid a dime
(I just posted about them yesterday) were a young
couple with a small baby. They said there was something wrong with the furnace but wouldn't
cooperate to let us fix it. Anyway, when we finally went to small claims court they had moved out. I showed up to represent my partners dressed as usual in my standard wall street/captain of industry attire. They
showed up with the baby and dressed in what appeared to be Goodwill rejects. We did not get our
money.

John Galt

 

[wabmester]

Evicting a tenant is something like firing an employee. Except you get to hear their baby screaming. And you have to go to court to do it. And they usually leave a big mess when you're done.

In short, don't become a landlord unless you have a heart of stone, the patience of a saint, and an extremely high tolerance for pain.

 

[John Galt]

I was lucky in that I never had to actually evict a
tenant. Besides the young couple that stiffed us
for a couple of months, my only other rent lost was
a manufacturing company that leased a pretty large
building from me. They got into financial trouble, but because
I was close to the owners I collected my rent almost to the end. In fact, when they had no cash I just took
assets in lieu of rent. Some of their furniture is still sitting
in our home as I write.

John Galt

 

[Adventuregirl]

Hey everyone!
Thanks for all the responses! As usual, I have learned that I have a lot to learn! It's been really helpful to read about people's experiences with owning rental property. Not sure what the outcome with the condo will be yet, but you definately gave us food for thought....

Adventuregirl