6 mistakes landlords make
Investing in real estate right now can be surprisingly profitable. But if you're going to become a landlord, watch out for these common pitfalls.
Traditional investments are delivering low returns, and home prices are at bargain levels. Is it time to consider buying some rental housing?
Investing in real estate right now can be surprisingly profitable, if everything goes well. Rents are climbing in many areas, and more properties may be coming on the market. Last month, the Obama administration asked for proposals on how to convert at least some of the bulging inventories of foreclosed homes from Fannie Mae and Freddie Mac into affordable rentals.
Investors used to aim for rents that were 1% of the purchase price, or $1,000 a month for a $100,000 home — an annual gross return of 12% — says Michael McCreary. His firm, McCreary Realty, manages about 300 properties in the Atlanta area. Today, he says, some of his investors are getting as much as 2% of the purchase price each month.
In general, though, average returns after expenses are far less, more like 5% to 6% of the property value per year, says Ingo Winzer, president of Local Market Monitor, a real-estate forecasting firm. But that still is well above what many other investments yield.
Before you start scouring for deals, keep in mind that owning rental properties is time-consuming, expensive and fraught with challenges. Many investors lose money. You will want to avoid falling into one of these common traps.
Mistake 1: Confusing a cheap deal for a good deal.
It is true that you can buy some homes for ridiculously low prices — but that doesn't mean you can rent them out. Homes in deserted subdivisions aren't any more appealing to renters than they are to buyers. The same is true for less attractive properties or those in less desirable school districts.
Investors from the San Francisco area often look at the Sacramento market assuming they can get Bay Area-like rents, and end up overpaying, says Robert A. Machado of HomePointe Property Management. He uses several resources, including the website FinestExpert.com, to estimate rents. Other experts suggest canvassing apartments nearby to see not just their rates, but whether they are offering special deals, such as a couple of months of free rent.
Mistake 2: Overlooking key costs.
Knowing the potential rent isn't enough. Before you buy a property, you should also factor in closing costs of 3% to 6%, the costs to fix up the place and maintain it, and your holding costs. Then add the profit you expect to make -- and more closing costs, if you intend to turn around and sell it. Only then can you figure out what you can afford to pay.
Mistake 3: Forgetting that time is money.
In real estate, "time is your biggest enemy," says David Hicks, co-president of HomeVestors of America, a franchiser whose motto is "We Buy Ugly Houses." You lose money when your property is empty, whether you are painting it or are between tenants. You also lose if you buy in the fall and can't replace the roof until spring. You may be better off accepting a lower rent than waiting for a higher-paying tenant.
Article continues below
Mistake 4: Assuming you will sit back and watch the rent roll in.
"When you become a landlord, you become a rent collector," says Mark Kreditor of Get There First Realty, which manages 1,600 rentals in the Dallas-Fort Worth area.
Just like homeowners who can't pay the mortgage, tenants lose their jobs and stop paying the rent. Evicting them can take several weeks, and some steal appliances or other property. Kreditor says that once or twice a month, a tenant removes a home's copper tubing on the way out the door to sell the copper for its meltdown value.
You will need to screen prospective tenants carefully, or pay someone to do it for you.
Mistake 5: Underestimating repair costs.
As with all homes, you will be making lots of repairs. You may find wood rot or mold when you remove that cracked bathtub. Carpet in rental homes typically must be replaced every five years, and you may have to repaint after every tenant. Tony A. Drost, president of the National Association of Residential Property Managers (NARPM), suggests setting aside six months of expenses so that you will have money if a major repair is needed.
Mistake 6: Assuming that owning a rental is the same as owning a home.
You might put up with flaws that a renter wouldn't tolerate. In addition, many states and communities have strict and complex laws for landlords, even if you own only one property. A property manager can handle most of the headaches, but you should expect to pay one up to a month of rent for finding and screening tenants — and up to 10% of the monthly rent for management fees.
You can find property managers through the websites of trade groups NARPM and the Institute of Real Estate Management. In addition, many communities have local real-estate investor associations, which can provide support.
Free heat does sound good, but some landlords only turn the heat up on Oct 15, and turn it off on April 15. The rest of the time, you have to use space heaters, because they won't turn the boilers on no matter how cold it gets. If heat is included in your rent, inquire as to what dates the heat begins and ends.
There is a thing called CAPITALIZATION rate. The CAP rate is a good indicator on what your investment property will return for you. The higher % the cap rate, the more risk you have. When you buy larger apt buildings the cap rates tend to be in the 10-12% rate then if you buy a single family home or smaller property like a 2 or 3 family. If you buy a rental property, look at the cap rate in the area and it will give you an idea of what a "good buy" would be but will also give you an idea on the economic status of the neighborhood. The more RISK in an area or any given rental market opportunity, the higher the REWARD/earnings but you will have to face vacancy, bad tenants and repairs. I live in the Weehawken, NJ, the cap rates for 2 to 3 families are around 4-5%. For larger buildings with multi units you can get cap rates in the 6 and 7%. If you go to the neighboring towns like UNION CITY, the cap rates are in the 7-8% returns, some larger apts are at 9-10% returns. If you take a look at a neighborhood like Newark, NJ, the cap rates on similar properties are 14%, 15%, and even as high as 25% returns but then you are facing tenants who have bad credit, repairs and evictions. If you had 0% VACANCY for a full year you will make an outstanding 25% return on your investment but when your dealing with deadbeats, low income people who have no credit and destroy your property then it might not be worth the headaches.
I had a bad tenant, I evicted him and replaced him with a tenant with 750 credit score, 1.5 months security deposit and no pets.
Now I can really comment on this subject. I have been a landlord for five years, going on six. I can tell you how much money I have put into my house from people who are related, and non-related, friends of sort, just the clean-up cost alone is huge. Bad mistake indeed. When it comes to money, your not going to come out a winner. The last relative left with the houes full of bad furniture, the garage, the basement, and the shed full of junk. The cat tore up most of the carpet, and the dog took off all the paint off the bathroom door. It took 4 hours and 3 people to remove the junk out of the house. I had to pay to have some of it hauled off because it was just too much to place out for gabage removal. I found tons of cigaretts butts down the registers, out in the yard, and my nice bar chairs were ruined by the cat. On top of all this, they blamed the furniture in the garage being torn up by mice. That was the biggest joke of all. That is just one of the family members I trusted, and it just gets worst. Like a big whole dug in the backyard for a pool, and I had to fill it in with 4 tons of dirt. There were no discussion, it was done before I knew it.
To top it all off, you have to pay double the taxes for renting, and a yearly fee for renting. I guess the state believes your going to make a lot of money by renting your house. I recently had a talk with one of those city workers on such a matter, and you know what her responce was, "well I guess you should just sell it if the cost is too much". Like what a stupid answer when nothing is selling, no market for that, right!
Yes we know that your trying to spark the economy by tempting people to invest in the real estate market but isn't that same concept and practice what got our economy in the position it's currently in?
If ones actions never change how can one expect the results to differ?
Real Estate market isn't a place for taking chances right now and won't be for years to come, there is good reason why so many properties are vacant.
I wouldn't take a property right now if it was given to me, property tax and the thought it might or won't sell just puts me in a negative situation right out the gate.
Even with equity you closing costs, realtor fees, property tax and don't forget unless you lived in the home owner occupied for at least 2 years you will pay taxes on any gains you make.
At the end of the day the only thing you have is a head ache and a lot of hours and stress into something you were better off not touching.
In all, a terrible degradation is going on, and it's widespread.
One thing a lot of landlords forget: It may be your house, but for the time being, it's their home.
Treat your renters with respect, get things repaired on time, be responsive to their (reasonable) requests, and don't jack up the rent sky-high just because you can. Don't expect them to be "grateful" for a nice home when they're paying two arms and two legs for it.
But be sure to get a damage deposit.
A residential neighborhood with 50% rental domiciles can be a nightmare for the existing homeowners who work hard and play by the rules to pay down the mortgage and maintain their property only to come under siege from a swarm of semi-literate, itinerant, low-life tenants that are not screened properly by greedy landlords just interested in that monthly check.
City code enforcement is non-existent from shrinking budgets. Tenants bring with them their barking dogs, trash, clutter & junk with their decrepit cars, trucks & motorcycles. Garages are turned into Led-Zeppelin concerts replete with smell & sound. Front lawns are for parking and storage. back years are breeding grounds for insects & rodents. People would argue it's still better than a bunch of unoccupied foreclosures but my experience tells me otherwise.
Confronting these carpetbaggers only makes it worse and moving is not an option unless give away your property. It will eventually correct itself by 2020 or so but is it worth the wait?