The woes of being a small-time landlord
April Rental Advice: Think renting out that second home is the quick-buck solution to a sagging real-estate market? Think again. In landlording, money isn't fast, and the only sure thing is headaches.
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Mark Kreditor has been managing rental properties for 31 years and has this to say to anyone considering getting into the landlord game: Don't do it.
Monthly costs inevitably creep in. Taxes and association dues only go up. And, in the end, properties aren't even guaranteed to appreciate.
"It's going to be a hardship on your checkbook every month, and every couple years there's going to be a tenant that does something really awful, and you're going to hate it, hate it, hate it," says Kreditor, president of Get There First Realty and past president of the National Association of Residential Property Managers, a trade association. "I've never seen a better time than now to invest in real estate, and I still wouldn't do it."
OK, so Kreditor admits he's become a "glass-half-empty guy," with experience limited to a tough Dallas-Fort Worth market. But even the sunny pros caution first-timers not to expect what many often do: an easily paid-for mortgage, maybe even with extra cash every month. (Bing: Need a property manager? Start your search here)
"Getting into the business of landlording is no different than the stock market: It's a marathon, not a sprint," says John Bradford, owner of Park Avenue Properties in Charlotte, N.C. "By the time you debt-service it, do the maintenance, pay the property manager ... at the end of the day there's probably not a lot of cash flow left over."
(Readers: Do you think the housing crash has unfairly affected tenants? Has the attention to owners cost you comparatively more as a renter? We're writing on the topic, and would like to hear your views at email@example.com.)
Don Canale found this out too late, after convincing his wife it would be a good idea to buy a friend's rental investment. The friend had always made money. "It looked like from the outset a good deal for the Canale family to get into," he says. But that was in 2004.
Then he took over and the market crashed, lowering the value of the property by at least $30,000. The rental market followed.
- MSN Money: Should you rent out a room?
"We got it rented for exactly $50 less than the payment was each month," Canale says. Add $125 in association fees, and he was paying $175 a month before repairs or maintenance. He's since been able to raise the rent, but even in this very strong rental market he's netting just $25 month from rent, hardly enough to cover the inevitable vacancies and repairs to come. With depreciation and expenses, Canale is down an estimated $40,000 on his investment after eight years.
"We're basically saddled with it until the market recovers, if, hopefully, it does," he says. "My gut tells me it's five or 10 years before that happens."
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Many, if not most, small-time landlords — those with one or two rentals — never get to take advantage of the first rule of real-estate investing: Buy when the price is right.
The decision to rent often comes after the decision to move into a bigger home, or to move to another area. Renting is seen as an opportunity to capitalize on an existing situation. Many, particularly in the past few years, are reluctant landlords, renting only because they can't afford to sell at today's low prices.
Looking at when investors buy provides some insight on how difficult it can be to make money on a rental. Kreditor has long since tossed the 1% rule, which estimated that a monthly rent check equal to 1% of the purchase price heralded a sound investment. He advises against investing in a rental that costs more than 50 times the anticipated monthly rent. That's a tough ratio to hit: $75,000 for a $1,500-a-month rental; $100,000 for a $2,000-a-month rental.
"You make your money when you buy," Kreditor says.
Joe Buczkowski, founder of LeaseRunner, a landlord-service business, has his own quick trick to calculate if a rental property is a good deal: Divide the annual rental income by the purchase price. "If your answer is 10% or better, then you're looking at a very attractive rental property," he says.
To make that 10%, a $200,000 property would have to be able to rent for at least $1,670 per month. Even then, any cash flow is minimal. "Any return in rental real estate right now is still modest," he says.
The problem is that many people who own $350,000-plus homes can't fetch enough rent to come close to that 10%. Many are "just trying to buy some time, postpone any foreclosure or short sale into the future," Buczkowski says, "and they're OK with that."
In the end, a cheap house
Stephen Foster, president of Boardwalk Real Property Management in San Antonio and the national treasurer for the NARPM, views rental finances from another angle.
Let's say you're paying $1,500 a month in mortgage, taxes and insurance, but you can fetch only $1,200 a month in rent. In 20 or 30 years, when the mortgage is paid off, the property will be yours. "But could you buy that house for $300 a month? No," he says. "It's not an overnight thing," but you're still ahead.
In the meantime, however, be prepared to be an around-the-clock, detail-oriented businessman, legal expert and handyman, or to hire a property manager.
Best and worst markets for landlords
If you didn't already believe rents are high, the real-estate website Trulia turned up some interesting evidence: Rental rates are so high that it is now considered cheaper to buy than to rent in all but two of the country's 100 largest metropolitan areas.
- On our blog, 'Listed': Renter, beware? Report says buying is cheaper in 98 of top 100 cities
The analysis, released in March, looked at the asking price and rental rates of comparable units, then divided the sale price by the annual rental income. If the resulting number, the price-to-rent ratio, is 15 or less, it is considered cheaper to buy; if it's above 15, it could be cheaper to rent.
Only Honolulu and San Francisco had ratios above 15.
"The price-to-rent ratio reflects people's expectations about what will happen to home values in the future," says Jed Kolko, chief economist for Trulia.
Where the price-to-rent ratio is higher, such as in San Francisco and New York, the long-term employment and long-term home-price outlooks are also strong, Kolko says.
Cheaper to buy
|Top 10 metros||Price-to-rent ratio|
|2. Oklahoma City||4.3|
|3. Dayton, Ohio||4.8|
|4. Warren-Troy-Farmington Hills, Mich.||5.4|
|5. Toledo, Ohio||6|
|6. Grand Rapids, Mich.||6.1|
|9. Gary, Ind.||6.7|
|10. Memphis, Tenn.||6.8|
Cheaper to rent or about the same as buying
|Top 10 metros||Price-to-rent ratio|
|2. San Francisco||15.5|
|3. New York||14.5|
|4. San Jose, Calif.||14.3|
|5. Orange County, Calif.||13.5|
|6. Los Angeles||13|
|7. San Diego||12.7|
|8. Colorado Springs, Colo.||12|
|10. Albuquerque, N.M.||11.9|
Do I get the tax benefits of a small business?
The short answer is yes, but you can't use excessive costs of the rental to get out of paying your other income taxes.
That's because as a nonprofessional landlord — someone with a separate, primary source of income — that rental is considered a passive business activity. As such, the Internal Revenue Service limits net losses (rental income minus rental expenses) to $25,000 per year for taxpayers with an adjusted gross income of $100,000 or less. That allowable net loss gradually diminishes as one's income rises, reaching zero at an AGI of $150,000.
That doesn't mean you can't deduct what you spent on the home. It just means you can't deduct a lot more than you earned in rent. Let's say a tenant pays $1,500 a month for 12 months. That's $18,000 you have to declare in income, but also $18,000 you could spend on the home before reaching any loss.
And what will the IRS let you write off as a business expense on that rental?
"Really anything related to the rental property," says Allan Peiser, managing partner for Goldin, Peiser & Peiser, in Dallas. Just think of whatever you paid for beyond the mortgage principal: the mortgage interest, property taxes, maintenance, repairs and upgrades, management fees, even depreciation losses.
If the net losses in one year still exceed the IRS limit, don't worry. They're only suspended and may be applied to another year or when you sell the home, Peiser says.
I'm glad to see some positive comments about being a property owner, it seems every time I read something about it on here its usually negative. I'm 28 and have several rental properties, yes iv had bad times and troubles here and there but that's only made me better. Your going to have trouble along the way no matter what you do in life, if it was easy then everyone would do it. All I have to say is if you don't want to be a property owner then don't be, that's just that much more for me and others like me who know the value of owning real estate. Iv had many conversations with many wealthy successful people (not to mention hours of research) who obtained a lot of their wealth through being a property owner. I can tell you that I much rather put my money into an investment property then into a 401k or any other retirement fund, where I'm going to have to trust the government or economy to be stable when I retire so I can have my money I paid in over the years. I much rather have to depend on myself then anyone else these days.
It is high time that bad landlords are given prison time as they seem to violate the existing laws with total impunity. The average tenant just does not stand a chance even with good lawyers. I just don't know how they sleep at night after taking advantage of their unwitting innocent victims.
Bought my latest rental cash paid for. No debt to stress over for late rent. I then gutted the entire house, New roof, new interior drywall and insulation, new windows, new paint inside and out. new landscaping. New carpet, all new appliances. New water heater. total cost, about 35% of purchase. My rent if consistant, will pay off return in 8 years. The money goes into a bank account for just the house. When its done, and I sell in 8 years, I will have doubled my money, if I only sell for the amount I invested. Try that with any bank you can name.
It is alot of work, but someones going to do it, and I will and can. Got a tenant waiting while the paint dries already. and yes I had a bad tenant ( Family) that cost me $40,k a few years back. Thats part of the game. Live with it or stay out. We all gotta live somewhere.
If you have a good tenant....Take good care of them...I've had excellent and horrible. Do your inspections regularly and watch out for the meth lab and pot farm..Be alert to black tubing and makeshift attic fans in and around your locked garage that nobody seems to have a key to! Also beware of tenants that want to bring dogs in after the fact....They serve as alarms..This happened to me and the tenant was good as gold on paper with a stellar credit report!
Because of medical marijuana...the hands of the local authorities are usually tied but the feds will take your property.
I own two properties that I rent out, and my experience as a landlord has--for the most part--been good. One property I bought in 1987 and lived in myself for 5 years before I turned it into a rental. My goal was to pay it off before I retired so that the rent could supplement my income. The other rental property is also paid off--though I did refinance my own home so that I could buy it without a mortgage. The key is to screen your tenants and make sure that the rent does not exceed 30% of their monthly income. I live within a few miles of both my properties, so I can manage them myself. Also, I live in in a military area and prefer to rent to military. For one of my tenants, the rent comes directly from their allotment--so it's always in my account by the 1st of the month. Unlike the writer of this article, I think the glass is at least half-full.