Rentals...Worth the effort?

[ultrarunner]

One African American woman tried to start something... she filed a complaint and it was taken seriously... said I had discriminated due to her race, her familial status as an unmarried mother with a child.

The agency went to the home and interviewed the person who I did rent who just happened to be African American, unmarried with two children... case closed.

The woman I did choose had no charge offs or late pays...

The last 12 years I have been transitioning to commercial property because so many new laws have been written affecting residential rentals...

We now have a rent control, pay for a rent arbitration board, Just Cause Eviction in where a tenant cannot be asked to move unless the reason is provided to the city and approved... and the latest one is the Tenant Protection Ordinance...

 

[Sprinklerman]

Commercial is great , especially when you have triple net leasing

 

[California]

Rentals are a job... a hands on job and I am onsite about every two weeks ...

Lots of good advice in your post.

Oakland? You didn't mention Nickerson's ''How I Turned $1,000 Into a Million in Real Estate -- in My Spare Time'', the roadmap to bootstrapping spare income into a fortune. Nickerson was in Oakland, and published that in 1959. He worked for the phone company and bought rentals in his spare time, fixed them up, and used them for collateral to buy more. His specific advice is horribly outdated now but his overall model still has value to inspire creative planning.

One of the points I learned from that book is what you said above, in my terms: 'show the flag'. That means appear at the rentals often enough to spot problems before they grow, and tenants feel you will make any repairs timely that they need. The approach has to be 'I can make your experience better' like a good onsite apartment manager, never intrusive. And select tenants who will appreciate this collaborative approach to making them comfortable. You want people you can give a good reference to when they eventually move up - and quality people (character, not income level) do eventually move up.

We started poor, our first home was a FHA 3% down duplex. But the rental from the other side of the wall paid the mortgage, even some toward (shared) utilities, so we had essentially no housing expense of our own. That let us pour a huge part of our incomes into IRA's and savings. I suggest this as a starting point for anyone starting from literally nothing. We eventually sold that duplex for little more than it cost but the ability to put away savings was its advantage. The next duplex (we lived in that one too) cost $45k and resold for $72k providing a nice down payment for our first family home.

The bootstrapping model described by Nickerson - after taking out the obsolete advice - is still a valid model.

 

[300UGUY]

Almost everything is related to your local economy. If property values are going up, and people can find jobs, you can make money on it. My brother had rentals in Detroit. Lost every dime invested. Complete loss. My BIL bought a couple duplexes in A2. Makes out like a bandit. Same state, 30 miles apart, different worlds. Different economies. I know of several people who had rentals in the Detroit area, and nobody did well. That's one of the reasons that the city fell apart, you could not rent a house out for enough to cover the maintenance, much less a profit. I have a rental, my 1st renter was a 25 year employee of a major corporation. (IT) A year in, she lost her job, and within a year, could not afford the rent, due to working retail jobs. Even a good renter with impeccable credit scores, will likely have problems if they lose their job. And being a tough guy is easier to talk about than to do.

Currently I have a young single mother as a renter. Her dad, a neighbor, is paying the bills. It's working so far....

 

[ultrarunner]

I confess to not knowing Nickerson... and from my own city none the less.

A book that gave me a lot of insight starting out is Leigh Robinson's "Landlording"

I actually got to know Leigh in later years and related a few experiences. His book was just as much about the philosophy of being a landlord as it was about the nuts and bolts.

Joining the local Apartment House Owner Association also helped because the Association kept up to date forms compliant with the ever changing rules in my city...

My first purchase was in 1983.... it was a time of great unemployment and jobs were scarce.

It also meant a glut of property and I still remember walking past the boarded up buildings on the way to school... that were given up for unpaid taxes. The city was desperate to get them back on the tax roles and came up with a plan where a person could move in and make a couple of thousands in improvements and after 5 years buy the home for $1

One of the $1 homes I walked by as a kid sold for $350,000 not too long ago... talk about a return on investment.

Back in the 1960's the demographics of the Bay Area changed a lot... I've told the story of people letting homes go for back taxes and it is hard to believe for many.

The rental business in Oakland was quite a bit different than other areas... a lot of the tenants did not have bank accounts... they used check cashing places... some would get paid every two weeks so I would show up on pay day and it worked.... I put together resumes for my tenants and helped in other ways when I heard of job openings.

I had friends that said I was coddling the tenants... they tried their way and lost their shirts... constant evictions and lawyer fees... I guess a lot of it is knowing your market and being able to come up with a viable plan.

Thankfully, my evictions are far and few....

I also have broken the rules... if I have to chase down a tenant only to learn they don't have the rent... it will never get better.

On the other hand... if a tenant calls me ahead of time with a one time partial payment and the rest on a date certain... I agree because I can work with people of character.

In 30+ years the demographics have totally flipped... it's gone from 90% Section 8 to 90% not on Section 8.

My tenants today range from Doctors, Engineers and High School teachers to first generation immigrant families...

Along the way there have been a few reversals...

15 years ago I rented to a 18 year student that was basically on her own... her mother died when she was 12 and her father was disabled... this young lady's goal was to become a doctor... she did three things... go to school, work and study... she was at the local community college and applying to Med School scholarship programs all over the country and coming up empty... one day she called all excited and said a spot had opened up and she had 7 days to pack all her belongings and move cross country to be there for orientation... told her to start packing... last year she was the doctor that treated my friends kid.

Another one is I applied for a home loan to lower my interest rate as anyone knows it is the Underwriters that make the decisions and most borrowers have zero interaction with Underwriters by design...

Well, one of my former tenants calls me out of the blue and asked if I remember her... of course I did... She is the underwriter making the decision on my refi... plus she now had my complete financial history on her desk... and yes, I did get the loan.

Moral is things change and I believe how you treat people does come back on you.

 

[300UGUY]

I confess to not knowing Nickerson... and from my own city none the less.

A book that gave me a lot of insight starting out is Leigh Robinson's "Landlording"

I actually got to know Leigh in later years and related a few experiences. His book was just as much about the philosophy of being a landlord as it was about the nuts and bolts.

Joining the local Apartment House Owner Association also helped because the Association kept up to date forms compliant with the ever changing rules in my city...

My first purchase was in 1983.... it was a time of great unemployment and jobs were scarce.

It also meant property was available and I still remember walking past boarded up buildings on the way to school... that were given up for unpaid taxes... the city was desperate to get people into them and came up with a plan where a person could move in and make a couple of thousands in improvements and after 5 years buy the home for $1

One of the those $1 homes I walked by sold for $350,000 not too long ago... talk about a return on investment.

Back in the 1960's the demographics of the Bay Area changed a lot... I've told the story of people letting homes go for back taxes and it is hard to believe for many.

Wish I could say at 22 I had a grand plan...

What I did have was the desire to own... and I kept getting turned down because I didn't have 2 years on the job and 3 years in the field...

I kept looking at the least expensive homes on the MLS and finally was able to put together a deal on one on 92nd and B street in East Oakland and paid cash for it.

Didn't really know what I was doing... did have a few hand me down Craftsman tools and my old Valiant and a box trailer... hauled a lot of 1 yard concrete with that Valiant... today, the same yard requires a 3/4 full size pickup to take one of the 1 yard ready mix...

I did learn about people and earned the respect of the neighbors who were really skeptical at first.

The rental business in Oakland was quite a bit different than other areas... a lot of the tenants did not have bank accounts... they used check cashing places... some would get paid every two weeks so I would show up on pay day and it worked.... I put together resumes for my tenants and helped in other ways when I heard of job openings.

I had friends that said I was coddling the tenants... they tried their way and lost their shirts... constant evictions and lawyer fees... I guess a lot of it is knowing your market and being able to come up with a viable plan.

Thankfully, my evictions are far and few....

I also break the rules by working with some people... if I have to chase down a tenant only to learn they don't have the rent... it will never get better.

On the other hand... if a tenant calls me ahead of time with a one time partial payment and the rest on a date certain... I agree because I can work with people of character.

Every year at Christmas I deliver a gift to each family...

The difference I see in the cities is that your city recovered. Detroit started down in the 60's and never stopped. I had one friend that bought 13 rentals in 1979 all in Detroit, nice places. He put a lot of work into the houses, but every year, they were worth less. He sold out in 95. He said that after all the cost, and valuing his own labor at zero, he would have been better off leaving the money in the bank. He ended up with some section 8 tenants, because at least the rent got paid.

 

[ultrarunner]

Currently I have a young single mother as a renter. Her dad, a neighbor, is paying the bills. It's working so far....

Accepting a cosigner is a viable alternative...

I find if a parent/grandparent or employer is unwilling to co sign chances are there is a good reason.

 

[ultrarunner]

The difference I see in the cities is that your city recovered. Detroit started down in the 60's and never stopped. I had one friend that bought 13 rentals in 1979 all in Detroit, nice places. He put a lot of work into the houses, but every year, they were worth less. He sold out in 95. He said that after all the cost, and valuing his own labor at zero, he would have been better off leaving the money in the bank. He ended up with some section 8 tenants, because at least the rent got paid.

Just about everyone told me what a mistake it was starting out...

I was lucky in two ways... I didn't listen and things are better today... although you only have to go back a few years and my property values were down 50 to 60%... BUT still worth more than I had into them and still generating income.

I have no idea what the future holds... California has been counted out so many times and so far has always bounced back...

Remember checking out Detroit and seeing all these grand old homes boarded up and thinking how can this be?

 

[teejk]

#1 Check your state's laws...some states make it difficult to evict a "problem" tenant. #2 The old adage about "nothing party's like a rental" comes to mind. With that said, I think the trend towards renting vs. owning is in your favor as the population gets older. The good old days on residential real estate appreciation seem to be behind us at least in your locale (and mine). Carefully screened tenants can probably make it work.

 

[Dale Mercer]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

 

[LD1]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

Thats how rentals work, It dont make them a waste of time though, if you are aware what you are doing.

Over the (29 years IIRC) a rental depreciates to 0 value. Thus when you sell it, the entire amount is subjected to taxes. Which is why most reccomend to stay cash flow positive. So when you sell, you recoup your investment and not necessarily make a profit upon sale. Rather the profit was the positive part of the "cash flow positive" all along.

But even if you set it up to be neutral cash flow.....IE.....rent coming in pays all bills and mortgage and leaves none for your pocket......then when you sell, all the money it is sold for minus taxes is still profit. Since you incured no expenses that wasnt covered by the rent.

If you were cash flow negative.....thats on you and a bad investment.

Mine is $500 positive. So I put $500 a month in the bank. ($6k/yr). The annual depreciation over 29 years is like $6500. So even though I put $6k in the bank a year, on paper it shows I loose money. So I dont pay taxes, persay, for the first 29 years.

After 29 years, If I choose to sell, even if I sell for what I paid (187k), and take taxes out, its still a nice chunk of change that didnt really cost me anything.

If you are loosing money all along, then loose money on the sale, you are doing something wrong.

 

[teejk]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

Now wait a minute...did you sell it for more than you paid? Did you get annual deductions for depreciation at higher rates than capital gains rates when you sold? Rental real estate is only a "timing" thing. A dollar spent today still has to come back to a dollar when you sell it (even if that dollar got depreciated down between buy and sell...you will "recapture" those benefits on sale...if you did it right usually at lower rates). People tend to forget that...

 

[LD1]

The only way I see loosing money is if you are loosing money every month, then sell for less than you paid.

If its at least net zero where you aren't making or losing money every month, but just breaking even....then even if you sell it for a dollar, that's a dollar profit....since purchase price is irrelevant.... As rent money paid the mortgage and not the money in your pocket

 

[ultrarunner]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

Here people will 1031 exchange until they die and the estate gets a stepped up basis.

Another approach is for the husband and wife to convert the rental to their primary home for 3 of the last 5 years last I checked and then up to 500k in profit doesn't count.

You are correct in that simply selling to get out carries recapture and many are caught off guard.

I know a Realtor that lives his life around this... he took his 4 unit building that he owned for a long time and exchanged it for a new luxury home... rented the home for a couple of years and then moved in as his primary... the way it was structured taxes were no longer an issue...

It does take planning and you need to execute...

 

[PILOON]

Guess I have been lucky.

We have rent control board that is very slanted for the tenants.
Seasonal rents are not covered by the board but short term (under 30 days) considered hotel and taxable as such.

I always got a 'caution deposit' up front and full rent prepaid.

I had 2 waterfront properties that I rented 'by the season', getting 5 ea summer and winter month blocks.
Summer renting was easier being lakefront but winter also not bad with choice of ski hills within 15 min drive plus virgin snow trails for cross country and snowshoeing.
My lease was about 2 paragraphs long basically saying 'enjoy the use and not abuse and return as you found it upon arrival'
Also we were about 1 hr drive out of Montreal. (with a huge population base) So I could be choosy.

Majority of my tenants were long term repeats, one retired couple rented 8 years running another with teens renting 6 winters running.
Only twice did I have problems but deposit covered the damages or clean ups.
Often folks actually left premises so clean and tidy that I never even needed to dust!

In the 'off time between seasons' I did whatever maintenance and updates that was needed.
Yard care and snow removal I took care of.
Folks were advised that grass and flowers were considered to be 'country rustic' (meaning that weeding and mowing was minimal).
Each property had a row boat and a canoe plus a dock and I provided life jackets as well.

True, I took pride in my properties and perhaps that is what made it work.
Both properties have been sold, and both to the last tenants that have become good friends and totally integrated to our little community and contributing to all our activities.

On the other hand I always tried to be fair and responded to their concerns which generally were usually reasonable.

LOL, one claimed bed was too soft and wanted firmer mattress. My reply was too soft for you, too firm for the next, sorry but I don't have space to store dozens of mattresses, funny but when he purchased he never upgraded that mattress.

Had another who's car never started and I'd boost him every 2ng WE. Each time he'd bring me a bottle of scotch as a thank you.
Another enjoyed gardening and planted more than I had plus she weeded constantly.

 

[WoodChuckDad]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

Rental is a business. I'm not trying to be mean, but you should have known that before selling. Really, if you did your own taxes, the whole depreciation thing should told you that you had to pay it back at sale. The one I just sold, I worked in as a 1033 exchange and avoided the repayment of depreciation. I do have some cap gains for the increase in value, but I saved quite a bit in the depreciation repay.

 

[LD1]

Even not knowing, I still dont understand how you can "loose" all your profit to taxes?

I dont know a single person that purchases a rental and structures it cash flow negative. If you are, its not a good investment if you have to tap into your personal funds just to break even every month.

Worst case is cash flow neutral. Meaning you arent saving any money.....but not loosing money either.

So the whole time you are paying the mortgage on the rental.....it isnt really "your" money paying for it. Rather the rental income. So at the end of the 10, 15, 30, or however many years you finance......even if you made ZERO profit along the way........if it didnt cost you any of your personal money, you are ahead of the game. And your "profit" is the equity.

Should you choose to sell, sure, uncle sam is gonna take1/3 of it or so.....but the 2/3 that you keep is pure profit.

Again, if the combination of purchase price, rental income, length of term on the mortgage, etc is such that you were LOOSING money and having to tap personal funds month over month......not a good investment. And I would certainly not have held onto it for very long.

 

[California]

Its been 30 years so likely the laws have changed, but when I sold my rentals I asked less than 29% down payment and carried the balance as a mortgage to me. This spread the tax on capital gain over several years instead of all due in the year of sale. Even so - the last, and largest sale was in a year when I was finishing my MBA and only my wife was employed. But that was the only year we have paid taxes in the 48% marginal rate bracket. And only seven years after a beat up Ford pickup constituted my total assets.

The most important thing I learned in grad school was the value of planning. As applied to rentals make a clear plan of where you will be at the end of the plan. Then focus on working toward that. As I learned more about finance I shifted to a more sophisticated goal, from simply operating rentals, to seeing the advantage of reselling properties that were now worth more due to my renovations - and then carrying the financing. My income from those notes over the next several years covered the payments on a nice home that is nicer than what our wage incomes could have supported in those early years.

Everybody's situation is different but work through different scenarios and see if there is potentially a better outcome if you re-state your goals. In this exercise you might discover a more direct path. And be sure to include taxes in your calculations!

Also - a hard look at where you might be in the future might help avoid a Detroit-type outcome. It's not that hard to see that a neighborhood is declining, and bailing out even at a loss might in some cases be the best way to preserve what you can. Blindly holding on would be unrealistic.

 

[California]

The Brits traditionally have a different perspective on wealth. Americans ask 'how much is he worth' and expect to hear net assets.

Brits ask this question and expect to hear how much passive - non work related - income the individual receives annually and perpetually.

Learning that new definition opened my eyes!

 

[teejk]

Its been 30 years so likely the laws have changed, but when I sold my rentals I asked less than 29% down payment and carried the balance as a mortgage to me. This spread the tax on capital gain over several years instead of all due in the year of sale. Even so - the last, and largest sale was in a year when I was finishing my MBA and only my wife was employed. But that was the only year we have paid taxes in the 48% marginal rate bracket. And only seven years after a beat up Ford pickup constituted my total assets.

The most important thing I learned in grad school was the value of planning. As applied to rentals make a clear plan of where you will be at the end of the plan. Then focus on working toward that. As I learned more about finance I shifted to a more sophisticated goal, from simply operating rentals, to seeing the advantage of reselling properties that were now worth more due to my renovations - and then carrying the financing. My income from those notes over the next several years covered the payments on a nice home that is nicer than what our wage incomes could have supported in those early years.

Everybody's situation is different but work through different scenarios and see if there is potentially a better outcome if you re-state your goals. In this exercise you might discover a more direct path. And be sure to include taxes in your calculations!

Also - a hard look at where you might be in the future might help avoid a Detroit-type outcome. It's not that hard to see that a neighborhood is declining, and bailing out even at a loss might in some cases be the best way to preserve what you can. Blindly holding on would be unrealistic.

Agree. Appreciation is no longer a given in many markets. The benefits of depreciation deductions made it work when interest rates were high (save a dollar today to pay it back 20 years from now made sense at one time IF people remembered that the dollar had to be repaid, which many of them didn't). In the right markets rentals would make sense though but I always advise people...there is no such thing as getting high returns at zero risk.