Casual “Investors” becoming Landlords

[Happs]

I have read that in addition to institutional and corporate investors, regular “mom and pop” type people are buying houses in cities like Las Vegas, Phoenix, Miami etc due to low prices and low cost of money, renting them out and then hoping for price appreciation. Sounds like the same game as 2003-2007. They say that it’s a better deal than a CD at the bank or getting a better paying job, yet they have no experience in being a landlord. Even if they put the property into an LLC, do an income verification, credit check and criminal background check on tenants, they could still have issues, correct? I mean even if you do your due diligence, you could still have headaches I assume. Just on the surface, it seems as easy as buying a house, hiring someone to remodel/renovate if needed, and then collecting rent. There’s got to me more to it than that, yet a lot of people are repeating the behavior of the boom years. Do they expect rent to increase if interest rates rise?

Do you think these “investors” are in it for the short or long term? I wonder what percent interest these cash investors are borrowing money at to buy a $200,000 house, put $20,000 into fixing it up and then renting it out for $12,000 per year? How much profit can there be per year in rent when you factor the cost of money borrowed, plus taxes on rental income, etc? I think short-term plays are risky in this market as I think that housing is overvalued in a lot of non-California markets.

Am I missing a big picture factor, because I’ve always thought that one should be wary if too many people/investors are in one sector?

[spdrun]

During boom years, the problem was “fix and flip people” hoping for short-term appreciation, not rental investors. If people can get 7.5%+ renting out properties at reasonable rents, then why the hell not buy a few?

One house I’m looking at in NJ needs maybe $10k of work. It will sell for maybe $110k. Taxes are $450/mo, insurance is $100/mo, ancillaries $100/mo, common utilities (basically gas/water) will run about $250/mo. Both apartments will rent for about $950/mo, which hasn’t changed a lot in the past 5-10 years.

Assuming one month vacancy per year, that’s still an 8.5% cap rate. Try getting that at a bank, what with “Zimbabwe” Ben-Shalom’s zero-rate policy.

Another condo has $220/mo carrying charges, stable and with good reserves. Rents for $1000/mo. Tenants pay all utilities that aren’t included in common charges. Taxes are $100/mo, extra insurance is $25/mo, call it $50/mo for ancillaries. 8.1% right there if I pay $90k.

Rental income is taxed, but only on profit. You can deduct:
* Property taxes
* Maintenance expenses
* Utilities paid by landlord
* Depreciation
* Mortgage interest

Basically same as any other business. And if I paid $200k, I’d expect to be collecting closer to $25k-$30k/yr in rents — I’d have to for the deal to make sense and turn a profit. And fuck yeah, it’s better than “getting a better-paying job” — the idea is for my housing expenses minus rental income to be negative inside of this year.

Live in NYC for basically free, combined with good income from one’s “full-time” gig? Killer. All of the benefits of the city, without being a wage-slave like 80% or so of its residents, and the ability to save $10-20k per year and put it towards travel and fun. Awesome.

As to my possible inexperience, both of my parents are architects, and have been in the rental business as a sideline on one level or another for a decade or so. I’m an engineer who has worked in the construction business in the past, though not residential.

[Happs]

Great post. I appreciate the detailed explanation of the numbers.

However, what if more “wage slaves” decide to get into this business (at the $100,000 or less house level) and the market become saturated with “everyone and their neighbor” becoming landlords and flippers? Won’t that drive down prices?

Suppose interest rates go to 15% and housing prices plummet as a result of it. Will rising rents compensate for it?

[spdrun]

Who cares about interest rates going up if I’m locked in for a decade or three? What I’m looking for is a steady predictable income, keyed to inflation, to supplement my freelance/small-business endeavors. Rents are highly unlikely to decrease in the areas where I’m looking, since they’ve basically been stable for a long time, increasing slightly with inflation.

I doubt prices will plummet — adjusted for inflation, they’re already at levels that existed when rates were MUCH higher. Appreciation would be nice, but it ain’t the goal here.

And lastly, I know someone (good family friend) who came from abroad 40 years ago and was VERY successful at this game while also working as an electrician. It can be done.

[Jazzman]

This has been happening for some time. Many are cash buyers chasing yield and are using property managers. You can’t manage remotely, and you still have issues even if your property is professionally managed. This is not so much a repeat of the boom years, as it’s not chasing appreciation, but yield. Many will sell even if they just beak even, if better alternative investments emerge. Some may retain an exposure to RE for diversification, as was the norm anyway. I agree short term plays in places like CA are fraught, and you may have missed the boat if you didn’t buy two years ago.

There is no such thing as a casual investor in RE. Even with healthy rent ratios, and manageable fixed costs, the unexpected can/often does happen. Heavy expenses can wipe out your margins at the flick of a switch. Rogue managers, neighbors from hell, huge hikes in local property taxes. My biggest mistake was not managing my managers. Be firm and have exit strategies.

[Happs]

For the true individual investor or mom and pop who doesn’t have a “property manager” I would think that even a thorough background check can’t prevent a tenant from moving in who could cause unreasonable wear and tear, thus eroding profits. I read apartment reviews of large complexes owned by big corporations who do credit and criminal background checks and on tenants, yet people in reviews write and complain about “trashy” people in the complex.

[spdrun]

You’re assuming that credit and criminal checks can effectively detect trashy people. The better test for trashiness is the same as Justic Potter Stewart’s obscenity test.

[Jazzman]

I agree, good credit doesn’t mean good tenant. Credit checks assumes the problem is always with the tenant. It can be the landlord (you), property manager, or any number of external factors. One of my most troublesome tenants was a senior banker. My least troublesome tenants lived under my roof. Property managers account for 15% of my headaches. Maintenance the rest.

[spdrun]

Best way is to talk to his/her friends. Talk to their family. Talk to their last (not current, who may want them out) landlord. Talk to a professional contact. This is where 3-4 references, phone #s not letters, come in.

Talk to THEM for 15 minutes. You can usually tell who’s who, and if you have only a few properties, you have a lot more time to vet prospective tenants than if you manage 10 100-unit apartment houses.

Oh, and trust your amygdala.

[Anonymous]

So, as an investor who is renting out a couple of places in Phoenix, let me say:

1. There are no casual landlords as I read above and absolutely agree with.
2. You will always have headaches – no free easy money here – goes with the turf. Don’t do it unless you can handle it. And then after you try to do everything right, knock on wood, alot.
3. Your math is a bit off. I bought a $200k house with 25% down and 4.125% loan, putting in $10k to fix it to nice and will rent it for about $17k/yr
4. Therefore I am cash and net positive. With a reasonable maintenance reserve, discounting depreciation (and appreciation) I figure about 7 to 8 percent return on my initial investment.
5. That’s why I do it – it’s below rental parity. This is now, not a year or 2 ago – my properties from back then do a lot better. With the Phoenix market progressing – pretty soon this window of below rental parity will be gone.
6. I appreciate the appreciation, but as we all know, especially in Phoenix, it all may be illusory. I’m good with the return and inflation hedge from rent – for retirement planning. I’m in it for the longer term.
7. Nothing is full proof, but background checks help. Make your applicant pay for it, you’d be surprised how many weed themselves out. No criminal history. Decent income – these days, use credit history selectively – a person with a failed business tying down his credit but has a great job and references may still be a good bet.

[Happs]

Want_to_Retire: Good post and points. The math you give makes it seem like an great investment, business plan/model and source of income.

How would you be impacted if banks start to unleash REO’s and a new cable television show about people buying them and getting jobs as landlords and being successful at it, akin to the shows about buying storage units? All of a sudden many houses in your rental neighborhood become rentals?

Do you also have a long list of trusted, vetted, reliable and reasonably priced people in the trades? How long did it take you to come up with that list? Suppose the tenant calls and says someone threw a rock in the living room window and it needs to be replaced. Would you know of an honest glazier?

The math makes it all seem like peaches and ice cream. I’m not being sarcastic, but I wonder why more people aren’t getting into it, because it sure beats a regular wage job.

[spdrun]

“5. That’s why I do it – it’s below rental parity. This is now, not a year or 2 ago – my properties from back then do a lot better. With the Phoenix market progressing – pretty soon this window of below rental parity will be gone.”

Unknown — I think the market in Phoenix is only progressing BECAUSE properties are below rental parity. Once parity is approached, investor demand will shrink to nearly zero, and that’s what’s driving the market right now.

[spdrun]

The math makes it all seem like peaches and ice cream. I’m not being sarcastic, but I wonder why more people aren’t getting into it, because it sure beats a regular wage job.

Because most people:
(a) aren’t mechanically handy
(b) think that landlords are big corporations, and that the little guy can’t succeed at something like that
(c) don’t have good business sense
(d) don’t have access to 20% to put down on rental properties
(e) have heard horror stories about their great uncle’s dog’s breeder who rented a house out and got it turned into a clubhouse by a meth-smoking outlaw bikie gang
(f) are fat, dumb, and somewhat happy with their 9-5 gig. OK, maybe not happy, but not as anarchistic as I.

[paramount]

The original post/poster is nothing less than a vicious elitist attack on the proletariat.

[Anonymous]

It was never peaches and cream, even 2 years ago when the numbers looked way better. However, the math is what it is. If the Phoenix market keeps progressing, it will reach rental parity, and as has been pointed out, investors will be more leery at that point (investing would only work if you are gambling on price appreciation). That said, I only buy in nice areas (not rich, not fancy, just nice and I would live there) that are centrally located (from my own experience I’m hating suburban sprawl more and more) or by an easily accessible transit corridor. Even if the sales price takes a hit – people will still want to rent there.

Why doesn’t everyone do it now? I’ve asked myself that before I bought 2.5 years ago. spdrun listed quite a few zingers. A lot of people don’t want to be landlords because it’s hard and different, especially if the rental unit is in another state. I’ve told my colleagues who own rentals in LA what a temporary sweet spot Phoenix was in, and they couldn’t pull the trigger – they think it’s too small of a return for potentially too much hassle. I disagree but I’m sure that’s because I have life and investment plans different than theirs. That said, the reason why the Phoenix market is roiling is because a lot of people are doing it, and also buying and flipping, etc.

I’m not that worried about people jumping to be landlords when and if a REO flood hits. Ill prepared individuals make no money in this business and will exit quickly. Corporates are more interested in large block housing and use their economy of scale – a condo here and a house there just don’t cut it for them. There might be pressure to lower rents temporarily, but I have a decent cushion to break even – I’m also already below my local markets to make sure I can get the tenants I want to rent to.

I don’t have a long list of trusted tradesmen. I’m trying to build one. The people I’ve used haven’t been bad, a couple have fallen off, others have been added. I think if you are reasonably handy and do some research you can control the cost most of the time.

[Author]

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