Author Topic: Landlording: worth it financially?  (Read 6114 times)

sassy1234

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Landlording: worth it financially?
« on: July 11, 2013, 08:19:48 AM »
Hi Everyone,
I am a landlord by mistake.  I moved for a job, and have been renting out my home for just under three years. 

Here is my breakdown of our profits.  Is it worth it?  Am I making enough profit?

Mortgage: $1150 included taxes and insurance. 

Rent collected:

1st 12 months:  $1275  per month, kept $300 security deposit.  House in good condition.  Renters were total jerks and hard to handle. 

Next 18 months: $1050 per month.  Lower rent negotiated because they signed a 2 year lease, however they left early anyways.  $1,000 worth of damage.  Did not pay last months rent, so I lost big time.  Kept entire deposit.  They won't give me their forwarding info, so I can go to small claims.  More stress than I could handle.  Spent 2 weeks of my vacation getting the home in proper condition. 

New lease just signed: $1225 and they signed a 3 year lease.  They seem low key and nice. 

Also, this home is out of state, so when something needs to get fixed, we have to pay someone locally to do it. 

We have now owned the home for 6 years.  It will be 9 years when the next lease is up.  We love the idea of making this an income property, but the distance is hard, and I don't know enough to assess if we are making enough profits.  Finance is not my strong point. 

Any advice is appreciated.  Thanks,
Landlord Laura 



freelancerNfulltimer

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Re: Landlording: worth it financially?
« Reply #1 on: July 11, 2013, 08:44:16 AM »
You're not making enough profit on this house to make it a good rental. But we don't have the whole story. What's your mortgage balance and what could the house be sold for? You may be able to sell the house and find a better investment vehicle or you may be so underwater that it's better to sit and wait for the housing market to completely turn around.

You may want to think about using a Property Management company since this is not a local rental for you. They will handle the maintenance calls and the collections if/when needed and do the proper income verification, background and credit checks. You may less money but the it may be worth it for peace of mind and saving your vacations for actual vacations.

sassy1234

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Re: Landlording: worth it financially?
« Reply #2 on: July 11, 2013, 09:18:34 AM »
The mortgage balance is 132,000.  We bought the house for 142,000 and refinanced once to 5%.  Not exactly sure what the house can be sold for.  I am guessing 132,000 since we bought in 2008. 

How much profit should we be getting then, to make this a good investment?  Is there a general rule? 

At first we were renting the place to buying ourselves time, to get settled in our new city, settled financially, we did not want to sell the house without owning it for at lease 5 years, etc. 

A Property Management company does not make since, we are hardly making any profit now.  We are willing to put time and work into it. 

I am curious of what others think we are not making enough profit.  Going forth, we will always collect at least $1225 in rent and are considering asking for 1350.  There were people fighting over the property this last time around.  We are probably not charging enough. 

Laura 

freelancerNfulltimer

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Re: Landlording: worth it financially?
« Reply #3 on: July 11, 2013, 09:27:56 AM »
A general rule of thumb is you can expect 50% profit from your rental to cover vacancies, collections, repairs and maintenance. So if you are receiving $1225 you would go off the number $612.50 in rental profit. Your mortgage is $1150 so using that 50% formula you are not cash flow positive.

You've already experienced repairs and broken leases so you can see that it's not as simple as Mortgage-Rent=Profit.

You may want to hire a Real Estate agent to tell you what they think the house would actually sell for. You don't know until they pull comps.

You can't just say, "we will always collect at least $1225 in rent and are considering asking for 1350.". You don't know that you will always collect at least $1225. Rents change up or down depending on your local economy. Tenants have to be evicted. Tenants cause damage.

My mother is a property manager and I could tell you some tenant horror stories. That doesn't mean being a landlord isn't a good idea. It just means you have to have a good rental property. Something that is a good primary home doesn't necessarily make a good investment property.

For what it's worth I'm in the same boat. I have a condo I own and rent out that isn't a good rental property. It was my primary residence and I currently can't sell it for what is owed. I lose money every month because of condo dues and I've had lots of repairs due to my tenants so I'm close to proving the 50% rule.

Good luck!

sassy1234

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Re: Landlording: worth it financially?
« Reply #4 on: July 11, 2013, 11:00:41 AM »
Thanks, that is very helpful information. 

I wonder how many other landlords rent and keep properties that do not make 50% or close to it?  It almost seems that even if you are not making a big profit, it still makes sense to own it because equity is being built for you, by someone else.  The house will be paid for in 22 years, and by that time, the property will serve as a nice retirement booster.  Does that thinking make any sense?


arebelspy

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Re: Landlording: worth it financially?
« Reply #5 on: July 11, 2013, 11:11:43 AM »
No, because you could sell and put it into a property that does make the 50% rule, get cash flow and the paid off property (and in fact use the cash flow to increase mortgage payments if you desire and have it free and clear in 12 years instead).
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Shelby

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Re: Landlording: worth it financially?
« Reply #6 on: July 11, 2013, 03:10:20 PM »
@Laura,
You've gotten excellent advice here on what makes a property a positive cash flow.  The 50% rule (which as Freelancer noted does not include your debt service, i.e., mortgage) gives you a good safety net to know whether or not a property will be a good cash flow.  As far as using a property manager, it still may be worth it to you.  I use one and because they know what rents the neighborhood can sustain, my PM was able to get me $250 more per month than I thought I could get.  That amount more than covers his fee of 10% of the rent and he has a stringent screening process.  With that said, I definitely think owning rental properties is a perfect avenue to building long-term wealth.  You might want to also check out the website BiggerPockets which is where I learned everything I know today about real estate investing.
Good luck!

Nords

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Re: Landlording: worth it financially?
« Reply #7 on: July 13, 2013, 06:26:35 PM »
I wonder how many other landlords rent and keep properties that do not make 50% or close to it?  It almost seems that even if you are not making a big profit, it still makes sense to own it because equity is being built for you, by someone else.  The house will be paid for in 22 years, and by that time, the property will serve as a nice retirement booster.  Does that thinking make any sense?
You're building a diversified investment portfolio, and your rental property is hopefully both income and growth.  A rental property ideally keeps you from doing something more stupid with your money.  But if there's something about the property which annoys you now, then it's going to be extremely annoying when you retire.

Properties build equity at about the rate of inflation.  You have to decide whether you're willing to put up with the property's current inconveniences indefinitely, or at least hire them out.  Otherwise you could consider finding another rental property with better parameters, like being closer to your retirement location.  Or you could sell the places, pay all the taxes, and invest the remainder in I bonds or CDs.

We own a rental in Central Oahu mainly because it was our primary residence before we found our "dream house".  We made the upgrade move in August 2000 for all the right reasons but we were reluctant to sell our old home at what turned out to be the pit of Hawaii's decade-long real-estate recession.  (At the time we were also too damn busy to sell the place.  Luckily we were both still on active duty and the credit union was happy to lend us the money.)  We realized that we could swing the rental cashflow (and our ER) with the right tenants, so we decided to landlord for a year or two and re-assess selling the place.

Then spouse's parents wanted to move to Hawaii, live in our rental, and watch their granddaughter grow up.  In retrospect nothing good came of that and we lost nearly six years of income.  (When they finally moved back to the Mainland we darn near doubled the rent.)  Since then we're on our second set of military tenants, we have cashflow, and we have no compelling reason to sell.  The rental is a single-level wheelchair-friendly home in a neighborhood with a very high walkability score, and our "dream house" is in a most excellent school district, so spouse has this fantasy that someday we'll move back into the rental when our daughter wants to live in our house and send our grandkids to her ol' high school.  (Our daughter is just starting her senior year of college followed by a Navy career, so the concepts of "grandkids" and "live here" are highly speculative.)  At this point we've owned that property as a home or a rental for 24 years and our personal finances are good, so it's easier to keep renting it out than to argue with spouse sell it.

However our cash-on-cash return is only about 3%.  That seems reasonable today, but it looked pretty idiotic when five-year CDs were earning 6%.  Whenever I get grumpy about the yardwork or the repairs or the tenant turnover, spouse points out that they're actually fairly short-term minimal fusses.  She's probably correct.  I'll make some snarky comment about our exit strategy being "probate", and she observes that we have nothing better to do with our money.  There's no longer any reason to relentlessly optimize every aspect of our investment portfolio.

This situation will probably continue for another 20 years, or perhaps 50 years if there are grandkids... in the meantime Oahu real estate prices are rising rapidly and we just raised the rent, so I suspect that our cash-on-cash return is actually dropping. 

Johnny Aloha

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Re: Landlording: worth it financially?
« Reply #8 on: July 15, 2013, 02:21:23 PM »
... in the meantime Oahu real estate prices are rising rapidly and we just raised the rent, so I suspect that our cash-on-cash return is actually dropping.

With rising rent, your cash on cash return should improve - not drop.  Cash on cash return = net annual profit / total investment (down payment, closing costs, repairs, etc).

If the numerator is increasing, your return is increasing.  And housing price appreciation doesn't affect your cash on cash return - but it could factor into your decision to sell and re-allocate money if prices run up.

Did I miss something here? 

arebelspy

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Re: Landlording: worth it financially?
« Reply #9 on: July 15, 2013, 02:45:07 PM »
Raising the rent does improve return, but appreciation drops it, if you calculate it the correct way.

That is, if you calculate it based on equity you could get if you sell (net of fees and taxes) , rather than your initial investment.

Let me give you an example:
I pay 50,000 for a house.  It rents for 1,000, and my return is 10%.
Let's say the rents rise to 1200, and the house value quadruples to 200,000.

If I calculate my return on investment, it's 1200/mo*12 months/yr = 14400 / 50000 (my investment) = 28.8%

Seems great!  But in actuality, if I sold and could net 150k to reinvest elsewhere, that's really a return of 14400/150k = 9.6%.

Bottom line: at any given time you need to look at what your return on capital is, not return on investment.

I have houses that were giving me 9% when I bought them based on my down payment.  Prices have risen, my equity has more than tripled (though the house overall obviously didn't triple, my equity did due to leverage), and now my return on what I could cash out is a paltry 3%.  I'm looking to sell and redeploy that capital elsewhere in that case.

If Nord's house is appreciating, he may see his return dropping, if he is calculating it based on equity, rather than initial investment amount.  (Which especially makes sense if you bought a long time ago, your return on investment may be over 100% if you only put a few thousand down and it returns more than that annually in cash flow, but what you should be looking at is what the return on equity is.)

(But yes, rising rents will increase your return, I agree with that.  Appreciation outpacing it though may still mean a dropping return on equity.)

Hope that made sense!  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Johnny Aloha

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Re: Landlording: worth it financially?
« Reply #10 on: July 15, 2013, 04:36:13 PM »
Got it - thanks for the explanation!

daverobev

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Re: Landlording: worth it financially?
« Reply #11 on: July 15, 2013, 04:47:54 PM »
Raising the rent does improve return, but appreciation drops it, if you calculate it the correct way.

That is, if you calculate it based on equity you could get if you sell (net of fees and taxes) , rather than your initial investment.

Let me give you an example:
I pay 50,000 for a house.  It rents for 1,000, and my return is 10%.
Let's say the rents rise to 1200, and the house value quadruples to 200,000.

If I calculate my return on investment, it's 1200/mo*12 months/yr = 14400 / 50000 (my investment) = 28.8%

Seems great!  But in actuality, if I sold and could net 150k to reinvest elsewhere, that's really a return of 14400/150k = 9.6%.

Bottom line: at any given time you need to look at what your return on capital is, not return on investment.

I have houses that were giving me 9% when I bought them based on my down payment.  Prices have risen, my equity has more than tripled (though the house overall obviously didn't triple, my equity did due to leverage), and now my return on what I could cash out is a paltry 3%.  I'm looking to sell and redeploy that capital elsewhere in that case.

If Nord's house is appreciating, he may see his return dropping, if he is calculating it based on equity, rather than initial investment amount.  (Which especially makes sense if you bought a long time ago, your return on investment may be over 100% if you only put a few thousand down and it returns more than that annually in cash flow, but what you should be looking at is what the return on equity is.)

(But yes, rising rents will increase your return, I agree with that.  Appreciation outpacing it though may still mean a dropping return on equity.)

Hope that made sense!  :)

Makes sense, except 'a bird in the hand is worth two in the bush' and 'better the devil you know' - ie, to sell and buy new, isn't there more risk - vacancy in the mean time, etc. Your return on what you put in is x - and goes up as rent increases. Isn't that good enough? I guess.. not if you're doing it 'properly professionally'. But cap gains and all that, too?!

honobob

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Re: Landlording: worth it financially?
« Reply #12 on: July 15, 2013, 05:05:28 PM »
Raising the rent does improve return, but appreciation drops it, if you calculate it the correct way.




Hope that made sense!  :)

Clear as MUD. ;)   Seriously, if the property value increases another $200,000 he could be losing money!  The big problem with the real estate discussions here is that as soon as someone feels painted into a corner they come up with a new way to figger/bastardize a known financial concept and then compare it to an inappropriate "return".   Ya can't have it both ways.

Cash on cash was the discussion.  ROE is totally different.  There is no comparison!  You are shooting yourself in the foot if you are making a decision to sell based on ROE alone.  Especially when the equity is INCREASING because of RAMPANT appreciation.

tryan

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Re: Landlording: worth it financially?
« Reply #13 on: July 16, 2013, 02:33:48 PM »
The owners SF home RARELY makes a good rental.  Because it was not purchased as an investment property.

You can tear the bandaid off slowly (continue to bleed a little every month).  Or sell the thing. 

Frankly i'ld sell and if you're interested in being a landlord (this experiance should have given you a good taste of it),  then buy something near-by that cash flows NOW. 

Nords

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Re: Landlording: worth it financially?
« Reply #14 on: July 20, 2013, 10:28:12 PM »
If Nord's house is appreciating, he may see his return dropping, if he is calculating it based on equity, rather than initial investment amount.  (Which especially makes sense if you bought a long time ago, your return on investment may be over 100% if you only put a few thousand down and it returns more than that annually in cash flow, but what you should be looking at is what the return on equity is.)
I'm basing our return on the after-tax equity:  the amount of cash I'd have in my checking account (for buying a CD) after selling the place, paying off the mortgage, paying depreciation recapture and (long-term) capital gains, and even some AMT.  I'd sell it as a FSBO so our marketing & closing costs would probably be minimal.  I know we could roll that over to a TIC fund (and defer taxes) but I don't like the way those are structured.

I'm calculating the basis from the rollover cap gains on a 1989 sale that funded this purchase, plus the improvements we made to it as a primary residence before renting it out.  We lived in it from 1989-1994 and again from 1997-2000, but it's been a rental property for the rest of those years.  We haven't made any significant improvements to it since the cap gains rules changed (was that in 2009?) but the resale value sure has gone up.  (We have comps from sales on the surrounding block and they're higher than the assessed value.)  The CPI has gone up by 1.88x since 1989 but this month's value of our rental property is 2.53x the purchase price.  I'd have to update the spreadsheet to see whether the difference between 1.88x and 2.53x would be eaten up by the mortgage payoff & taxes.

Again, Oahu rental property is very capital-intensive.  The median condo price is over $300K and the median single-family home is over $600K.  The size of the average residential lot is lower than 5000 sq ft (nobody on Oahu measures residence lot sizes in acres).  The quality of the materials & construction is considerably substandard to Mainland code because there's very little freezing weather around here and the land is too rocky for basements.  Homebuilders have only (very) recently started using wall/ceiling insulation and insulated doors/windows for air conditioning.  However the state's immigrant population (arriving after 1800) has a culture of building wealth through owning land and landlording, and it's probably even stronger than the culture of farming/fishing or building a lifestyle business.

As I mentioned a few posts up, this rental property was never part of our ER plans.  Today it looks pretty smart, but none of those reasons were on our radar when we moved out.

However based on our current family plans, all of this spreadsheet tracking & analysis is probably a waste of time.  The next time either of our properties change ownership will be through probate...