Rental Property: Real Life Experiences
Many people view residential rental property as a great investment. I’ve never had any interest in committing the time I perceive is necessary. I’ve also not made much money on my residences. As such, I haven’t seriously considered the purchase of investment property.
To get the true story, I interviewed three of my friends who are, with varying degrees of success, real estate investors. I was quite surprised to learn that, in spite of the problems they faced, they all agreed that buying rental property has been a great financial decision. In this post, I’ll provide insights into the financial benefits of real estate investing, along with the time and expense commitments. Lastly, I’ll relate some of their “ugly” experiences and the lessons you can learn from them.
Introduction to Interviewees
I interviewed three friends, all of whom have owned rental property, to get their insights. I’ll refer to them as K, J and B.
K and B are both retired now, but started owning rental properties when they were working as professionals in the insurance and manufacturing fields, respectively. J and her husband are also both retired. J’s husband was a building contractor for most of his working career and J is very handy and creative, so they both have lots of hands-on skills that are helpful to landlords.
K and J have had very positive experiences with rental property, though J has had a few significant problems. B, on the other hand, had a terrible experience. You’ll see most of her inputs to this post in “The Ugly” section towards the end.
What Rental Property Do They Own
K owns five properties in multi-family, multi-story properties. The buildings range from ten to 100 units. In the largest building (with 100 units), there is a front desk attendant.
J started with single family homes, but then invested in a triplex.
B owned a brand new townhouse in an association. She rented it out when asked by her employer to take a two-year assignment overseas.
The Good from Rental Property
My friends reported many good things about owning rental property, including fulfilling their motivations for owning rental property and providing a return on a diversifying investment.
Motivation for Buying Rental Property
Neither K nor B intentionally bought their first properties as rentals! As indicated above, B rented out her own residence when she was working and living outside the country for two years. K bought a place in downtown Boston near where she worked. She worked 22 miles from home, so planned to spend the night at the condo when it was snowing or she needed to be in the city until late. K decided to rent the condo only when she realized the current resident was paying good money each month in rent until her lease ran out. She decided using the apartment as a rental property was a much better idea than having a place to stay every now and then.
J, on the other hand, bought rental property intentionally for that purpose. She wanted a more dependable monthly cash flow to supplement their retirement saving. Also her husband being a contractor was a big plus for purchasing properties that needed remodeling.
Advantages
For both J and K the biggest advantage, by far, is financial. J appreciates the rental income to support her retirement and the ability to build equity. K has been fortunate to own in Boston where there is a low supply and a high demand for housing due to the plethora of colleges/universities. Therefore, rents continue to increase and the market value has more than doubled on each of the units. And she has a "free" place to stay in Boston for those rare times when the tenants vacate an apartment early.
Investment Returns
Both K and J say that the returns on their investments have met or exceeded their targets. K says, “Our decision to have rental properties in Boston is the best financial decision we have made.” J points out that, “the longer you own the property, the better the return.” In addition, rental property returns aren’t highly correlated with many other common investments, such as stocks and bonds. It therefore adds diversification to portfolios.
The Bad from Rental Property
To attain the nice investment returns from rental property, you need to commit a combination of time and money.
Expenses
The main costs of ownership are the original investment, insurance, property taxes, maintenance, and repairs. The original investment will be either the full cost of the property or the mortgage down payment. In either case, you’ll have closing costs both when you buy and sell the property. If you have a mortgage, you’ll need to make the mortgage payments. Depending on the type of property you own, you may have condo or homeowner’s association fees.
K also pays for cleaning and touch ups between tenants – things like broken refrigerators, plumbing problems, etc. Through the years, she has had assessments for building improvements – the lobby was refurbished, elevators updated, laundry room refreshed, etc. Before these capital improvements were implemented, the condo board researched and obtained the support of residents to allow the costs to be assessed.
Most rental-property expenses, including those for cleaning or for assessments, are deductible from your income for tax purposes.
Time Commitment
K and J take different approaches to splitting their commitments to their rental property between time and expense. K’s husband takes care of all of the time commitments which are primarily paperwork (property taxes as well as income taxes). These activities take an hour or two each month. And the inevitable problems (water leaks) don't really take a lot of time, but they are random and can happen (for example) when they were hiking in Slovenia which is annoying! They have a property management company (see next section), but sometimes they have to provide input.
There were three women living in one of K’s two-bedroom apartments. For some reason, two of the three women didn't get along at all. They would scream and throw things at each other. One of them kept calling K’s husband to ask for advice. He never understood why they called him! Finally, one of them moved out, ending that time commitment.
J’s husband, on the other hand, takes a much more hands-on approach and commits much more time. Up until recently, J and her husband did not use a property manager. During that time period, she and her husband spent a lot of time on maintenance and cleaning in between renters. They also spent time advertising, meeting with prospective renters and checking references whenever there was a vacancy.
Damage Stories
Both K and J have had tenants damage their properties. Here are a couple of their stories.
The tenants in one of K’s apartments were frying chicken and forgot about it. There was a rather large fire. It was extinguished, but it caused a few thousands of dollars of damage. The tenant's parents paid for 1/2 of the damages.
J had a tenant who hadn’t paid his rent in several months, as he had lost his job and didn't have enough money. After many attempts to contact the tenant by phone and email, J and her husband entered the house. They found all sorts of damage to the house and were confronted by the local police on their way out! The damage was done by the tenant’s son who stayed in the house while the tenant was on vacation. The police arrived because the tenant reported that there were trespassers on the property. Because J and her husband could document that they had tried to contact the tenant numerous times, they were considered to be in the house legally. The tenant was willing to move out, but wanted his full deposit back. He tried repairing the house, but made it even worse.
Property Management Services
K and B use property managers, whereas J hasn’t until recently.
Using a Property Manager
K used the woman who sold her the properties as a property manager for many years. K paid her based on the rental property management services she used. For example, the manager might tell K to purchase new blinds. The manager would order and install the blinds and then charge for materials and labor. The manager would also solicit tenants for apartments with a non-renewing lease.
In the future, K plans to use a "real" property manager rather than the informal arrangement she had previously. The new manager charges from 3% to 7% of monthly rent depending on how much service is needed. K has chosen the 3% option because the 7% option is a truly hands-off, i.e., the manager will collect rent, pay vendors, etc. and provide a monthly statement of accounts for her review. With the 3% option, the property manager is the first point of contact when, for example, the refrigerator stops working. He will assess the situation then call with his recommended solution (e.g., buy a new refrigerator). Once K has agreed to a solution, he’ll arrange it all and send the bill.
Property Manager Prices
Property managers have different rates depending on how much or little you want them to do.
J provided me with the pricing plan for a local property manager. The prices ranged from 2.9% to 11.9% of annual rent, plus a set-up fee of about $200. For 2.9% of rent, you get advertising, property showing, tenant screening, and a six-month tenant replacement guarantee. At the middle price point, the management company also provides rent collection, maintenance coordination, online account access, 24/7 emergency response and bookkeeping. At the high end, bill pay, move-in and move-out videos and much more extensive reporting are provided.
B’s property manager charged $250 a month to collect rent, pay mortgage and HOA dues.
Doing It Yourself
J and her husband have managed their properties themselves for the past 10 years, but recently hired a property manager. J says, “Managing your own property is a huge time commitment, but can save a lot of money if you’re willing to put in the time and do the work yourself.”
Cautions and Advice
K and J both agree that the single most important rule in renting is to have good tenants. If you aren’t careful, renters and their pets can cause damage. K would never ever allow pets in her apartments even with a healthy security deposit.
J prefers multi-family properties as she always has income from at least some renters. With single family homes, there were sometimes a month or two with no income. J also recommends being flexible with your plans. Sometimes, financially, it is better to keep a rental or sell it depending on the market and your own situation.
Along the same lines, K suggests being flexible about tenant improvements. One time, the daughter of a CIO of a major investment firm was living in one of her apartments (the one with the chicken fire) while she was an MIT student. She really wanted hardwood floors in the apartment (it had carpeting at the time), so her dad paid for half of the cost of installing hardwood floors throughout the apartment. Of course, K and her husband said, “Yes!” The tenant also wanted to paint her bedroom a rather dark purple color (for which she paid) and K and her husband agreed to that. While it sounds like a hideous color, K actually liked it and it is still the same color today.
Other Things That Can Go Wrong
Lief at Physicians on FIRE started quickly with his investing in real estate. He "lost everything" due to a combination of his timing in the real estate market, his rapid entry into the market and his lack of understanding. Learn more in his post.
The Ugly from Rental Property
Sometimes, rental property can be much more problematic than damage from small fires and tenant’s adult children. B’s story is really ugly, but had some benefits nonetheless and several lessons learned.
What Happened
B hired the father of a friend as a property manager to handle everything while she and her husband lived in London. Everything seemed to be going smoothly until an awful phone call from her mortgage company saying it was foreclosing on her condo. The property manager had been in business for 30 years. Unfortunately, his accountant had slowly been embezzling small amounts from prior clients for years. When B’s account arrived, the embezzlement started immediately, including not paying any of her bills and taking all the income. Within three months, B received the foreclosure notice from her bank!!! She fired the property manager and, to salvage her friendship with his daughter, paid the missed mortgage payments and fees herself. It took seven years before B and her husband’s credit recovered.
Other Issues
In addition to the financial issues, B’s neighbors and friends called to complain about the noise from the renter’s Harley Davidson motorcycle. There was physical damage to her home as well. A small (less than 15 pound) dog chewed all of the floor trim and peed frequently in the bedroom. B and her husband had to have the floor trim throughout the condo and the flooring and sub-flooring in the bedroom replaced. To top it all off, there was a leak under the master bath sink that was either never seen or completely ignored. As a result, B and her husband had to replace a living room wall and have the resulting mold mitigated.
Light at the End of the Tunnel
In spite of all of these problems, B and her husband still had a positive return on their investment as they were able to sell the property for more than twice what they paid for it after four years. By renting out the property, they were able to retain it and benefit from the appreciation. Even with the damage to their credit rating and repair expenses, it was an excellent financial decision to retain the property and rent it instead of selling it.
Lessons Learned
B has several pieces of advice for those who own rental property based on her experience.
Require bi-weekly cleaning (and inspections) as part of the rental contract. B now owns a property purchased specifically as a rental. She has hired a cleaning service and put the cleaning supplies under the sinks so the cleaners will see and can report any leaks.
Clearly state in the contract that no pets, motorcycles, loud vehicles or onsite vehicle repairs will be allowed.
Install moisture detection sensors.
Pay your own bills.
Have a legal review of your rental agreement with clear expectations and boundaries that would cause eviction or fees.
Closing
Rental property can clearly be a profitable investment, providing both cash yields and asset appreciation. However, as with any investment, it is critical that you understand the risks and mitigate them to the extent possible. In addition to the risks identified above, there is also the possibility that the value of the property will decrease either from general housing market trends or deterioration in the city or neighborhood in which it is located.
