Thinking of buying a 3 family in the local college area...

[pemulis]

The title pretty much sums it up. Currently I'm living at home after getting out of my lease on my apartment but increasingly I think I would like to buy a 3 or 4 unit building close the University where I live and live in one of the units while renting the rest out for income. Lots of nice old row houses there.

I have never been a landlord or owned real estate. I did the numbers and the net cap rate is between 6% - 8% on most buildings I am looking at and all look to be cash-flow positive. The university area has some rough neighborhoods nearby so that is an issue. This is in the midwestern United States so we are talking between 90 and 140k for one of these buildings and I have enough for a 20% downpayment. My income is high enough the expenses are still low if I can't find tenants.

The way I am looking at it in 5 years I could have 12k / yr from stocks only. I could also have 25k a year from stocks + rental income. The 2nd option looks much nicer. A good net cap rate also leaves room for a property manager if I happen to need move for work.

Any issues or suggestions? I am leaving it up the collective wisdom of this forum!

[dot_com_vet]

You'll be buying yourself a part time job. Is that what you want? Are you up for living Murphy's Law every day? Since you'll be living next to your tenants, do you like people? If you move, being an absentee owner is going to complicate things more.

I thought of doing something similar 10 years ago. I'm glad I didn't. You might be cut out for it. Other people certainly make a go of it. More work, more risk = more reward.

Source: Family and friends who became landlords

[Ian]

I once considered something similar to this (I know some areas with relatively cheap houses that seem to have a constant supply of renters), but even if I'd had more liquid funds at the time I don't think I would have gone for it. As dot_com_vet says, it's a part time job, and I don't think I'm very well suited for it. And as it happens, I've left the country and so I wouldn't have been able to manage a rental anyway.

One thing I haven't explored is how plausible using a rental management company or something similar is. I imagine it comes with a different set of risks and takes a significant chunk out of your return, but it might be something you should consider alongside other options.

[susswein]

I'm doing exactly what you're talking about, living in one unit of a 4-plex near the university and renting out the other 4 units.

It's working well for me, but here are some caveats:

1) Being able to do minor repairs yourself is crucial in order to keep expenses down.
2) The key to reducing hassles is having good tenants, and the key to having good tenants is being in a good neighborhood. Look for a building in the "nice" area near the university frequented by faculty members and grad students.
3) Be really picky about undergrad student renters. It's totally legal to screen student renters based on major, GPA, year in school, etc. and by living onsite you can enforce house rules that will weed out the party type. For example, by requiring a 3.0 GPA, no smoking, and quiet hours starting at 10:00 PM you're likely to get more responsible students. I won't allow room mates (i.e. no more than 1 person/bedroom unless a couple).
4) Be rigorous about credit checks, and require parents to co-sign if necessary.
5) don't believe the pro-forma cap-rates. A good rule of thumb if the building requires minimal repairs is that the annual rent from the 3 units you're renting out should cover your mortgage, taxes, insurance and utilities, plus a couple of hundred a month towards minor maintenance.

[pemulis]

@susswein, thanks for sharing your experience I really appreciate it! That is a really good idea screening by GPA. I'm a little worried about #2, there are not many "nice" areas near the university but most are not terrible. I could not afford the down payment on a very nice building though without selling a bunch of my stock in my taxable accounts (which I don't want to do due to capital gains and having held many shares for less than a year right now).

I suppose it is better to go for quality than to go cheap though...

@dot_com_vet no... I suppose not and no I don't particularly like people, I am a programmer after all... I still think it could be worth it perhaps and I might learn some things out of the deal.

[pemulis]

One thing I haven't explored is how plausible using a rental management company or something similar is. I imagine it comes with a different set of risks and takes a significant chunk out of your return, but it might be something you should consider alongside other options.

I was reading FI Fighter's blog and he has been using "turn key" management companies out of state even. He started out with dividend stocks but quickly moved to real estate investing. He has 5 properties now and his cash flow is $3000+ a month. That was kind of my whole inspiration for starting to look into this venture. I would be very happy with cash flow of half that.

[Ian]

That seems like something that I should at least research. I'm looking over FI Fighter's blog, but do you have any posts/series you'd particularly recommend? (As always, I'm interested in dissenting opinions or resources from other members.)

[pemulis]

That seems like something that I should at least research. I'm looking over FI Fighter's blog, but do you have any posts/series you'd particularly recommend? (As always, I'm interested in dissenting opinions or resources from other members.)

I think I read most of his popular posts. The one that really did it for me was the post about how you can retire immediately if you have 100k in cash to deploy. Little in the way of a safety net but the numbers really to do work, the cash flow looks great on paper.

I actually sent him a message on his site asking for more info on PMs and he mentioned a few property managers he used. The seemed fairly straightforward, similar to the ones I found when Googling. For example: they would charge 8% of monthly rents + some other fees, ect.

[JL13]

+1 on the buying a second job. Does it sound fun or rewarding in some way? Remember the web of goals, you're better off if your actions solve multiple goals simultaneously. So far it sounds like this plan solves the following goals:

1.) Income.
2.)...?

What else do you get out of it? Do want to learn maintenance or property management skills anyway and this is a good way to do that as well as earn extra income? Would you get satisfaction from being around to help tenants with issues?

To put it another way, if the plan didn't work out from a money perspective, would you still have gotten something out of it?

[Ian]

I've read that post and a number of others - now I'd like to see a counterpoint. Can anyone recommend a cynic about his plan or turnkeys in general?

I can't be optimistic or pessimistic on this subject because I haven't read enough to have any kind of opinion. However, I can't help but compare my monthly expenses to the numbers he's quoting...

[jacob]

Did someone say ... cynic?

I presume it's set up in a way that 100k with 20% downpayment buys 500k worth of housing which can be rented out for 5k/month. The mortgage rate is 4%/year so figure that the monthly mortgage payment on the 500k is 2500. That leaves 2500 in free cashflow. A manager would take a cut here but still leave plenty.

I'll ignore RE taxes and maintenance. You can do your own math.

What can go wrong?

Suppose the 500k is sitting in one house and the renter moves out. You now have to come up with 2500 from somewhere else. The solution here is to diversify, so suppose we're talking 5 houses instead.

Now if one is empty, your income drops from 2500-fee to 1500-fee (4000-2500-fee). If two are empty, your income drops to 500-fee. If three are empty, your income is a negative 500 and fee.

If that many are empty, the economy is in the bunks and you might be out of a job too. In that case, you better have a substantial cash reserve to carry you through a few years of 2500/month mortgage payments.

The strategy is essentially to use cash to buy a leveraged position that takes the risk of not having a renter while you guarantee to the mortgage bond seller that you will make the payments. It's actually not much different than when a corporation takes on debt to increase their return on equity in order to boost their earnings. It works, but there's a risk that they/you can't make the revenue and if you don't have the cash reserve (and the bank says no to further lending) it all comes crashing down wiping out your equity. Foreclosing one in five homes would wipe out up to 80k for example. That's your tail risk. It often goes unseen ...

[wheatstate]

I am doing this in a small midwest college town with a couple single family rentals and roommates in a large old house.

Living at home: Professional job with no rent = highest savings rate possible. If you can keep this a good situation for all, there is no reason to rush a change.

Know when rentals in your university town flip. Aug 1 is the flip date in my midwestern university town. Renting off season has 1/10 the applicants.

How much initial and ongoing home maintenance are you going to do?
Do you have the time/money?
Are you comfortable long-distance landlording? I am not.
How long do you want to hold this place?
When do you break-even if you include real-estate/mortgage fees if you needed to sell?

5-10 years ago, I liked the buy house with "good bones" at bargain price, fix and rent.
Now, I don't have the time/desire to repeat, so I hold.
I like the diversity it gives in my portfolio.

[Lou]

I'd tend to agree with what's been said. Being a landlord is a massive responsibility and there are plenty of legal requirements to be aware of. It really is a part-time job and can be very expensive, no matter how high the rent you charge. My advice would be to make sure you've done your sums and arrange to speak to a financial advisor about it first.

[Gilberto de Piento]

I've been interested in rental properties for a long time but I'm starting to think I'll never pull the trigger, especially because in my current city and in other cities I like houses are expensive. Thanks for bringing it up.

You might try biggerpockets.com though it tends to be very positive about real estate without considering other options. It's bogleheads only instead of index funds they're into real estate.

[SimpleLife]

Going from never having owned real estate to owning a multiplex? It could work, but I don't think it's a smart path to go from zero to jumbo like that. I'd say start small by buying a house with some room mates as renters to get a taste of what it is like. I'm considering buying a 20 plex, but I've been a home owner for nearly 5 years, own three houses (valued at about 700K), two of them rentals. I've been a landlord for nearly 2 years. I know the ins and outs of real estate and landlording pretty well. It is a part time job, and I do get called, sometimes at inconvenient times, for major problems (leaks, etc.). I'd caution someone who has never even owned real estate suddenly jumping into property management times many...

[pemulis]

Going from never having owned real estate to owning a multiplex? It could work, but I don't think it's a smart path to go from zero to jumbo like that. I'd say start small by buying a house with some room mates as renters to get a taste of what it is like. I'm considering buying a 20 plex, but I've been a home owner for nearly 5 years, own three houses (valued at about 700K), two of them rentals. I've been a landlord for nearly 2 years. I know the ins and outs of real estate and landlording pretty well. It is a part time job, and I do get called, sometimes at inconvenient times, for major problems (leaks, etc.). I'd caution someone who has never even owned real estate suddenly jumping into property management times many...

I really appreciate this advice actually- I think getting a reasonable single family home and renting rooms would be a good start. I should be able to pay cash for something like that within a year or two.

[Scott 2]

Your return on time invested would likely be much higher trying to maximize your income as a programmer / it professional. If you'd rather be a landlord, go for it, but you'll work just as hard or harder, and have less flexibility.

[billc]

+1 for Jacob's comment about tail risk and the nature of using leverage to increase the return.

From Buffett's 2012 Letter to shareholders: "...we avoid any sort of obligation that could drain our cash in a material way. That reduces our returns in 99 years out of 100. But we will survive in the 100th while many others fail. And we will sleep well in all 100."

There's lots of ways to invest $25,000. Make sure to consider your various options and compare the risk adjusted returns.

[unno2002]

Find yourself a "buyers agent", don't deal directly with the listing agent. The listing agent, and other non buyers agents have an obligation to the SELLER, not you. Find yourself a quality property management firm that knows the applicable law, can do financial checks, ect.. Get them involved with your search. They "know" good rentals areas, deals, etc., and they have the contacts with inspectors, mechanics, etc., to get stuff done at a lot less cost then you finding a plumber on your own… Personal opinion, if I lived in one of the units, I would NOT want the tenants to know that I was the owner.

[susswein]

RE: risk

A triplex or 4-plex qualifies for a residential (vs commercial) mortgage, so you won't need to put down 20%. Possibly as little as 3% if you go FHA. 3% + closing costs means you could get into a $200K 4-plex for $10k. Banks don't like to foreclose, especially when you're underwater, so the chance of losing the house (especially in a college area) due to long term vacancies if pretty damn small. Worst case you can tell the bank to take it back and you'll only be out the $10K.
After the Cali earthquakes 2 decades ago my cousin was able to negotiate a 2 year interest-free payment moratorium on 100+ units. That's how badly banks don't want to take back rental property.