rental property with actual numbers

[Riggerjack]

Rental property threads pop up here regularly, and then there are any number of contributed opinions for and against, rarely having to do with rental property viability, more the poster's attitude about property ownership.

This thread is about the house my wife and I bought in February of this year in Everett, WA.

A bit of history: This was a HUD home, it had been bought in 2003, by a young family that fixed it up cosmetically, and sold it in 2007 for 1/3 of a million dollars. The new owner had it thru the great recession, got brain cancer, got foreclosed on, and handed his keys on the way out to his meth-head daughter. She lived/dealt meth/stripped the house for 2 more years until the bank finally evicted her. Then the "repairs" began. At some point, it seems someone was hired by the bank or HUD to "fix" the house, good enough to sell.


This didn't work. HUD tried to sell the house, starting at 240k, and 4 separate deals fell through. Probably because the house couldn't be mortgaged in that condition.


We bought it for 175k, and spent 3 days a week and 25k fixing it up over 3 months. So we have about 200k financed at 4.25%, plus 36 days of labor for my wife and I invested.

If we were to sell it, we might get 275k, minus costs. But we didn't get this house to flip it.


We are renting it for 1425/mo. With an inflation clause to adjust by CPI each June. This covers the mortgage, $984, taxes $200, insurance, $60, with a bit left over for maintenance. Eventually, a few beams will need replacement, new siding and a new roof will be on the list. We will hire all that out.

We rented to a couple of introverted cat lovers with very high credit scores and more than enough income to make the rent, and raises in their futures. They were the first of 6 couples to fill out applications on the first night we showed the house.


So, we bought an asset worth $275k, for $200k plus 72+/- days of labor. Long term, the house should appreciate at about the inflation rate, the rents should also increase with inflation.


So, 1425x11.5(some vacancy) is 16387

Minus taxes and insurance is 13267

Minus repairs 25k over next 10 years is 10767.

Divided by 275k is a return of 3.915%. Not so great, right? Then if you factor in all my financing costs, I'm losing my shirt!

[Dragline]

Interesting. But shouldn't the denominator be 200K plus whatever you valued your labor at? I.e., actually investment, as opposed to current perceived value.

Or thinking about it another way, if you could sell for 275K and you paid 200K, the "flipping" return would have been 37.5%, albeit then you would not have a stream of income, but then again you would have had the 275 to invest in something else.

On the other hand, the whole thing sounds more like a hassle/anchor than an investment from my perspective. Admittedly, I am biased towards passive investments. But maybe the property will increase in value more than you expect.

[Riggerjack]

Well, not really.

you see, those numbers don't count the important parts.

Depreciation. I haven't worked the numbers, but I'm fairly certain I will get enough depreciation to save me between 1000 and 1500 in taxes each year. 10767 plus 1250 tax savings=$12017. Of course, this is only important before I retire.

Asset appreciation. This is tricky, as the last decade just showed. Housing long term appreciates at approx inflation, per jacob.
so 275k adjusted for inflation looks like:
275k in 1980 is 436.20k in 1990
275k in 1985 is 389.50k in 1995
275k in 1990 is 362.32k in 2000
275k in 1995 is 352.41k in 2005
275k in 2000 is 348.23k in 2010
275k in 2005 is 334.85k in 2015
Nobody knows what inflation will be like, so I took samples at 5 year intervals. For an average gain of $37250 over 10 years. That's 13.55% over 10 years. rents will be going up at the same time, but so will insurance and taxes. But what will stay steady is my 4.25% fixed mortgage. At 13.55%, my rental income has increased by 193 dollars per month, but my payment only increases by 35 dollars per month.

After 10 years, my rent is
1425+193x11.5(some vacancy) is 18608

Minus taxes and insurance (260+35) is 15068.

Minus repairs. at this point, all the major work is done. repairs will be much more minor. 10k/10 years inflation adjusted to 11355. is 13933

Divided by 275k is a return of 5.07% plus inflation. (edit) D'oh! I forgot depreciation again. Return of 5.52% plus inflation.

This works out better the longer you hold it. It works better if inflation is high, eating the returns out of stocks and bonds. it works out better if you leverage with a fixed rate mortgage, and hold. it doesn't work if an earthquake/flood/hurricane/war wipes out your house. If you can't deal with maintenance, or you can look a rental applicant in the face and say "no.", landlording ain't for you.

This is not my first rental. I've never had the clogged toilet call. Each of my houses has more than one toilet, and comes with a plunger. I've never had a renter move out voluntarily. That's why I have the CPI clause in there. I want my renters to be happy and comfortable. Charging less than market rates for nicer than average houses and factoring in CPI is part of that strategy. This is a long term inflation hedged investment. It doesn't get returns like the S&P 500, but it is stable, and balances out my portfolio.

I'll try to answer any questions you may have.

[Riggerjack]

@ dragline:
I was showing my numbers, but my purchase route is atypical. Most folks can't deal in rehab loans and do the work themselves. I felt a fair comparison would be the price someone could buy the fixed up asset at. My returns are actually slightly different, as the financing is a bit different than I described. I'm trying to combine my experience for price and rents, without using too much of my unique skillsets or finances.

[A Life of FI]

Have you thought about selling the house now, taking the $75k profit and your $200k original investment and putting it all in a REIT ETF?

Most REIT's pay a dividend equal to the return your getting now (5%), would give you the same long term inflation hedged exposure you are looking for but would be a lot more diversified (would spread the earthquake/flood/hurricane risk over many geographically dispersed properties) and you wouldn't need to spend time managing/working on them.

[Peanut]

I've read a little about calculating the capitalization rate for rental property. Net operating income/price of property. You would use 200k instead of 275k. Eyeballing some of your numbers I get approx. 6% although presumably actually a little less with financing figured in. Definitely good enough for many investors, although it comes with unique risks. As comparison, I've heard commercial property of the mall variety used to be a standard 10%, but came down several points post recession.

Robert Schiller found that over the past 100 years US housing stock appreciates on average 2%/yr. Using that rule of thumb in evaluating today's prices in your local market can be very eye-opening. And you can figure a "fire-sale" price for your own house by using pre-2000 sale prices.

[Ego]

If there is one person here who could be successful with real estate over a lifetime, it would be you. Your competitive advantage over the average flipper would be your willingness and ability to do work yourself.

On the other hand, from an investment perspective corporate flippers have a few competitive advantages over you. Negative cost of capital makes them extremely motivated to find investment properties. The bigger guys have insiders at the banks, appraisers, inspectors, brokers and title companies who give them an information advantage in property selection. They also have economies of scale wrt repair, maintenance and administration. Corporate structures limit their liability.

Your numbers look good. So, that begs the question of why no corporate flippers snatched it up. After four contracts fell through at $240K they dropped all the way to $175K. That's a massive discount. Why did they drop so far?

[Chad]

Agreed with Ego. Only select people can make this work and you are probably one of them. I know I wouldn't be pumped for 36 days of work on a house. It would actually be more for me, as I'm sure your construction skills are better than mine.

[Riggerjack]

REIT's tend to include all kinds of RE adventures. apartment buildings, mortgage companies, commercial real estate, etc. High fees, and no control. For my money, I'll choose stock index funds, low fees, volatile returns. my hedge is actual RE. It gets me the stability and control, though it lacks liquidity and flexibility.

We have flippers in the area, and while this house had 4 deals fall through, the price dropped each time. our market was was pretty slow through the winter, but is red hot right now. here, just over 5 months after I made my offer, I'd say it wouldn't have dropped so low. I guess that defies my low volatility argument, though...

Flippers with cash will usually wait out the biding wars on low priced houses, and let a deal fall through. Usually the high bid is financed, either by a homeowner type, or a low cash, starter investor. when the deal falls through because the house condition precludes financing, the banks are much more receptive to a low cash offer. They now have documentation of faults with the property showing that they can't sell it to a normal buyer, so the REO manager has covered his backside in accepting lower cash prices.

I know my numbers look low. That's because I'm super conservative when calculating my projected returns. I could have rented this house out at 1600-1700/month (I had applicants offer more rent to move up the list), but I intentionally went low to garner the largest pool of renters. I was very surprised by how strong the response was, but I am also very happy with the renters we have.

Landlording is a side gig. If you do the maintenance and pick the right renters, it doesn't take much effort at all. I haven't even seen my other house in 2 years. The tenant in there I've known since high school, and I expect he will be there into my retirement.

[Riggerjack]

Update. I lost my first tenants. We adjusted the rent to 1430 in June, but new job in South Seattle meant they needed to move.

We upped the rent to 1900/month, had 3 applicants in 4 days. We accepted the third applicant. I'm now renting to a retiree landlord and his wife. The first applicant was questionable, the second, I just couldn't reach references, and the third worked out fine.

Seattle RE has been very hot, and this spills over to the rental market. 1900 is still lower than we could get, but, again, I want stability more than peak returns.

For reference, we require 650 credit scores and at least 3x rent in income. Basicly, our renters could be buyers, but choose to be renters. We average 10 responses to our ad for each person who views the house, and everyone who has viewed the house has applied.

[Dragline]

Sounds like its working out quite well. Congrats!

[FBeyer]

...
This is not my first rental. I've never had the clogged toilet call. Each of my houses has more than one toilet, and comes with a plunger. I've never had a renter move out voluntarily. That's why I have the CPI clause in there. I want my renters to be happy and comfortable. Charging less than market rates for nicer than average houses and factoring in CPI is part of that strategy. This is a long term inflation hedged investment. It doesn't get returns like the S&P 500, but it is stable, and balances out my portfolio.

Those are the exact reasons I want to invest in a few small rentals as well. That and my combined Carpenter/cand.scient education Building/fixing myself is not only kind of fun compared to sitting in the office, it also saves a heck of a lot of money.

Make it nicer, make it cheaper, don't be a dick, find tenants that will stay for a long time, ie small families.
I don't care about blazing returns, I care about a steady cashflow.

[Hankaroundtheworld]

As you know, it is all about location. I have 2 rental properties, I make 5-6% yield on it, and hardly have to do anything. Occasionally there is an issue (like once per year), you solve it via maintenance agent, so may be one week work per year, and sometimes you have to change tenants, that takes a bit more time, but after 15 years I can say, it is not too crazy. Of all the tenants that I had, only one (french) couple made problems and left me with 2 Month not-paid rental, but over a long period, that is not that bad. Looking back, I am glad I took this route as rental income is relative uncorrelated with stock-market, and that gives some peace of mind (with all the volatility, expected low returns in coming years and increasing risk in stock market).

[IlliniDave]

I missed this thread when it first came out. Occasionally I find myself interested in adding a rental property to the mix, but ultimately the hands-on nature of it steers me away. I would also be disinclined to take on a mortgage. Both those are personal quirks. But it's interesting to see real numbers on a real property in a real place. Most of what I run across is hand waving about how lucrative it could be.

[rube]

My experience is only a little over 1 year with 1 rental and for the 2nd rental a few months. But so far my experiences are similar as HATW described above.

I am currently working to acquire 1-2 more.
It's not (completely) passive, but I like the steady cash flow and having something 'physical'.

Selecting the right rental and the renters (for you) is very important.

[FBeyer]

Screening renters is my primary concern too. I know construction and I can do math, but estimating people's behaviour is not a strong suit. All those irrationalities and inefficiencies don't make sense to me!

What I gathered so far regarding "soft skills":
Estimate whether the renter (or at least one person in the familiy of renters) is bound to pick up a wrench rather than the phone if something breaks.
Estimate annual salary and ability to pay rent in case of short-term job loss.
Prefer renters with a more calm demeanour; less likely to party the place into oblivion.
Estimate whether the rental unit is bound to provide a good base of living for several years for the tenant (like being close to schools/transport and/or public libraries).
Deposit is always 3 months rent. That way, if the tenant stops paying rent, the tenant will be automatically evicted with three months notice and the money up front pays for those three months rent.
Always make a visual inspection and take pictures of the rental unit before the tenant moves in. Attach pictures and sign a paper agreeing on the state the unit was in when it was initially rented out.
When the unit is vacated, it has to be in the same state as when it was first rented out.

[ajg01]

My uncle has a beach front condo 2nd floor 500 sqft condo in Seattle. Valued at 360k. Crazy.

Anyhow, I always find relative and perceived value of "damage" induced depreciation quite interesting...

$275K vs $200k

My dad built my childhood home valued at $350k for $105k in about 8 months in 1995. Refinanced for some dumb reason in about 2005 and didnt realize it was an ARM. No surprise it foreclosed and sold for $80k after 2008 only needed paint and new carpet...

My last few homes, where I payed rent. Landlord bought first on tax sale $8000 rent for $350. Second $40,000 rent for $450...only worth $15000... They were slum lords.

My current home, which I purchased, was a flip. It was only $5000 above land value when the seller bought it for $22k as foreclosure. I bought for $110k about a year later. He put about $15k plus 1 or 2 months of labor into it. He definitely knows what he's doing. Sounded like he did atleast 3 or 4 other houses at the same time...

One trick I know is where farmer's purchase land locks for next to nothing... An estate sale was up for auction. There were 5 lots. 1 family baught the house for a reasonalble price. But they didnt want or couldnt finance the other 4 lots which were all land locked. The county law says all potential buyers must own an adjacent lot if the land does not border a road... So a farmer bought a couple hundred acres for about $8k. What a steal!

When looking for a home I noticed many homes that were shitty investments. Crooked or small and awkward. Some had nice floors covering crappy subfloors. Cheap and fast fixes. Sure they were cheap for the investor to buy but all their work added little to no value.

So I would say after a good feeling for DIY vs contract out is realized, due dillegence is really the deciding factor of success.

IMO good rentals have a higher rent:value ratio. With ROI in 1 or 2 years max. And flips are atleast a 25% and atleast a 25k ROI in less than 1 year.

So I would agree with others and sell. Just my 2 cents

[banker22]

Your returns are way higher than you state, given the leverage. How much total cash did you actually put in? What is your net income post interest payments? How much principal are your tenants paying down for you every year?

[Jason]

I am always enticed by the idea of rental properties but then realize I have no carpentry skills. The people I have seen become successful in it either have such skills or can acquire enough properties to hire someone to fix the house and/or insulate them from the pain in the ass tenants.

The most successful person I know in this area bought at college campuses: rent is guaranteed (as paid by the parent) but you spend the summer fixing them up for the next group of students.

I have never seen anyone successful at flipping houses, only renting. Houses were not meant to be flipped. Their economic benefit was a stabilized housing cost against inflation. That's where the income growth is.

Also, try to buy by commuter rail lines. That is the best possibility of a gentrification and increased rents.

[halfmoon]

I love, love, love having rental property; it gives my heart a warm little glow whereas our stock investments carry an edge of anxiety. The stocks just feel so more volatile. Housing prices can fall, but there will always be renters if your property is well-located and decently maintained. We mow the grass and clean the gutters because it makes our presence known to the tenants and lets us see quickly if there's an issue such as litter. I absolutely hate trashy yards.

We hire out major stuff (roofing, painting) these days. We used to do everything, but we're getting old and lazy.

DH frets when one tenant's rent is late, which is pretty much every month. She always pays eventually, though, and we charge a hefty daily late fee that she pays without complaint. Our late fee begins on the 2nd of the month. We stress heavily to each renter that we have a mortgage to pay and expect the rent on or before the 1st to avoid the late fee. None of this 10-day grace period baloney.

Other than that, we're pretty nice landlords.