The Investment Scientist

What It Takes to Be a Landlord

Posted on: November 28, 2011

Owning a rental property as investment may sound attractive to a lot of people who are sick and tired of the volatile stock market.  However, owning a rental property is like owning a business. Do you know what it takes to be a landlord? Listen to Paula Pant talks about it.

Podcast: Becoming a landlord

Table of contents

Consumerism Commentary Podcast[00:00] Introduction from Tom Dziubek
[00:36] Interview with Paula Pant
– [00:54] Owning rental properties
– [01:51] Analyzing a property’s profitability
– [03:04] Expenses involved
– [04:08] Things to look for in a property
– [05:19] Renting to professionals
– [06:54] The affect of the number of rental units
– [08:39] Paula’s experience
– [10:19] Fixer-uppers and meeting the needs of the tenant
– [12:25] The costs of fixing up a house
– [16:40] Income tax implications
– [19:26] Being a landlord
– [21:54] Finding good tenants
– [23:05] What tenants look for
– [23:38] Tasks to outsource
[28:17] End

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8 Responses to "What It Takes to Be a Landlord"

I started as a real estate investor in the fall of 2008. Not a great time to sell real estate but very good when you’re buying. I had lost half of the value in my 401 K and IRA, and the dividend income which made retirement enjoyable was soon to vanish. My wife and decided we needed something with local control rather than the boom and bust with Wall Street and Washington. Rental housing looked to be within my skill set and if it was broken I could fix it, if it was vacant I could rent it again. Both of these solutions were not available for any of my portfolio investments.

A beginner needs to figure out his target audience. My prior business experience caused me to lean toward working class people, blue collar folks. In my experience when Johnnie Briefcase loses his job, his skill set will only allow him to do the same job somewhere else. If his check book gets empty, you have to wait for the next payday. With Joe Lunchbox it’s different. He can fix a friends car, paint the living room for the guy next door, or haul away the junk from a neighbor’s garage. He can litterally go and make something happen. Most white collar guys can’t do that.

Our target house is a 3 bed 1+ bath, we would like to have a garage. We are happy to buy the ugliest house on a nice street in a owner occupied neighborhood. We avoid rental row because someday when it’s a seller’s market we would want to sell our property. Heavy rental areas are not where people usually look to buy houses. The houses we buy are not our dream houses, but they are a step up for the family that has outgrown a 2 bed townhouse. And, they are a fall back position for the family that may have been caught in the mortgage crisis, lost their dream home, but have too much family for an apartment.

Most of the horror stories come from accidentlal landlords or landlords not willing to work at the tenant screening process. The guy with a house left over from a divorce has no margin in the deal to make profit each month. The $50 bucks or so he clears each month, if he’s lucky, is wiped out by any vacancy or repair. The landlord that doesn’t screen the tenant carefully will generally have evicition, late pay, partial pay, and so on. A lease is a contract worth $10k and up generally, and the tenant is agreeing to pay in monthly installments. If you don’t check the credit, criminal, and rental history for a $20k deal, don’t be surprised with the results.

The real key to a solid real estate investment is the margin between purchase price and market value. If you buy a $100k property for $47K, put $20k in repairs and restoration, you have a $33K margin in that property. That margin translates to cashflow in the form of rent, risk reduction in the form of a quick sale if needed, and good capital gains if you sell years from now. One the other hand, if you don’t have the margin, you can’t make it cash flow, there is no chance of a quick sale, and when the market improves, if you’re still in the game, your capital gain will be much smaller.

We have had good succes at buying these types of home in the Columbus, Ohio area. They are generally leased successfuly before I have all my tools out of the property. We insulate, update kitchens and baths, freshen the electric, put in new windows, provide all appliances including washers and dryers. In short, it is a modern home in a mature area.

It is a lot of work, but no more than my day job was. the ROI is better and more consistant than any investment I have ever made. We are returning about 14.1% each year of the dollars we have invested. Our properties are easy to live in and the vacancy rate has been less than 2% of available rental months. Since we rehab them so heavily, there are very few service calls. And, we like doing it. We must we have Our home, and 8 investment properties. We get about $110k in rental income a year, after the mortgages, taxes, insurance, and repairs we are left with about $40K disposable income. If I had started sooner it would probably be bigger, but I don’t have to be the next Trump, I just need to identify and work at my goals.

I read “Rich Dad Poor Dad” like so many other investors. When he described his first definition of wealth as having enough assets that they would pay for all of your monthly expenses that struck me as a reasonable goal. We did that in the first year and a half. Then I realised my wife would need a retirement income, she’d like to have a nice car to drive too, travel a bit, wardrobes need to be updated. So, the last year and a half have been to work in that area. We won’t buy a property that won’t cash flow. If you have target cashflow, everything else in a real estate deal follows. If you’re counting on a quick capital gain, then you are at the whim of the market.

Ron

Ron,

Your comment is 10x more insightful than my few posts on real estate investments. My key take-away:

1. Real estate can be great investment
2. It takes works to make it great
3. Focus on cashflow and the rest will follow.

By the way, have you heard about section 8 property investment?

Michael

We have made the decision to avoid Sec 8. The guy that has the money makes the rules. With entitlement spending looking shaky, what if you had a string of Sec8s an they greatly reduced or stopped providing low income housing assistance. Then you have a string of money losing properties with no way out. So far it has not been a neccesity. I once thought it a great way to handle taxes. When I stopped acquiring and rehabbing, I will have income tax to pay. I thought why not get a couple of Sec 8 doubles, rent them for the going rate and apply that money to my taxes. My wife didn’t want to own inner city rentals, so the plan is to seek SSA, disabled, or people with other sources of gov’t money to fund the tax account. Taxes aren’t so bad when you can let someone else provide the money for them.

Ron,

I did not quite understand your tax argument. Can you elaborate? How it is a great way to handle taxes?

Michael

If you establish your income comfort level, say the net from 10 properties, when you quit acquiring and renovating properties the accelerated right offs and cash expense go to zero. Each of those positive cashflow properties generate income, taxable as unearned income (no self employment tax). At that point the investor can either fork over some of his comfort level by paying taxes from what he earns, or he can add a few more properties to the mix and dedicate the income from those to funding the quarterly estimates. This creates the illusion of tax free income on 10 properties while in reality he owns 12 or 13. It is true he is paying tax on the entire lot, but in his life he lives on 10, comfortably. It seemed a great idea to take gov’t subsidised housing dollars and return them to the government. In essence I’m building a 130% pie to live a 100% life. Most people only see a 100% pie and live on what’s left after the gross to net calculation. In casino terms, I’m laying off the taxes on people that need a place to live.

Michael, there are many tax ramifications to real estate and I am not a tax professional. My solution for taxes is to just build a bigger pie. Obviously there is income sheltering and coversion of monies to LT capital gains. All of these need to be discussed with a tax profressioonal and completely understood by and investor. I was in business for 16 years in my early career and so I look at rental real estate as a business. In a business we make informed decisions for planned outcomes. Mostly, people look for investments to be more passive. Put the capital in, let time do what it does, get your money back. Rental real estate is not like that. It’s hands on and because of that not everybody want’s to do it.

People know nothing of it and they fear it. My next door neighbor can tell me more scary rental stories than I can imagine, she has never owned a rental property. Our target resident is a family starting out, or empty nesters looking to avoid maintenance, or a single mother looking for a home to settle in. When we find the right resident it becomes a long term arrangement. That’s only frightening if we pick the wrong individual. Our 2% vacancy came from asking a resident to leave after his lease expired. We didn’t like the way he lived or conducted his affairs. The home was rented 1 day after he left. It took about 30 days to put it back together. It’s a business. We like it.

Take care,

Ron

Ron,

Do you put each property in a separate LLC?
Have you thought about estate planning ramification of having most of your wealth in real property?
When you are in your 80s, do you think you can handle 13 rental properties?

I’ve seen cautionary examples related to my questions, but I’d like to hear your perspective on those issues.

Best regards,
Michael

On LLCs:

I understand the concept of limiting liability by creating a seperate entity for each asset. On paper and legally it would make sense to have an LLC for each asset and for a management entity as well. There are compliance costs that go along with that move in both accounting and insuring the properties. There is also the fact that it sometimes doesn’t work.

My mentor at one time held about 55 properties. He’s incorporated, has LLCs, and other legal firewalls. Last year a young lady died from carbon monoxide poising in one of his properties. The door to the furnace room in her home had vents at the top and bottom for ventilation. On her own, she covered these vents with plastic because she felt a draft when the furnace was running. These vents supplied what HVAC techs call “combustion air” for the furnace. That is air to properly burn the natural gas. Without proper air supply the furnace began generating CO gases. One person escaped and unfortunately the young lady died.

My mentor tells me that because he is an “active” manager of the properties, he is still being sued, both personally and as a business entity. It is anecdotal I know, but still it flies in the face of all we are told about limiting liability through legal entities. Attorneys follow the money.

Add to that the cost of the accounting and Schedule Ks for each member for each property, and following the cash from a management entity through the pipeline of LLCs, then rolling them up on a 1040 of some kind, and the insurance companies look at that as commercial rather than individual. Looking at all these factors I decided to buy 2 liability umbrellas, 1 commercial and one personal. My choice, people can debate both sides, but in the end that was my decision. It may be changed later, it’s only a decision.

On estate planning:

at this time my holdings are far below the Federal exemption for estate tax. As we know these laws change, and at that time new decisions may be made or old ones affirmed. Inflation could prompt a review as well. More likely some combination.

At my age, if I held the properties until death, my wife would gain them through joint tenancy deeds. At her death the estate would have them appraised. The State of Ohio would get some estate taxes, presently Federal is exempt. The estate (executor) could sell the properties and distribute the proceeds to our children. Or, Our 2 daughters, hers and mine, could split the holdings and continue operating them as income properties. They would also inherit a new basis for depriciation based on the new appraisal. They may have no inclination to do that and a cash amount may be more appropriate. Capital gain tax is avoided as it becomes an estate tax matter. Either way by size, insurance, and wills, I think I’m, at the very least, OK. If I lived in a state with no estate tax that would be better, but the market I’m in is here.

When you get big, several million dollars big, then there is no doubt more than I am aware of.

On rental @ 80

Maintaining a property isn’t that hard if you budget for it. I have several shell accounts that I fund through the business checking each month. I have a “spending plan” for the entire year that I check off each target as the year transpires. When the proceeds come in I set aside cash for county taxes and insurance, repairs, phone and office, and short term interest. I pay the mortgages, pay the member draws, and set aside retained earnings. Actually, retained earnings comes first, I may make something wait that is less important than RE. On the spending plan all of the properties are conolidated, meaning there is one entry for taxes, insurance, etc. That one entry is the cash need for all properties that month. Each time I check off an entry I’ve reached another small goal. If we add a property, I re-figure the targets from that point forward, print a new sheet, and move on.

And, It’s all on one page.

One of the things about adult condos I have never understood is why people leave a home they lived and loved in, sell half of their things to avoid maintaining a house, when all they need to do is hire someone to cut the grass and shovel snow. And, pay a handy man for a few other things. The HOA fees at a condo do essentially that and the retirees agree to pay the HOA fee in perpetuity. I don’t get that. It’s probably just my poor vision.

When I reach a point where fixing a bad switch or painting a place is more than I want to do, I have a repair budget to get that done. If the budget is too lean it can be adjusted, that’s what business people do. The compare plans to actuals and adjust. If it needs far more cash, then maybe add another unit to provide more cash. Or maybe sell and move to a sand state with no estate taxes. There are a lot of ideas on how to handle things. My wife and I have an agreement. She will let me know when we have too much cash! So far she has not mentioned that as a problem!

In my first business a good friend gave me some advice. I was struggling and we both knew it. He said in his experience it was a better solution to find the ways to increase income than to focus on cost cutting. You can cut until you have macaroni one night and rice the next, but in the end you still have to buy macaroni and rice. There is no limit to how much income you can make.

It took a while for that thought to sink in. In the rental real estate business more cash flow simply means adding units. While that is a sometimes large undertaking, once that productive unit is in place it sends a check each month until you decide to sell that asset.

People get confused about rich v wealthy. “Rich” is the guy with the 6 or 7 digit salary. If his industry has a downsize or a merger he can be unemployed just like the guy at the factory, only his job pool is a lot smaller. Wealth, it comes in every month, whether you’re sick or well, whether you spend your time riding motorcycles or painting pictures. A string of rental units with positive cash flow is a small personal form of wealth.

In the encyclopedia it describes the origins of wealth as: Land, Improvement to Land, Natural Resources, and Value added through manufacturing. In the 20th century, Intellectual Property was added to that list. Most of us will not own a gold or even coal mine. It is unlikely we will create the next Apple or Microsoft. We like hit songs, but most of us can’t write them or screen plays or books. That leaves Real Estate. Land and improvements are available to those that wish to start.

Take care

Ron,

My wife and I are both learning a lot from your writing.

If I understand correctly, you don’t hold your investment properties under your own names, but under one LLC. To protect yourself, you bought an umbrella insurance for the LLC and one for you personally? Is that correct?

Have you thought about starting a real estate investment company and offer your expertise as a service to folks who are interested in RE but don’t want to do the works, however minor they are?

Also, my wife and I recently bought our primary residence. Purchasing the primary home is a major financial understanding and I have found many people did it poorly and dug themselves a big financial hole instead. I wrote a post about my decision process in buying my own primary home, the process is very different from buying an investment property. Can you comment on my process? Is it about right? Do I miss any major consideration?

https://investment-fiduciary.com/2011/11/29/buying-my-primary-residence/

Best regards,
Michael

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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