Question of the day: Is being a landlord worth the hassle? The latest round of texts from my tenant at Rental A, a single mother of three, prompted this post.
I frankly didn’t expect I’d become a more patient and compassionate person by becoming a landlord. But when you get a letter from the natural gas utility of impending disconnection of service, you get to flex a few of your empathy muscles. I hope she pays that dang bill or I’ll go ballistic.
When I started out renting single-family homes, a little over five years ago, I had no idea how it would go. All I had was a spreadsheet that seemed to show a promising return on investment, and a good friend and established landlord to mentor me.
The beginning was rough. I had to put a lot of work into spiffing the place up. Especially after the previous owners left the place coated in a virtual sheet of grime.
Let me tell you, it’s hard to find interested tenants during January in Minnesota, when the house is empty of furniture, and the new landlord is dicking-around with light fixtures and patching holes in the wall. I think a few college students even passed.
But eventually, you sign-on a tenant. And even though I had a full month vacancy at the outset, our first rental house has produced consistent, not-stop monthly rent checks ever since.
Yes, owning rental real estate is a good thing. Especially when you come into it prepared, willing to learn, and with a clear vision. I knew I would have to pick up a few skills to avoid costly handyman and repairman bills.
I knew I’d have to apply some marketing elbow grease. But most importantly, I knew I wanted to run rentals that I would be willing to live in.
For starters, you have no choice but to become more patient and compassionate. As we touched on, you get to meet and interact with all sorts of people from different walks of life. My current tenant at Rental A is a wonderful person, and boy, does she have her hands full. Three girls, one of whom was an infant when she moved in.
If the rent checks keep rolling in, sure, it’s pretty easy to stay level-headed, even with the most “needy” of tenants. And I’ve had my share of head-scratchers with Rental A to put this notion to the test. For instance, there was the time she had her ex punch a hole in the drywall. A hole large enough to extract a small child, who’d managed to lock herself into the bathroom.
Another time I had to replace the dryer because a pair of skimpy undies got trapped in the drum somehow. Talk about getting your panties in a bunch. That was an interesting discovery…
The point is, part of becoming a successful business owner is treating customers with respect. You’ll find that as a landlord, even the most challenging tenants will meet you half-way.
Is Owning Rental Property Worth It?
Can you retire early with real estate rentals? I certainly believe you can. The following paragraphs reveal why. Sure, there is hard work involved. And there are tough lessons along the way. But as with anything, if you’re willing to put in the effort, you can expect big rewards.
Before I became a landlord my friend and real estate mentor often prodded me to get into the game. He had started up his real estate empire of a few duplexes (which would eventually become 5). He created his portfolio over four years while working a full-time job and supporting a family.
At first, I thought this guy was nuts! That’s way too much work on top of a day job and family commitments. Don’t the tenants keep you running around in circles? What about those dreaded 2 AM plumbing calls?
My misconceptions about becoming a landlord persisted. It wasn’t until I read the book “Killing Sacred Cows: Overcoming the Financial Myths That Are Destroying Your Prosperity” by Garrett Gunderson, that I realized I had a lot of work to do to diversify my portfolio. After this epiphany, I approached my buddy and asked him to mentor me in becoming a landlord…
The first step was to recruit my friend’s real estate agent, who specializes in rental property investing. This guy fits the bill too. He’s no non-sense, cautious, and an experienced landlord. We looked at probably a dozen properties before I found the house I’d eventually call “Rental A”.
At showings, my agent would point out things I’d have never noticed, that would’ve been a code issue upon city inspection. For example, “Um, that basement ceiling needs to be at least 6′ 9″ to be a legal bedroom.” But the kitchen has stainless appliances! Sigh…
I’ll admit, through much of the process of house hunting, securing financing, and closing, I was pretty nervous about the new responsibilities I’d be taking on. First off, I had to find a tenant.
Second, I had to figure out the Minneapolis landlord rules and get my property licensed for rental use. So many boxes to check! This is when you start to wonder, “Should I just put that down payment into an index fund, no fuss, no muss??”
Without much hassle and without having to take more than a single day off work (for the closing), I got the house spiffed up and rented within six weeks of closing. Whew!
Here’s the main thing to understand about the passive income nature of rental homes: 80% of the work with becoming a landlord occurs at the very beginning, in those two or three weekends of concerted effort, after assuming ownership of the house.
Your time will be spent cleaning under appliances, cleaning the appliances themselves, painting, replacing fixtures, screens, and whatever landscaping needs taming. It’s a lot of grunt work, mixed with a sprinkle of design (the fun stuff, like putting knobs on kitchen cabinets or replacing an old faucet.)
The other 20%? That’s to do the occasional maintenance work like clearing gutters, planting a new tree, checking in new and checking out old tenants, and cashing rent checks. It’s very manageable, once you’ve teed-up everything at the outset.
Benefits of Real Estate Investing vs. the Stock Market
Let’s compare two scenarios where you have $30,000 to invest, and no credit card debt or auto loans:
- Stocks: Put 100% into a total stock market index fund with low admin fees, and assume a stable rate of return of 5% per year (after inflation).
- House, Then Stocks: Put 100% into a down payment on a $150,000 rental house with $1,400 monthly rents, then, sock all of the rental profit into the same total stock market index fund in option 1, year after year.
Here’s the 30-year projection of returns:
Now just imagine if instead of option 2, you rolled your initial rental home’s profits into down payment purchases of a second, and then a third, and then a fourth rental home, and so on. You can see we’re generating a substantial cash flow snowball effect. Early retirement becomes that much more achievable.
A Side Benefit of Managing Rentals: Handyman Skills!
This comes in quite handy for maintaining your own home. You get to be efficient at cleaning out gutters with five houses to deal with each fall and spring. Another sweet benefit of becoming a landlord I’ll tuck in here: You get to use the tools you purchase for rental work (tax-deductible no less) on your own house.
I honed my tiling skills putting up a back-splash. Kitchen faucet and plumbing replacement? I’ve spent enough frustrating hours to become a master of that craft as well. Thank God for Advil too – cuz lying on your back and trying to maneuver in that tiny space under the sink is a royal PAIN.
I’ve ripped out the carpet and laid down new laminate flooring. That skill sure came in handy with the Airbnb flooring project this past fall. Mending fences, as in, for real fences? Been there, done that.
The key thing I’ve learned (and applied) to our own home is hydrology, i.e., drainage. Almost every single rental at the time of purchase had a wet basement. Not standing water mind you, but the nuisance of random puddles or mildew growing on cinder block walls. You can imagine, in a small house especially, how that odor can overtake a dwelling.
The solution? 99% of the time, it’s as easy as extending the downspouts to route rainwater at least 6 to 10 feet from the foundation. Some of our newly acquired rentals had the cheap plastic coil stuff emptying right into a flower bed, right at the base of the foundation. D’oh!
Tax Benefits of Owning Rental Properties
There are several tax benefits associated with real estate rentals. The most pleasant discovery for me was depreciation. Depreciation of the house itself, the structure, takes a healthy chunk out of your tax bill each year until full depreciation is reached.
As an early retiree in waiting, I’ve opted to accelerate depreciation on two of our rentals. Why? Accelerated depreciation offsets our tax burden even more during the higher income-earning years leading up to retirement.
Depreciation is much less beneficial when you’re no longer a W-2 employee. Be sure to work with a reputable accountant to sort through the different depreciation scenarios based on your specific circumstances.
(Or better yet, I’ll send you to Bigger Pockets, where you can get the full scoop on depreciation. Long story short, depreciation is like a tax-free loan. You will have to pay 25% of the total accumulated depreciation back to the IRS as a “recapture tax” if and when you sell.)
As I mentioned already, you can claim just about any legit business expense as a tax write-off on your return. This is very helpful when you need to buy a new appliance or replace a furnace. It lessens the sting when a write-off sheds 33% off the sticker price. Owning a business does have its benefits.
Other “hidden benefits”? Your mileage, home office, and cell service are legit write-offs as well. At least the portions of those services used for the business. There are entire topics dedicated to the tax code aspects of rentals. I’m just scratching the surface here. It is all good, by and large.
Building a Roster of Trusted Contractors
These are the guys who become effectively part of your “team.” You figure out quickly who’s good and who’s scamming you. It helps to have a subscription to Angie’s List (also a write-off) but even more so, a friend in the business with an established network of electricians, plumbers, tree trimmers, handymen, exterminators, garage door servicemen, roofers, etc. etc. etc.
You get to know these guys well when you have multiple properties to manage. If you’re a repeat customer, they tend to prioritize you a bit higher, so you’re not left flapping in the breeze when sh*t needs to get done.
This isn’t to say it’s been all roses for yours truly. I had a plumber a while back who was a complete a-hole. The a-hole part I could live with, but when he tried to convince me I needed to replace all the drainage pipes at rental A, I knew he had to go. I’d rather pay Roto-Rooter $100 every four or five years to snake the galvanized lines until those pipes started to fail.
Dropping $2,000 prematurely was not going to happen. The funny part was how “a-hole” chose to up and leave the drain clearing job without a word after I turned down the replacement option over the phone. My tenant was there to witness his profanity-laced discontent with my decision. Good times.
So yeah, when you make friends with decent contractors, it’s like gold. You can learn from them too – if you’re willing and able to take the time to watch them do their work. I highly recommend it, so you can become a little more self-sufficient and save $$$.
Becoming a Kick-Butt Business Owner
This was perhaps the most hidden, yet most effective aspect of becoming a landlord for me. I know for certain that by simply taking on a rental business, I’ve been that much more confident and assertive at my day job. Why? I think you start to internalize being a true business person.
Another aspect? Consider this: You’ve taken on tenants, and that’s a pretty big responsibility. You have customers living under your roof. Are they in a safe living environment? Are their needs being met? It’s not unlike becoming a (responsible) parent, or caregiver. You bring that newfound discipline with you to the office.
Since I’ve taken on rental properties over five years ago, my work performance has improved in parallel. It’s sort of a paradox. Your first impression might be that this major side hustle is a huge distraction from work. But likely, it’s as simple as having no other choice than to get your sh*t together, and learn to juggle and prioritize like a maestro.
At any rate, you’re the boss of your rental empire, and you bring some of that swagger to the office. You quickly learn how to plan, prioritize, and juggle many tasks. Especially as your portfolio grows. Is the process of becoming a landlord worth it? If you appreciate the benefits of challenging yourself to improve, then YES.
How to Start a Rental Business in 10 Steps
- Location is everything. Explore Craigslist to determine rents in neighborhoods you like. (Yes, I said “like”. If you can’t envision yourself living there, then don’t become a landlord. You won’t appreciate the property and it will show.)
- Know the market and set your income expectations. Cross-reference rent prices with Zillow.com to determine the spread between the monthly mortgage (property tax and hazard insurance included) and monthly rent. This spread is your cash flow. I target $500 per month, and that’s after factoring in about $1,000 per year in maintenance expenses. There are other metrics you can use to decide if the property is a good investment, such as CAP rate and Cash-on-Cash, but focus on the spread for now.
- Set aside money for a down payment. You’ll need 20% (single-family house) or 25% (multi-family duplex or quad-plex) of the purchase price up-front, or roughly $30,000 for a $150,000 single-family house. A good place to start would be your tax refund (if you get one), as it is typically a large amount of money all at once. You can use a free income tax calculator to give you a better idea of what you can expect back.
- Get the right real estate agent. A good agent who has experience as a landlord and property manager is a must. Even better if he or she manages rentals in the neighborhoods you’re considering. An experienced agent will not be hesitant to walk away from iffy properties and will be able to point out all of the potential problems so you don’t have to learn the hard way. The agent will get you hooked up with the MLS online so you can check out new listings as they pop onto the market.
- Shop around for a good rate, but try to get pre-approved from a local mortgage broker. I prefer having a local mortgage broker I can meet with in person, if necessary. I’ve worked with the same guy for all four of our properties and we’ve built a good working relationship. Since the housing crash back in 2008, underwriters have ratcheted up scrutiny on all loan approvals. Be prepared to provide a lengthy paper trail before getting the bank’s blessing. You’ll give that office fax machine all it can handle!
- Shop around. A LOT. You can’t be too picky, but you certainly don’t want to rush the process. You want to make sure this rental property hits all the key criteria:
- Close to amenities like markets, schools, mass transit options, playgrounds, parks, lakes, restaurants, etc.
- The foundation is SOLID. Spend most of your time in the basement. That’s where the money is lost if you start with old mechanicals, collapsing foundation walls, and water seepage issues.
- Make sure the surrounding houses up and down the block are in as good or better condition than your rental. You don’t want the opposite, where your rental is the castle of the block.
- The roof is in good shape and has at LEAST five years of life left in it.
- Avoid funky configurations. Crazy bedroom dimensions of 14’ x 6’ aren’t all that functional. Neither are bathrooms right off kitchens. I just don’t get those. Ick.
- The windows are solid. You don’t need anything bright shiny and new, but you sure don’t want a house full of rotten windows to replace ($$$)
- Put in an offer, and light a candle. But be prepared to lose if you’re in a hot market! I can’t tell you how many times I’ve lost out to competing bids on properties. Easily a dozen, just in the last couple years. That’s not from coming in too low as much as sellers love cash buyers, and they also appreciate homestead buyers a bit more than us picky investors. With that in mind, be reasonable with your offer but never remove the inspection contingency. (That’d be a rental property investing no-no!)
- Find a QUALITY inspector. This is important. Unless you know the ins and outs of a house from electric, to structure, to plumbing, etc., do not take chances with your choice of an inspector! Thanks to online reviews in Google and Yelp!, I was able to find a quality shop that earned every nickel with their attention to detail.
- Make sure your upfront repairs and improvements are minimal. I use 3-5% of the purchase price rule since my rentals are more “turn-key” in quality. That’s about $5,000 – $7,500 in upfront expense. If I spend any more, my return on investment starts to take a turn south. You can get away with a higher percentage of the home is a rehab job or a foreclosure.
- List the house on Craigslist! We’ve come full circle from step 1. Get your post up as soon as you’ve closed on the house. Try to get a hold of the listing photos from the seller’s agent, and upload at least one photo per room, and include an exterior shot. Assuming they’re good quality images, you can re-use them over and over.
More Rental Property Investing Tips!
- Try to keep your rentals within a 10-15 mile radius of your home. This is especially true if you’re managing the property on your own, which I recommend.
- Create a pay-it-forward system where your soon-to-be leaving tenants show the home to prospective new tenants. This saves you, the landlord, time and travel, and saves the current tenants the hassle of having to clear out for showings. It also gives the current tenants incentive to show it well, to avoid having the hassle of showing after showing until someone signs a lease.
- Make your Craigslist listings the best of the best. Use good photos that rely on daylight and show a clean, clutter-free house. Pretend you’re writing a blog post – the more content and detail, the better tenant you’ll attract.
- Obtain lease agreement and lease application templates from other landlords renting in the same area. You can do this by conveying interest in a Craigslist post. Read each form carefully and be sure the lease is thorough and covers your interests, end-to-end. Nolo.com is a good resource if you prefer to start from scratch. I got my templates from my mentor.
- Put a provision in your lease allowing a lease buy-out. This allows a tenant to move out early, without having to owe for every remaining lease month. The tenant would pay a lesser “penalty” fee per month, but not more than a third of what rent would be. This softens the hassle of having to find new tenants, but also, more importantly, provides an incentive for tenants to STAY PUT.
- Make sure closing occurs no earlier than late spring, and no later than early fall. You want to be able to rent this thing right away to avoid vacancies right after closing. Fewer tenants are looking for a place to rent during the holidays and winter, particularly in the colder, northern states.
- Treat your tenants as customers. Get back to them quickly and resolve problems quickly. Congratulate them on big events, like marriage, newborns, etc. The little things will build trust. You’ll be returned the favor when they tell future tenants what a great landlord you are at showings!
Punch Your Ticket to Early Retirement!
I owe a lot to my friend and mentor who helped me get started in the world of rental properties. He’s not so nuts after all. It’s a daunting thing at first, but after that first house, you will be a seasoned landlord.
Just remember what I said at the outset. There are some hard lessons and it’s not all roses.
Remember to consider short term vacation rentals as well. These opportunities should be carefully considered as vacation rentals can often yield higher revenues than long term rentals.
Airbnb and VRBO are excellent platforms for hosts. Our Airbnb condo in Northern Michigan brings in anywhere from $500 to $800 per month after financing and maintenance costs.
The only downside with hosting short term vacation rentals (other than the extra time and attention) is the tax treatment is a little less favorable, though not enough to sway one from playing the game.
Discuss the options with your accountant and explore existing vacation or short-term rentals in a market you know has some viable and sustainable demand. Check out my definitive post on vacation rental properties to learn more.
Are there other benefits of becoming a landlord you’d like to share? Please comment below!
Featured Photo by Michael Browning on Unsplash