The Good Rental Property And Its Evil Twin

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Very early on in my investing career I received a great lesson in rental property ownership.  In the early 1990s I saw the potential for the Las Vegas market and decided that it would be a good idea to have long-term investments in the area.  At the time there were about 5,000 people moving there each month and builders were adding new housing at a furious pace.  There was a good supply of resale homes and the rental market was strong.  I was looking for future appreciation as opposed to immediate cash flow.

I lived in New York at the time and I would be investing long-distance.  I did have connections in the area and I received recommendations for real estate agents and a property manager.  I knew that investing outside of my local area would have some challenges and I was prepared to accept that.  Further complicating matters was the fact that I was taking on investment partners.  I did have partnership papers drawn up and everything was clearly spelled out. 

One of the major advantages of investing in the area was that there were an abundance of newer homes with FHA mortgages, at the time these mortgages were fully assumable.  With partners putting in cash, I was able to acquire properties fairly easily.  My plan was to acquire two properties and see how things worked out.  If it went well I would look to acquire additional properties.

The Good House

After several trips to the area and looking at dozens of houses, I located a property that met my criteria.  It was a 3 bedroom, 2 bath house in an excellent neighborhood.  The only work it needed was to have the carpets cleaned.  The purchase was smooth as could be due to the assumable mortgage and there were absolutely no complications with the closing.  My property manager began looking for tenants right away and had located and qualified a young family that would be ready to move in almost immediately after we closed escrow.

I had purchased the house for just over $100,000, including all closing costs.  The rent was enough to cover the mortgage, taxes, insurance, management fee and an allowance for repairs and maintenance.  After everything I was left with about $150 per month which was added to the maintenance fund as well.  The tenants were absolutely perfect.  There was never a problem, they paid the rent on time, and the house was always immaculate.  They stayed there for five years until a job transfer caused them to move. 

The House of Horrors

We all know of parents who have a child that is so good that they can’t wait to have another, then Damian arrives with his Omen.  House number two was like that for me, if it had been house number one there would not have been a number two.  The second house was located in a different part of Las Vegas, but still in a good area.  The owners were desperate to sell and I was able to make a fantastic deal.  I was expecting to get even better cash flow than house number one.  It was also going to be a mortgage assumption so I expected a quick close.  My property manager began looking for tenants and had a family ready to go fairly quickly.

Then the fun began.  There were problems with the assumption because of missing paperwork and there were some title issues as well.  It took several weeks longer to close escrow than anticipated.  The tenants that were going to move in couldn’t wait and rented a different house.  We had to return their deposit because we couldn’t deliver the house when promised.  My property manager started looking for new tenants but was having a hard time finding anyone who qualified.  We eventually settled on someone who was looking for a six-month lease.  Big mistake.

The rent was constantly late and we had to file a notice to evict more than once, but they always paid before we could throw them out.  They left at the end of the six month term but left the house a shambles.  The carpets were ruined, holes in the walls, banister torn off the stairs and numerous other problems.  We kept the security deposit but that wasn’t enough.  They also moved without any forwarding address and we decided it wasn’t worth it to track them down.

After making several thousand dollars in repairs we rented the house again.  The next set of tenants were a problem as well.  They were constantly calling with one problem or another, rent was always late and rent checks bounced.  They left at the end of the lease and we rented again.  Problems again even though all of these tenants went through a screening process.  Because of extended vacancies, excessive repairs, eviction costs and other expenses this house was always losing money.

Lessons Learned

My partners were so fed up with that second house that they insisted on selling.  I can’t say I blamed them, but my preference was to hold on.  We did wind up selling house number two at a minimal profit after five years.  After taking into account all of our costs over the years, we made a profit of about $5,000, that amounted for about a 1% annual return.  Certainly not worth all of the headaches.

We also sold house number one at this point, a better result but not a home run by any means.  That first house netted a profit of just over $30,000 plus five years of positive cash flow.  When we calculated everything it amounted to about a 6% annualized rate of return. 

The end result was that I learned an incredible amount about owning rental properties and about long-distance investing.  It was also a lesson in working with partners.  I have invested with partners since then, but I am never eager to do so.  The rental property business is not an easy one but I have applied what I learned and my expectations are much more realistic now and the results have been much better.  These were not lessons that I could have learned any other way.  No book, course, guru or mentor could teach me as much as owning these rentals did.

Sometimes adversity is what you need to face in order to become successful – Zig Ziglar

 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.