Landlording & Rental Properties

4 Reasons Your Home Probably Won’t Make a Good Rental

Expertise: Personal Finance
13 Articles Written
rent-sign-front-yard

We all make mistakes. Some are more costly than others. Each contains a lesson.

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In mid-2006, my wife and I purchased our first home. The property market in our area was booming.

In early 2008, we needed to move to another city for career reasons. Unfortunately, during the time span that separated these two events, the global financial crisis happened. We couldn’t sell our house; we didn’t even get an offer.

With an eye toward making lemons into lemonade, we decided to rent the house out. What we made was more like sour medicine.

For nearly a decade, we poured dollar after dollar into a money pit. Ultimately, we sold our former home for a loss nine years after we bought it. We lost money on our capital, we lost money every week we owned it, and of course, we paid real estate fees to get rid of it.

The house cost us a small fortune to operate as a rental. We’ve learned a lot since then.

Just thinking about buying a home for the first time brings waves of emotion. It’s both an exciting and frightening concept for most people. First and foremost, know you’re not alone! Over one-third of all Americans are considering buying a home in the next five years. Our First Time Home Buyer’s Guide prepares you for the road ahead.

“Maybe we can rent it out.”

I love to talk about real estate. That’s what happens when you have a passion for something—it tends to work its way into conversation. But time and again, friends, colleagues, and acquaintances tell me that they aren’t interested in “fixing toilets.”

The closest a few will come is to say that maybe they’d like to turn their existing home into a rental. In fact, this is a line that I hear often: “I’m thinking of buying a bigger house for our family. Maybe we’ll keep our current house and rent it out.”

Most of the time, it’s bad idea. I think it’s great that these people are considering rental property, but most don’t know how to make the numbers work. I didn’t know either.

For me, getting through the learning curve involved taking on board a number of lessons that I think are critical for people who want to use rental property as an investment vehicle for their future.

owner-occupied-financing

Related: The Part-Time Investor’s Guide to Truly Passive Rental Income

Lesson 1: A rental is a business.

Unlike stocks, which represent shares in a business, a rental property essentially is a business. The purpose of a business is to make a profit.

Think critically about this. The rental income from your property must cover all costs with something left over: profit. Costs include property taxes, insurance, ongoing maintenance, capital repairs, property management, and more. They also include the mortgage payments.

In my experience, the size of the mortgage is usually what pushes the property from being a good, cash flow positive rental into a cash flow negative money pit. Put simply, if the market rent that you can easily get for the property does not cover all of your expenses, then the property is not a good rental.

The main issue is this: If you originally purchased the house to live in yourself, then you probably paid too much for it. You purchased it based on emotion—the desire to find a place for you and your family to live comfortably.

This was not a business decision. A large percentage of the time, when you look into market rents for your home, you’ll find that the rent you can expect to get cannot cover all of the expenses.

There are a number of reasons for this:

  • You overpaid to begin with because you really wanted it and because you were looking at what you could afford.
  • The property has many features that don’t increase rent—marble countertops, plush carpet, top-of-the-range appliances, elaborate decking, swimming pools, the list goes on.
  • You paid for a large yard. Land costs money, but yards need to be maintained and renters don’t usually want the hassle.

It’s not that renters deserve less. It’s that in many cases, they won’t pay for more. But you did.

Lesson 2: A rental is an investment.

Are you looking for an investment or a hobby? A lot of “mom and pop” investors put a lot of their own time and money into the rental. They do this either a) by putting in a very high deposit (or using existing equity) in order to have the rent cover the difference in the mortgage plus other expenses, or b) by constantly paying out-of-pocket for the difference.

Either way, they are “topping up” the mortgage with their own money. Let me ask you this: If you purchase stocks or bonds, would you expect to keep dumping money into the investment every month just to hold onto it? I don’t think so.

But with a rental property, if you are “topping up” the mortgage payment every month, then you are not investing. You are subsidizing the lifestyle of your tenants. You’re paying for your tenants to live in a house that they can’t actually afford (or are at least not willing to pay for).

The problem with using a lot of personal cash or equity to make a deal work is that it doesn’t scale. The reality is, depending on the market that you live in, it can take a long time to save up the money for a down payment on a property. If you leave that money there—known as “parking your money”—then you will have to continue to save money in order to purchase another property.

Let’s say that it takes you five years to save enough to purchase another rental. This severely limits the number of rentals that you can purchase in a lifetime.

This brings us to our next lesson.

business-plan

Lesson 3: A rental is part of a bigger strategy.

Why do you even want a rental? If the purpose is to have some income from your rental property in your retirement, I encourage you to take a close look at how much income you can actually get from a single rental.

Look at the total rent that you collect in a year. Then, subtract all of the costs other than the mortgage payments. This is how much gross income your rental could produce in a year once the mortgage is paid off. And don’t forget that if you take this money as income, you will have to pay taxes on it.

Looking at just one of our single family residences as an example, after all expenses other than mortgage payments, it brings in about $12,000 per year. If I were to take that as income, then I’ll have to pay tax on it as well. I don’t know about you, but that’s not going to change my lifestyle in a significant way on its own.

You need to think bigger. If you want $100,000 in gross annual income, for example, then you’ll probably need around eight or nine similar rentals. Ten is a nice, round target.

Some investors like to get into multifamily housing, as this tends to produce higher yields.

You can’t live on one single rental property that you nurture and coddle because it was once your home. Of course, it’s still an “investment,” but it’s not enough to live on alone.

Lesson 4: You need the skills of an investor in order to scale.

Let’s go back to that first rental that you bought. If you are parking your money in that one rental, then it’s going to be very difficult to continue buying more rentals in order to fund your “financial freedom.”

An investor looks at it differently.

Related: 6 Tips to Craft a Highly Coveted Rental — Without Over-Improving It

An investor will look at the median rent for the property being considered. Next, the investor will tally up all of the actual expenses (e.g., property taxes, insurance, etc.) and likely expenses (e.g., maintenance allowance, vacancy allowance, etc.). The investor will then look at current and expected future interest rates and plug in a likely purchase price.

If the rent will not cover the expenses and mortgage payment, then the purchase price is too high. The purchase price needs to be lowered until the rent does cover all costs. Once a price is found that will work with the numbers, that represents the highest price the investor is willing to pay. Negotiation should, of course, start lower.

Even though you will need to put down a deposit and will initially have a mortgage less than the amount of the full purchase price, you cannot scale if you don’t eventually refinance the property and get your original deposit back. If you can’t do this, then you paid too much for the property and it will take years—sometimes decades—to make up for it. This is why an investor will use the full purchase price for calculating mortgage payments when running the numbers.

Numbers Tell the Truth

I have experienced both sides of this.

We lost approximately $5,000 per year for about seven years while renting out our first home. We also lost $20,000 on the purchase price, plus we had to pay the real estate agent about $18,000.

So, all up, the property cost us about $73,000. We learned a lot from this experience, but the lessons were very expensive.

Did you purchase your home on the basis that it might be rented out in the future? If not, the numbers probably won’t work.

As an exercise, run the numbers and see what you come up with. Find out what median market rent is in your area for a property of your size. Consider all the costs of owning the property and renting it out. This exercise will most likely tell you how much money you will lose each year.

In the end, it’s not about fixing toilets; you can pay somebody to do that. The risk in owning rentals, as with most investing, lies in not knowing what you’re doing.

The math is actually very simple. It’s the mindset that needs to be shifted.

A rental isn’t a house that you’re not living in. A rental is a property that is purchased at the right price.

Would your house make a good rental?

Let me know what you think with a comment!

In 2013 Brad awoke from lifelong financial slumber and took responsibility for his family’s financial future. His primary vehicle for wealth-building is buy-and-hold real estate. He is passionate a...
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    John Murray from Portland, Oregon
    Replied almost 3 years ago
    Most new investors make mistakes. Everyone must learn. I have been very successful in the RI rental game. Here is what I have learned. 1. For every 100-200 properties I look into I put is 3-5 offers and close one. 2. Every new project takes 500-800 hours of my work and about $100 per day of my money. 3. You have to have at least $300K-$500K of capital and do this full time to start. 4. Building trade skills as well as building methods and material knowledge is a must to succeed rapidly. 5. Provide outstanding service to my tenants and they will stay and pay rent on time. 6. Get a wealth building CPA that is a passive income expert and save thousands.
    Domenick T. Investor from Springfield , New Jersey
    Replied almost 3 years ago
    Thank for the great article Brad. I started out in a very similar way as you did right around the same time. I was losing about $13k every year. I became obsessed with trying to break even on cash flow. I made some improvements, found some great tenants, saved costs where I could and eventually when the market turned a little better I was able to realize a small profit. I learned so much from the experience. I decided to buy more rentals and haven’t looked back! The key to making a former home a successful rental is to understand one thing – if you own a home in a non-rental community, then it will probably never work out. You can’t change the neighborhood. If there isn’t a large enough pool of people willing to rent your type of home, then you need to sell and invest somewhere else. I was lucky enough to own in a strong rental community so I was able to find great tenants willing to rent my condo. You can make it work but the fundamentals of a good rental have t be there.
    Juan Hernandez
    Replied over 2 years ago
    I purchased my first beach condo 5 yrs ago in the best area in my country. I had a bargain price but I had to completely remodeled. I put the best features since am competing with others condos and Hotels in the area. I am short renting with a minimum of 3 nights. The apartment is advertised in Homeaway and is been a success. I am making a 7-10% back in my investment not counting the capital gain. I purchased a bigger one in the same area and the return have been better. To me the key to the success is to invest in the hot areas for renting. I mean with hot areas by having high rental rates, for instance, tourism areas.
    Nathan Williams Investor from Austin, TX
    Replied over 2 years ago
    You lost 73K? Of your own money? Why didn’t you just walk away?
    Patrick Murphy Residential Real Estate Broker from Phoenix, Arizona
    Replied over 2 years ago
    Great article and I agree 100%, there is one more aspect and that is emotional. My wife and I moved out of state so we rented our beautiful house that we renovated and lived in for 9 years, renters had no skin in the game and trashed it. When we got the house back we were heart-broken to see it. This is where we lived and met our neighbors then to have someone treat it with no respect. Think to see all of the blood sweat and tears you put into your work and how you enjoyed it for so long then just to see it trashed. We were lucky we sold it for a good profit and took the money back to our new state and bought rentals, those we figure are a business and we are able to detach ourselves, but our beautiful home was hard. We now have 9 and for some reason those are easy to detach yourself from. Thanks for the article
    Patrick Murphy Residential Real Estate Broker from Phoenix, Arizona
    Replied over 2 years ago
    Great article and I agree 100%, there is one more aspect and that is emotional. My wife and I moved out of state so we rented our beautiful house that we renovated and lived in for 9 years, renters had no skin in the game and trashed it. When we got the house back we were heart-broken to see it. This is where we lived and met our neighbors then to have someone treat it with no respect. Think to see all of the blood sweat and tears you put into your work and how you enjoyed it for so long then just to see it trashed. We were lucky we sold it for a good profit and took the money back to our new state and bought rentals, those we figure are a business and we are able to detach ourselves, but our beautiful home was hard. We now have 9 and for some reason those are easy to detach yourself from. Thanks for the article
    Domenick T. Investor from Springfield , New Jersey
    Replied over 2 years ago
    Great points Brad! I started in the same way. I converted my condo into a rental even though it had no business being a rental because the numbers didn’t make sense. I was too far underwater to sell it though. What made the difference for me was that (1) I treated it like a business and was determined to at least break even and (2) it was in a very hot market that I knew would recover quicker and rents would continue to climb. That’s another mistake new landlords make when converting their home into a rental. They don’t realize that the neighborhood is actually a poor rental market. If the ratio of renters to owners is too low then they will have a very hard time renting the property and will incur too many vacancies to make the numbers work long term. They would be better off cutting their losses and moving on to a proper investment.
    Domenick T. Investor from Springfield , New Jersey
    Replied over 2 years ago
    Great points Brad! I started in the same way. I converted my condo into a rental even though it had no business being a rental because the numbers didn’t make sense. I was too far underwater to sell it though. What made the difference for me was that (1) I treated it like a business and was determined to at least break even and (2) it was in a very hot market that I knew would recover quicker and rents would continue to climb. That’s another mistake new landlords make when converting their home into a rental. They don’t realize that the neighborhood is actually a poor rental market. If the ratio of renters to owners is too low then they will have a very hard time renting the property and will incur too many vacancies to make the numbers work long term. They would be better off cutting their losses and moving on to a proper investment.
    Charles Bellanfante
    Replied about 2 years ago
    Great Post. Totally factual.
    Vikas Kashyap
    Replied about 2 years ago
    Very good information
    Suzan Hampton
    Replied almost 2 years ago
    Very helpful article-thanks! Considering now whether to reno/rent or reno/sell my mom’s house in what I believe is an established, middle-class, owner-type neighborhood in Kansas City. Must do research and run numbers but I’ve felt uneasy thinking about renting it but didn’t know why. After reading these comments, I think it’s because I don’t see any other rentals around there.
    Michael Smith
    Replied 9 months ago
    It doesn't matter, you can always try it out on AirBnb and alike before going long term. The most important part- the numbers have to work.
    Daniel Vidrio Rental Property Investor from Benicia
    Replied 9 months ago
    I imagine this is a common mistake Newbie investors make and one I can cans sympathies with. I've made similar mistakes when if first started off. Too me it was very painful lessons and it took me 5yrs before I could build up courage to restart. I purchased a short sale home and now looking to add 2bd ADU and 1bd JADU.
    Rebecca Hopkins
    Replied 9 months ago
    In this scenario, the question isn’t “will I bring in more rent than I put into buying and maintaining this property,” because you’ve already bought it. You are financially and emotionally invested in the place. The question is “will I lose less by selling it for what I can get for it right now, by leaving it empty til prices come back up, or by renting it out”? This depends on current and future conditions of the local economy you’re leaving behind. You should be asking this of the property management companies you’re thinking of hiring, because if you’re moving more than a hour or so away, you will not be able to stay on top of the goings on in “your house” and that will cost you more than just money.
    Steven Peterson Rental Property Investor from Chattanooga, TN
    Replied 9 months ago
    Is this not all self evident? Who has a rental that didn’t look at the numbers first?
    Jason Colucci
    Replied 9 months ago
    I don't mean to be insulting to anyone but I feel like this is common sense stuff. Don't rent your house if the rent doesn't cover the monthly expenses.
    Kees Boer
    Replied 9 months ago
    So, you said something about having to pay taxes if you receive rental income from your rentals. I.e. positive cash flow. So, if you don't receive income, where would you put that money so that it is not income? and that you don't have to pay taxes?
    Kristi Kandel Developer from Stateline, NV
    Replied 9 months ago
    "It’s the mindset that needs to be shifted." SO true. There are so many people I've run into that just don't get that it's a business and a really great path to financial freedom.
    Fabio Teixeira
    Replied 9 months ago
    Great topic and great discussion. Thank you Brad and eveyone who've shared their thoughts and experiences.
    Peter Grote Investor from Seattle, WA
    Replied 9 months ago
    Nice article Brad, however, I don't think your single example applies across the board. Examples where I think it can make sense to rent out one's house are when the owner has lived in it long enough to have equity. Even if the owner "overpaid" because it was an emotional purchase if the home is in a desirable, area the value should increase over time - which is one reason why we invest in real estate in the first place. Secondly, most people reading the article are real estate investors and have experience as landlords and so renting their home wouldn't be any different than managing any other rental property - assuming they are ready to leave it emotionally. Really it comes down to evaluating it objectively like any other investment - what will the cash flow be? is this the best use of the equity? or do I want to sell and invest in something else?
    Courtney Macon
    Replied 5 months ago
    Hi! Thank you for your article, it was very helpful! My husband and I bought our first house 4 years ago and owe just under $70K. It's a 3 bedroom, 1 1/2 bath, about 1400sq ft. We pay $489 in mortgage (includes insurance and taxes) and the median rent in our area is about $750+. We are looking to buy a small piece of property and build a home. I seem to think keeping our current home and turning it into a rental, wouldn't be a terrible idea. My husband is unsure. What do you think?
    Sheetal Kumar
    Replied 4 months ago
    Thank you It was an amazing article. I recently came across with one such amazing site that helps first time home buyers to buy their dream house. Visit: www.homecapital.in to know more.