Newbie Rental Investment Questions

17 Replies

We are looking to purchase our first rental property, but are feeling overwhelmed about the amount of information and "analyses" people use to make their decisions. We have a few personal friends who own rentals and none of them ever really went into depth with these things and all are doing well so far...

We live in Colorado Springs where home prices and population have been increasing. There is still a growing market here, and the colleges and military bases all bring in plenty of renters. My husband and I rented here for several years here before buying our house and our rental applications were turned down often because we were competing with so many other applicants (we have pets!)

If we're buying a single family home that is not undervalued or a foreclosure in a growing area where home prices are expected to rise, shouldn't we reasonably assume that its value will go up.. as we expect to happen with our own home? (we don't live in California!)

Also, for a place that is going to be used 100% for renting, do you buy the worst house on the block that can rent cheap or a nice place that you would live in yourself, but that is considerably more expensive?

Hello Kim:

I live in CA and own a duplex. You have to run the numbers and figure out what you and your husband can afford in terms of time and money. If you purchase the "worst house on the block", it still needs to be (to use HUD verbiage) decent, safe and sanitary to rent. A cheap home may need repairs that will have a considerable cost in terms of time and money. Are you and your husband doing repairs should the home need any? Conversely, paying for a home that is expensive will need a rental income that will cover costs, as well as, your mortgage. So take a little time, put pencil to paper, try the analyze tool here on BP and be honest about your situation, financially and otherwise. Good luck!

Malissa

@Kim Rose Try not to get caught up in what everyone else is doing and how they are over analyzing their properties. What you guys need to do is sit down and see what attracts you to real estate investing, where you want to get to, and how you want to get there. I started by renting out my homes when I moved away, a lot like what you are talking about. Then, I started buying pure rentals in nicer neighborhoods where I wanted to live that were under priced or needed work. I was able to force appreciation with improvements and make the numbers work as a rental home. I try to be as close to the 1% rule in those SFR as I can, 1% of the purchase price per month in rent. I run every deal through a calculator I came up with that shows income and breaks down each expense and estimation of repairs/vacancy/etc... Then I look at what the cash on cash return is and what my overall ROI is without any appreciation. From there, I make a decision on whether the property works or not. So, start with the 1% rule then further analyze it with all the detailed numbers and conservative estimates. If you are buying homes cheaper homes in worse neighborhoods, certainly those quick look numbers would need to change. A lot of people want 2% or more on those types of properties. I manage my rentals myself, some from a distance, so I want the kind of houses and renters that I don't hear from very often if ever. Of course saying that now my phone will ring. However, that is my choice and I'm sure it won't work for everyone. A lot of people will certainly disagree and say their method of investing works better than mine. And, my strategy may change in a few years time as well.

I would caution you not to invest based on appreciation alone, paying market prices for houses as rental properties hoping they will continue to go up in value is dangerous. I like to buy about 25-30% below market to ensure I can withstand that type of drop in prices. To do that, I have to wait for the right deal to come along and constantly be looking. I have enough cash now to where I am making cash offers on undervalued homes, renting them out and then pulling the majority of my capital back out by placing financing on the property. I can only do that on a couple more residential secondary market loans then I am over to commercial or portfolio loans. But, it wasn't like that at first so I was looking for short sales, foreclosures, big price drops on the MLS, etc... It took time and I made some purchases then that I wouldn't make now.

Good luck and if you have any questions I would be happy to help out, I wish I was a member of this site when I was thinking about getting started.  

@William Allen , I guess we're looking at it too simplistically and not digging deep enough.. but the way I see it is that in 30 years with just a $30k downpayment we will have a fully paid off house.

Unless the housing market crashes, how can any real estate investment in the long term not be worth it? Even if there's no appreciation.. if the house just maintains its value and even if we put in $100k into.. we still come out with a profit. I know I'm missing something here and I must be very naïve.. but it just seems like too much of a win situation.

We already have our entire retirement riding on the stock market. Real estate seems like something a little more comfortable.. at least if one day we go completely under we have a fully paid off house to live in!

Here are some reasons why you could lose money on a rental when banking on appreciation only. 

Vacancy, high and unplanned capital expenses (roof, A/C, plumbing, electrical, etc...), repairs, tenant trashes your house, drop in the market, spike in insurance rates, property management, and the list goes on.  

These are the things that you need to build into your analysis and the reason a lot of new landlords lose money because they think if their mortgage = their rent they are in good shape. Also don't forget about the opportunity cost of money, you are right that you are investing $30k into that home and the tenant is paying down your loan principal. However, what would that money turn into 30 years later doing something else with it? You want to make sure you beat that return with your real estate investment and to do that you have to calculate the ROI of your money and ensure you are achieving the return which is in line with your goals. You are right, you may come out with a profit but how much??

If it was easy to just buy any house, rent it out, and make it big wouldn't everyone be doing it?  Maybe they should, don't give away the secret...  I'm sure there are some folks on here who can tell stories of the money they lost in rental properties.  Or maybe they are on the stock market forums now and sold their houses to us for a big loss?

Good luck with whatever you chose to do but remember that you make your money when you buy!

@Kim Rose

Welcome to BP. Lots of good info has already been stated. I'll give my two cents on the two questions you asked.

First, can you expect your home value (rental or personal) to go up? Usually, yes. But there is no guarantee. So you want to purchase a rental property that has monthly cash flow. That way any appreciation is just icing on the cake.

Second, you definitely don't want to purchase the nicest place on the block, whether the block is good or bad. Then you'll have a hard time selling it some time in the future. The worst place on a good block seems like an awesome option. Buy it cheap, fix it up and create some equity. You probably don't want to purchase the worst place on the worst block, unless you are ready for some major challenges.

Keep moving forward. Read and learn as much as you can. But your real learning starts when you actually take actions. Meet with a lender. Meet with a Realtor. Etc.

Mike

@Kim Rose I started out thinking just what you are thinking. I did just what you are contemplating. Buy a house or two, cover the mortgage for 30 years and wha-la nice retirement. The plan was working until I decided I wanted more. I wanted to be "retired" before 30 years. I wanted to be able to buy more in order to be wealthy and have financial freedom. Once I started wanting those things, then what I bought and what I paid changed drastically. Much of the  conventional advise here is based on creating and growing wealth for a much shorter term than 30 years.

The statement of "begin with the end in mind" comes into play here. Your end is to own a free and clear house in 30 years. Many people here have and end of financial freedom in 10 years or 5 years so what works for your end would not lead to their end.

My biggest mistake was to not have better more lofty goals. Had I had better goals to start with, I would have made better purchases and would be better off today. What we challenge people here to do is to have better goals.

In a hot market, it is discouraging to search and search for a good deal and come up empty. You feel like you are missing out. Your agent get impatient and probably won't understand your long term goals. 

My advise is two things.

1) Figure out what kind of tenant you want to rent to and then only buy properties that those types of people will rent. This is advise I give everyone starting out.

2) Look in your market for your target homes for at least 6 months. Visit every property and go to all open houses. Find every FSBO. After you do that, you will then know what is a good buy. Use that 6 months to decide what you would buy based on what you have seen. The next 6 months you can then decide to pull the trigger. For me I would look during the Mar to Aug time frame and buy during the Sept to Feb time frame. If you are careful, you should be able to purchase a home that you could then sell and break even or make a few dollars the day you close. Remember to sell it costs you about 10%.

You make your money when you buy.  

@Bill S. That is some great advice! Thank you. How does one find these undervalued homes? We are not paying in cash. I feel like experienced investors in the area would just snatch up the good deals quickly. And the homes that are on the MLS that are excessively cheap have been on the market for a long time and just seem suspicious. It seems like these amazing 25-30% below market value deals are just elusive for average people.

Welcome to BP!

@Kim Rose check out a lot of the info on here through the "Learn" tab at the top...there are free resources that can help answer those questions.  A lot of it comes with education and takes some time to learn about the business side of real estate.  Having that better understanding allows you to have the vision to find "deals" despite having little or no money down.  A lot of good advice has been given.  Good luck as you begin your journey!

@Kim Rose

Ok so a couple of things here,

I love the idea of investing in a place that has Military and college students. I think it's great for rentals. 

I try to buy the worst house on the block, but then I fix it up. My rule is that I will not rent a place out to people that I wouldn't live in myself. So I love crappy houses, but I redo them up to a decent clean standard. I'm a simple person and don't need a palace, but it also has to be a nice decent place. If you have a crappy place, expect crappy tenants :)

Don't do an investment based on what a property "could" appraise for in the future. Do the numbers work now? Will you be making cash flow now (with the money added in for repairs)? If not, don't do it. Yes, your property will probably appraise for more in the future, but I just count that as a bonus. Don't bet everything on that.

Now I think you have something here, when you were mentioning that you rented for a while but had a hard time finding a place because you have pets. We actually do have quite a few places that we rent to people with pets. It's kind of an untapped market in our area. The good thing is that people with pets are willing to pay a bit more because they know it's hard to find people who want to rent to them. We have had some really great tenants with pets! 

The downside is of course that pets can DESTROY your place. It is a risk. Typically though, my opinion is that it's the owners that are bad not the pets. You have to do a good job of screening your potential tenant and really go with your gut. 

Excited for you and your real estate journey!

@Lacie Morris Thanks for your input! We have been tenants for a long time with our pets. Here in Colorado, there are lots of pet friendly rentals. Our problem with renting a house though in the more desirable neighborhoods was that there were so many qualified applicants  that the landlord always preferred the ones without pets or the ones who had 1 dog and not 2. We have had to pay exorbitant non-refundable pet deposits and monthly fees.. and it seems to be a welcome money maker for lots of landlords. And especially the greedy ones. We had a horrible tenant experience with one landlord who charged us a large non-refundable pet deposit and then when we moved out claimed that our dogs had caused several thousand dollars worth of damage beyond our pet/security deposits... which was entirely false. We had to see a lawyer about this and in the end learned that this was her tactic for bullying tenants into keeping their entire security deposits. We decided it wasn't worth taking her to court over. As tenants, we then decided no more private landlords ever again.

Welcome to BP, @Kim Rose ! The rental and housing market is an interesting one here in Colorado right now. I wish you all the best. By the way, I'm sorry to hear about your landlord experience. Did your lawyer talk to you about treble damages in connection with the landlord withholding the security deposit unjustly? Just a thought. Again, welcome!

@Kim Rose if you are shopping on the MLS you won't find any 25-30% off deals unless you have cash and cozy up with a great agent. Those kind of discounts last less then a few hours and are purchased with cash. It is realistic IMO to find a deal that is around 10% off if you know what you are doing, shop carefully, and have an agent that will drop everything to get your offer submitted.

The higher discounts come when you are able to tap into that segment of the market that never sees the MLS.

@Bill S. I actually asked my realtor about this 20% below market advice and he responded that it doesn't happen and that this is a seller's market. There are a few properties on the MLS that have been there long-term and have had multiple contracts fall through due to either structural or water damage. Are these the properties we want?! And if we are purchasing a home at near market value... do we want a single family or multi?

@Justin Windham The lawyer did mention compensation for unlawful withholding of our security deposit--but he also said that with legal fees we'd probably break even. He also said that if we won the case, there is no guarantee that she would even pay the funds owed. In the end, it seemed like a lose-lose... we left the ball in her court to see if she was going to pursue the cost for "damages" and put us into collections.. but the lawyer suspected she was bluffing just to keep our entire deposit, which she was. We moved into a much nicer apartment building and let it go.. She was a real nightmare landlord. We had so many very serious issues happen with her. Now we feel that if someone like her was able to be a landlord, why can't we?!

@Kim Rose You can minimize your legal fees and look into pursuing the mater in small claims court. The jurisdictional limit is $7,500 in CO, so that's the most you could be awarded in this court. If you won, you could certainly get a judgement against the landlord, and if she has income or assets, you should be able to collect. I'm glad you're in a better place now and perhaps you want to leave it at that. I just thought I would throw that out there.

@Justin Windham YES! We finally bought our first home this spring and are very much done with this landlady. It was over a year ago now. If she came after us, we would have pursued it.. but we didn't really need the money (it was just the principal of it all) so we just decided we rather have peace of mind and let it go. Even if we won, doesn't mean she would pay up. Lawyer said he had many win cases in the millions where there was no payout. So it was a learning experience... no more private landlords if we were ever to rent again. As tenants we learned the risks that come with dealing with landlords.

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