Why You Should Plan to Be a Landlord… Even If You Won’t Be

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Real estate investors can be broken into three categories: landlords, flippers, and speculators.   Which do you want to be?  In my opinion you should plan to be a landlord.  Yes, many of my fellow BPers are going to take umbrage with that statement.  Yes, it’s horribly biased.  Yes, it’s self serving.  However, before y’all bust out the pitchforks, let’s take a glance at my reasons.

I’m going to start off by examining my investor categories.

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Speculators

A speculator is anyone who banks on appreciation when evaluating an “investment.”   Even if you take into account other considerations, ask yourself this: Would you be in the deal without a future price jump?  If the answer is no, you’re a speculator.

You’ll notice above that I put “investment” in quotations.  That because speculators aren’t investors.  In the purest form of speculation – you buy a property and cough up money every month to cover it’s expenses.  Your “plan” is that one day the price will go up and you’ll strike Texas Tea.

Paying a small amount over and over again with the hope of a big pay day.  Does that sound familiar?

speculative investing

Yep, speculators are gamblers in a different guise.  Can you make money doing this?  Of course!  But to do better than blind luck you need inside information that isn’t priced into the market.

To avoid the speculation trap, evaluate your investments assuming no appreciation.  If anything, plan for a drop in price to help temper your investment risk.

Increasing the value of a property through hard work is not speculating.  It’s sweat equity.  Both a flipper and a landlord can create sweat equity as we’ll see…now.

Flipper

A flipper is all about sweat equity.  It’s the most labor intensive of the real estate investment approaches.  Like every investors, they put in long hours finding a property to buy.  Unlike other investors, once they own the asset a flipper has to keep working hard.  Overseeing contractors, managing expenses, and forcing deadlines takes time.  Not to mention selling the property when it’s done.

As Glenn Schworm points out, Time is always working against a flipper.  Debtees aren’t charities.  Whether it’s a bank, hard money lender, the US government, or the county treasurer – you owe them money for every day you own the property.

Another factor a flipper should be aware of is the property itself.  I’ve been involved in gobs of rehabs and I can say one thing for certain: there will be surprises.  You could spend month’s doing your due diligence (losing the deal in the process) and something will still catch you off guard.  These “unexpected gifts” aren’t always negative, but 90% of the time they are.

As a flipper you are still at the mercy of the housing market.  Did the prices in your area drop 10% since you bought the property?  Tough, put that sucker on the market because Time is so close you can smell the garlic on his breath.

Landlord

A landlord is also known as a buy and hold investor.  Guess what they do?  While they’re holding the property, they rent it out and create a monthly cash flow.  This creates an asset which pays them to hold it.

One great thing about being a landlord is the tax benefits.  Not only do you get a lower capital gains rate if you own the property for over a year, but you can take full advantage of depreciation.  Tax depreciation is essentially the government giving you a loan with 0% interest.  It’s one of the few times the friendly version of Uncle Sam comes around to dinner.  When no one is looking he slips  a few bucks in your pocket and whispers “pay me back when you can” (ie, when you sell.)

So far, this post has been lacking in graphs.  Let’s rectify that shall we?

Historical HPI vs rent

This chart shows historical rental rates vs home prices.  I find it compelling for two reasons:

  1. Home prices are astronomically more volatile then rent prices.  Looking for nice steady returns?  Landlord it up.
  2. Now is the best time to buy rentals in the last 15 years.

Sidebar

You’ll notice how prior to 1999 home prices stayed in line with rental prices?  It confuses me to no end that real estate analysts expect the market to “rebound” in the next few years.  Rebound to what?  Artificially inflated prices?  I’ve seen no compelling data that the housing market will surge.  I believe people claiming the contrary are succumbing to wishful thinking.

That said, I pray I’m wrong.  I own real estate and am not opposed to making money.

Plan to be a Landlord

Now’s where you’re going to catch me out.  I’ve been very careful to say you should plan to be a landlord.  I’m not arguing you should become a landlord.  It’s not for everyone.  Even if you hire a property manager, you’ll manage some aspects of the day to day operations: maintenance, accounting, etc.  Across my real estate holdings I employ 5 or 6 full time staff (depending on how you count).  When tax time came, I still poured over general ledgers to make sure the depreciation and expenses were spot on.  It’s a straightforward way to protect your investment.

However, you should plan to be a landlord – even if you hope to flip the home.  Crunch the numbers as though you were going to own the property for 5 years.  Is there enough cash flow to make this worth your while?  Yes, this requires even more legwork: you must understand the market rent and develop a relationship with a good property manager.

If the investment makes sense as a rental, proceed as planned.  Buy the property and fix it up as needed.  When the work is done, you’re presented with two options: sell the home or rent it out.  Remember, it’s much easier to rent a home than sell it.

Why is this an effective strategy?  It shrinks time down into a cuddly teddy bear.  He’s not so scary.  Worst case scenario you rent the home for a while, earning money while you wait for good selling market conditions.

For tax purposes, consider owning the property for at least a year to take advantage of the long term capital gains rate.  If you do a like-kind exchange you won’t pay those taxes right away, but Uncle Sam will want pound of flesh one day.

Wrap It Up

Plan to be a landlord.  Buy property expecting to own it for a long time.  Bide your time and sell it when the market is in your favor.

Do keep in mind, real estate is still a form of investing.  All investing carries risks.  Leave yourself as much wiggle room as possible so you don’t implode if it goes pear shaped.

Photo: URBAN ARTefakte (Archiv…

About Author

Kenneth Estes

During Kenny's decade in finance he bought many single family rentals in rural areas, as a hobby. Along the way, he talked some brave souls into joining him as investors and recently retired from finance to take his hobby to the next level. Find more by and about Kenny on his personal blog and his recently created twitter account!

26 Comments

  1. Great article Kenny! I myself would’ve never in a million years planned to be a landlord, but being a newbie and noticing the recent market, I’m on my way to builiding capital to purchase that first investment property! Great source of information you provided!

      • Hi Kenny! Yes, I’ve been a B&H investor since 2000, in the SFH segment (first in Calif and then in Indiana).

        I will be moving to Houston end of the year and will be looking to transition to small multi’s (I’ve been drinking Ben Leybovich’s koolaid lol!). So I haven’t started investing there yet, but I’m excited to get going!!

        • Jose Gonzalez on

          Sharon,
          I am an investor in Houston, now I have several properties in place and know a great team of property managers, contractors and I even built a team for my repairs there. If you need anything just let me know!

          Jose Gonzalez

        • Hi Jose! Congrats on what you’re doing in Houston. I certainly appreciate the offer of help and will definitely take you up on that once I’m there. I truly believe in the power of referrals and would love to be introduced to those that may be able to help me.

        • Hahaha Sharon – it’s one hell of a good-tasting cool-aid, isn’t it. Sure worked out sweet for me. But that’s not all that’s funny. You see – I’ve been drinking Kenny Estes’ cool-aid and decided to form a syndicate to buy a couple of big multi-families – thank you Kenny 🙂

          I figure raising $3 mil. with 60% leverage = $7.5 mil – I should be able to get into 200 doors or so. Had several meetings – I love this game! Any thoughts Kenny or Sharon.

        • That’s great, Ben! Sounds like you’re in the big time now lol! I will follow your venture with interest.

          For now, I’d just like to get my first MF under my belt. Good luck!!

  2. Thank you for writing this Kenny! The take home message for me while reading this ties in with “having multiple exit strategies” and not limiting my options in any one deal.

    I especially liked the graph you included. Would you share the source?

  3. I like this post. While being a landlord can give the most financial returns, it seems to me that the people who chose to speculate or flip houses are doing it for the time factor. Landlording takes the most time and commitment, it’s almost a full-time job if you don’t hire a property manager. If people get into real estate to grow their assets and earn passive income, then being a landlord, no matter how much money will earn them, is not worth the time.

    Unless they can work with a company who will do most of the work, such as maintenance and leasing, leaving them to simply analyze reports and make decisions. But that wouldn’t make them a landlord anymore, right? They’d be speculators?

    • Kenneth Estes

      Thanks for the comment Angela!

      Someone doing what you’re describing would be an investor. The role of an investor is to find assets which are under or overvalued and make trades to bring the market back to an efficient point. Yes, this requires looking at numbers and reports, but it’s also very hard work.

      In your example, they would also be a landlord because ultimately they are responsible for managing the properties and the tenants. Granted, they might delegate much of that burden, but it’s still their head on the chopping block when things go pear shaped.

  4. Jose Gonzalez on

    Kenny,
    I appreciate the article, I agree in the way you have done things and how you think. In the long term I have seen the buy and hold investors to build much more wealth than the flippers/speculators… sooner or later they get caught in a downturn of the market and suddenly interests eat them up.
    Now, I have recieved several comments about which properties to buy and hold from experienced investors, one of them surprised me since someone told me “if it is a property that you would not have your grandma there, dont pursue it” or “Better get into great neighborhoods even though the numbers are lower”… I got a little confused there… I have a great property management company which selects quality tenants in every neigborhood, yet some areas for sure I wouldnt send a relative to live there but the numbers are just sexy in the short run.. let me give you an average example of my last buys
    Price $45-50 k
    Repairs $6 – 10k
    ARV $75 – 95 k (I always pursue a 70-80% rule even though I will hold them)
    Rent $950 – $1050

    So, with this returns I accomplish between 1.6 to 2% cost/rent ratio…thats 12 to 15% return on investment, which you can accomplish over 20 with leverage…
    The cash flow is great and why would I worry about high appreciation when in about 6 years the property is fully paid and the increase on the rents in the 2 years that I have learning this there has been around 15% (Houses that went vacant in the range of $900 now I put them on the market at $1000 – 1050 and last around 24 days with a very selective process)
    Please let me know your thoughts about this and the comments of those investors.

    Thank you!

    • Kenneth Estes

      Jose, thanks for the comment and the question!

      The advice to “only buy where your grandma would live” isn’t an rational argument, it’s an emotional one.

      You are correct that in the worst areas in any town, you can find good investments. The numbers could look good and most investors will look over it for their emotional reasons.

      However, the amount of work you to do for this money goes up. As a general rule, vacancies will be much higher, evictions more frequent, and past due balances larger. If you can find a way to efficiently handle those things, and you’re ok with the reputational risk of being a “slum lord” then go for it.

      Personally, I don’t want to deal with that. I’m more than happy to rent to working class people, but try and avoid “war zones” when possible. When we do invest there, it’s usually as part of a package and the cash flow is amazing.

      • Jose Gonzalez on

        Agree, the ones that I am mentioning are not in war zones, still they are mixed neighborhoods mainly working class, I was able to buy them at those prices… now… the least is about $65 k =( I wish I had at least a couple more years!. All the houses I have bought need tenants with a minimum of $3,500+ of mixed income. So we are probably in the same page… still I wouldnt send my grandma there!!
        Thanks for the comment and the good wishes!

  5. Mark Ferguson

    Great article!
    I flip to get money to buy long term rentals. I definitely agree flipping is more of a job. Great graph, it really shows how crazy the housing bubble was.

    The reason I can see house prices rising a little more is supply and demand. Everyone I talk too across the country has an inventory problem and that is causing prices to go up. For five years there was no building because we had so much REO inventory, not that inventory is gone and there is very little building.

    With my area there is no way they can build cheap enough to reach the lower to mid market, they can’t even build cheap enough to reach our average price. That would cause me to believe supply and demand would cause prices to rise some more before they level off. There are many other factors that could change that.

    • Kenneth Estes

      Hey Mark.

      Thanks for the comment. You could be completely right, and I hope you are!

      I’ll assume you’re correct that supply is low (home prices are up 12.2% in the last year and it seems like a reasonable reason for this).

      I’m not sold that we’re in a position where new homes won’t offset this lack in supply. The metric you’re looking at is new home builds in low to average price housing. I have not pulled any data, but my gut is that a large amount of what we currently consider low to average price housing was at one point considered high end housing. It was only as houses got older that that they fell into a low/average designation.

      Mid to high range homes are being built all over the place.

  6. First of all, great article because I totally believe that EVERYONE should be a landlord because EVERYONE should own real estate!

    Second, love the way you tied it to tax benefits. I tie owning real estate to tax benefits when discussing it, but I’ve never tied it with being a landlord. Love that!

    Thanks, Kenny, for a great post.

  7. I’m a landlord but also a Realtor and help many investors in Miami. Right now flips are very competitive and scarce. However it is very easy to find a lucrative Rental Property. The rental market due to supply and demand has gone through the roof. There are simply not enough condos to compensate for the flow of miami residents.

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