So You Want to Be a Landlord
We did a lot of stuff wrong when we bought our building, but we also did a lot of stuff right. I’m going to tell you everything we did so you can learn from our mistakes and ride off into the sunset on your horse… er, house.
In 2015, we bought a three-unit apartment building from a bank in our Upper Midwest City. The apartment had been vacant for years and needed a ton of work. It was partially dilapidated. But it was on the market for what amounted to land value, which is an important detail.
We made an offer, and ultimately, it was accepted. The reason why some developer hadn’t already snapped it up was because the building had some issues: it didn’t have a garage, which would be a problem for some potential tenants (less for those Millennial types who don’t care about cars), and the property needed significant renovation. Basically, it really only made sense for someone to redo it and live in one unit and rent out the others. That became our plan.
When you start to evaluate rental properties, there are many schools of thought around how much to offer, how much to charge in rent, and what to do regarding capital expenditures — the answer is “keep them below market value, at least 1 percent of purchase price, and depreciate the eff out of them.” (Oh, yeah, you should probably get a CPA too. Those folks are helpful when it comes to this kind of thing.)
The “1 percent rule” means that you should be making 1 percent of the gross purchase price in rent every month. Some folks subscribe to the 2 percent rule, which states that you should be really after 2 percent instead. It depends on the market and the location.
Our rules for buying property:
- Within 1-2 blocks of public transportation. Sorry, small town. You are nice to visit but a terrible place for most rentals. Public transit is key for street traffic, which makes it easier to rent — and public transit proximity in an urban renewal core means you can get young professionals to rent your property for $$.
- Under market value. “Market value” can be subjective, but you want a bank-owned, short sale (that’s when the amount due on the property is more than what the property is available for), or maybe a house owned by an older person or out-of-state landlord who doesn’t know the true value of their property.
- Low taxes. Seriously. Taxes are a killer. We have relatively high taxes where we live, so we could have really made out like bandits if we had lower taxes. Alas. (If your taxes are equally high, I hope you at least get some good city services.)
Warning: It is likely that various local markets are due for a course correction (real estate cycles typically last 7 years) so you may want to wait for the “course correction” to buy property, unless you are buying it significantly under market value.
Ideally, your property should:
- Qualify for first-time homebuyer (FHA) financing
- Qualify for 203k FHA financing (that’s a special rehab loan that also allows you to put down just 3.5 percent)
- Qualify for a rehab loan from your bank, with some of the money used for the repairs wrapped into the purchase price
We chose the bank rehab loan. If you do get a 203k FHA loan, use an experienced lender who has done many of these and try to get a “streamline” loan instead of a “full” loan. That way you don’t need to hire another general contractor and can decide what to do with the money yourself. Be aware that the streamline loan is limited to $35K on the purchase price; the full loan does not come with that limitation.
Regarding rehab, there are two schools of thought:
- Do as little as you can — and paint can go a long way — but be sure that you are fixing life/safety issues that might keep you from renting.
- Fix everything right now and assume that you will not need to fix any of it again for a long time, which can make it easier for you to manage the property, especially if you’re a first-time landlord. Focus on kitchens and bathrooms — that’s where it’ll cost the most and also be the most rewarding.
- Purchase price: $224,900
- Renovation costs: $150,000 (this was largely cash on our part but have paid down a bit; we currently have a mortgage of $270,000 + a line of credit on our house for about $50K)
- Monthly payment, including taxes and insurance: $2,700 (rounded up)
- Average rental in our neighborhood for a 2 bed, 1 bath with new fixtures: $1,550
- Capital expenditure: 8 percent (this is the money you set aside for new repairs, other issues, and improvements to the property)
- Vacancy rate: 10 percent. This is the money we assume we’ll lose every month the apartment is not fully rented. Your town may be higher or lower. Boston, for example, has a 3.35% vacancy rate.
- Total monthly expenses including vacancy rate, cap expenditure, principal, interest, taxes, and insurance: about $3,000 (I rounded up)
- Rent for unit 1: projected $1,650
- Rent for unit 2: projected $1,550
- Rent for unit 3: $0 (we live in this one, but if we didn’t, we’d rent it for $1550)
- Total rent projected: $3,200 (plus another $1550 if we didn’t live there ourselves)
With us living there, we net about $200/mo.
If we didn’t live there, we’d net about $1750/mo.
- Get a Realtor (R) and tour a variety of properties. Ask for lots of “comps.”
- Get a good inspection! Do not skimp on this! Rental properties may have lots of deferred maintenance and it’s important to know what you’re getting into.
- Pretend to be a renter to see what the neighborhood/your competition looks like.
- Be aware of what is legal or not legal — your city will have resources for this kind of thing, like “landlord night” type workshops and also help make sure your units are compliant, inspected if they need to be, etc. Make sure you are lawful in your rentals–read up on any landlord-tenant acts, lead paint ordinances, or any other related stuff.
- Get an umbrella policy. You will need it someday.
- Don’t put in granite countertops because you like them. Put in granite countertops if they wear well and if you can charge more rent for them. Or be like us and put in butcher block, which is cool and cheap and if tenants “ruin” the counters you can just sand them and then oil/wax them. The tile backsplash is cool, but how will it show when your tenants’ stuff is all over the place? Etc.
- Take good photos before you rent to your first tenant and use those photos over and over in case your tenants are not squeaky clean — you will need to show prospective renters that this is a good place. Alternatively, if you have great tenants with nice furniture, take photos of their unit and put those up when you are looking to get a new tenant in place.
- Do a background check through an online service. Have the tenant pay for it. Call employers and past landlords. This is where you want to be thorough — do it before they move in.
- If a potential tenant asks to pay the deposit in installments after they move in, that’s a big danger sign. Run away. That means they’re not financially solvent enough to come up with the money all at once and are just one missed paycheck away from disaster.
- Join your local investment club. You will learn all kinds of stuff.
Your mileage may vary. I’d love to hear about other Billfolders who bought their own places and what that looks like. We’ve had a couple of sets of tenants so far but are not fully rented now — I wanted to do more work on the house first, though now I’m wishing I hadn’t gotten so excited about new renovation projects — and so we are aiming to have a new tenant in our remaining unit by February 1.
WearsPants lives with WearsShorts in the Upper Midwest. They love The Billfold.
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