Early in my investing life, I purchased residential rental property for the passive income and hedge against inflation it provides. My mom was a realtor and came across undervalued houses from time to time. She had access to bankers who’d be willing to finance my purchases. She knew construction people who could estimate how much “simple” property improvements would cost. She knew which houses were in up and coming neighborhoods and which to avoid.
In the course of this experience, I learned a thing or two about landlord life. I also learned a thing or two about myself. Both may benefit you if you are interested in the passive income residential rental property can provide.
I developed two sets of rules:
• Rules for buying and holding residential real estate and
• Rules for managing the tenant relationship.
Rules for buying and holding residential real estate.
• Know that the three rules of real estate are location, location, and location. Buy in as desirable a neighborhood as you can afford. Buy near good schools, shopping, restaurants, entertainment, etc.
• Hold property until you’ve at least made back all your transactions costs. These include realtor commissions, title search and insurance, appraisal, and closing costs. This typically takes about five years.
• Don’t buy in a red-hot market when prices are rapidly rising each month. You’re witnessing a bubble and bubbles always burst. Hint: think 2008.
• Have a sizable emergency fund (10% – 15% of the purchase price) to replace the roof, heating and air system, appliances, and toilets. Know that all of these will self-destruct within a month of one another on a holiday weekend.
• If you’re planning improvements, know exactly how much they’ll cost. Be aware of the extent to which they’ll add to your resale value.
And now for the hard part.
Boomer, the above was easy. The harder part, the part that can destroy any profit you might make, is your relationship with your tenants. Many Americans do not have an emergency fund to readily address life’s unexpected expenses. Odds are your tenant is like most Americans.
This means a tenant’s unexpected expense, like a car repair, can result in you not getting paid.
Here are some rules for helping ensure you do get paid.
Rules for managing the tenant relationship.
• Always, always, always run a credit check on a prospective tenant. Use tenant screening services offered by Experian, Transunion, or Equifax. You are leaving a very expensive asset in the care of another whose values may not match yours. Make sure they have a history of paying their bills.
• Don’t get greedy with the rent. It’s better to charge lower rent to a long-term, financially responsible tenant than it is to have higher rents eaten up by frequent tenant turnover.
• Know that you are running a business. You’re not running a homeless shelter. You’re not running a charity. Evict tenants who stop paying the rent.
Again, with feeling: evict tenants who stop paying the rent. No exceptions.
This means evicting the tired, the poor, and the huddled masses yearning to breathe free. This means the single mom with the disabled child, the recently widowed father of four, and the sweet little old lady whose rent money now goes to a new heart medicine. No exceptions.
I couldn’t do it!
Boomer, I’m a softy. I just couldn’t bring myself to evict. I couldn’t. Professional property managers could have done it. But they ate into my profit margins too significantly. If I managed the property myself, my soft side foiled me!
Boomer, you may be tougher than me. Make sure you are. This is not a bad way for you to earn some money while hedging against inflation.
Alternatives without the drama.
In time, I discovered other real estate alternatives without the drama.
We’ll discuss these alternatives in an upcoming post.
In the meantime, Boomer, decide how tough you really are.