Advice From an 11-Year Veteran Landlord

I received the following response via email to yesterday’s question about purchasing rental properties. The sender gave me permission to publish it in full, and since it’s so full of great insights, I decided to do just that (with minor edits for readability).

I bought a mid-50s vintage 5-plex in North Everett with water views from 3 of 5 units and unit sizes ranging from 480 sq. ft. to 700 sq ft. in mid-2001. I did not read any books on the topic before investing. But I did speak with several experienced landlords. Based on my experience over the past 11 years, I would share the following with potential rental property investors.

The math of evaluating a rental property is simple. The art comes in making appropriate assumptions about what numbers to use. Some of the trickiest ones in my opinion are vacancy rates, market rents, appropriate cap rate, maintenance reserves, and maintenance expenses

There are a number of decisions that you have to make before you can make appropriate assumptions.

Which activities associated with running the business are you capable and willing to be involved in?

You’ll need time for accounting, tax prep, marketing, advertising, maintenance work, process development, surveillance, banking, landscape maintenance, cleaning, etc.

How much time do you have to be involved in the above activities? When I started out, I was single and had a job as an engineer. At that time, I did everything except heavy duty plumbing and flooring installations and it took most of my free time. Now I have a young family and am a Project Manager and so have no free time. I hire professional help in most of those categories now. That changes my costs. Fortunately, rents have increased and costs have dropped over the last 10 years and so I can absorb that.

Don’t forget taxes.

I’m sure I don’t need to remind an accountant of this, but for others it’s important to run your analysis on an after-tax basis. See what taxes do to your projected “profit” and also what your “profit” does to the tax rate on your other income.

Are you going to be a cash buyer or are you using financing to buy?

Be sure to consider the fact that fixed-interest rate loans are generally not available for properties that have more than four dwelling units on them. Variable interest rates can put significant variability into your expenses. How high might rates go? How soon? My timing was lucky and so my rate has dropped significantly since I bought.

Also, banks usually expect much higher down-payments for properties with more than 4 units and especially if they are not owner occupied. I lived in one of my units for a number of years while I was single. This limits write-offs in some cases.

What quality level do you want to provide your tenants?

On one end of the spectrum, you can be a slum lord, minimize cash out for maintenance, but at some point end up getting a lot of calls in the middle of the night for sewer floods, etc. My job wouldn’t allow for unscheduled interruptions, so I chose to reverse all the deferred maintenance and upgrade as many items as possible to low-maintenance configuration. That took time, money, and some trial and error until I found the combination of products/configuration that held up well. On the other end of the spectrum, you can reinvest all your profits (and more!) into maintaining/improving your property and build equity (to a point) and usually have a more stable business and predictable income. A third option is to buy something nice and then just ride it until you can’t stand the hassle anymore and then sell for whatever you can get.

What kind of tenants do you want to deal with?

You can fill your units quickly if you have no limits on who you take. Lower vacancy rate, but probably higher eviction/collections rate and you’d better have a degree in psychology to keep up with all the mind games they will play with you. If you have tenants who have money but bad credit, you will still have lots of fun trying to collect from them if they cause damage. They don’t have a credit rating to lose so no incentive to cooperate. If you take tenants with long and clean credit histories and good rental references, you may wait longer to find them (higher vacancy rate) but will find them more cooperative if push comes to shove over damages because they don’t want their clean 20-year credit history tarnished. Pre-bubble, those individuals usually bought houses. There are more of them out there now and more inclined to rent (thanks in part to the fantastic data published on Seattle Bubble by the Tim!).

Location is a huge factor.

As with a house, make sure you have checked for undesirable factors before buying. Your proximity to things like busy/noisy streets, noisy industry, train tracks/yards, pollution/odor sources, high crime areas, high tension lines or pipelines, are all factors that should affect your assumptions

Conversely, things like a view, “nice” neighborhood, or convenient access pay dividends over the long run in being able to command comparatively higher rents, having lower turn-over, higher quality tenants, and less hassle. Of cause this may come at higher initial cost.

Consider not only what the condition of the neighborhood is but the direction it’s heading and the rate of change.

Consider the home’s layout and internal features.

Make sure that the property you buy contains units whose layout and furnishings are what most people are looking for (size, storage, appliances like dishwasher or washer / dryer). If the units are quirky in some way, it will be a continual drag on the business. I have two units that have an entry configuration (90 degree turn) that prevents bringing any large furniture into the unit. Harder to find tenants. I have units with small kitchens and no D/W and no room to add one. Not popular.

How much deferred maintenance is there on the property you wish to buy?

Try to identify all the systems elements (roof, gutters, plumbing, water heaters, exterior paint, doors, appliances, HVAC, etc) that generally have a shorter life than the structure. Estimate how old each one is and identify the typical life and cost for each. Then you can create a graph showing your expected outlays by year. As an accountant, you know that some of these can be written off against income in the year incurred while others (like a roof) must be written off over a very long period (Capital Improvements). I learned this lesson the hard way. Knowing what I do now, I would try to get the seller to take work orders for as many of the Capital Improvements as possible before buying. They can write them off against their gains in the year of the sale. If you pay for them after purchase, you may not recoup that money for 27.5 years (and after considering inflation, you never will).

How much insurance will you want to carry?

Umbrella (excess liability) is highly recommended for landlords and relatively inexpensive. Earthquake (or DIC) can be very expensive and tends to be more expensive or unavailable with certain types of architecture (like brick exterior or not secured to foundation, or post-and-pier foundations). But consider that fact that you may be on the hook to provide temporary housing for your tenants for the remaining term of their leases in the event and EQ damages your building too much for habitability…and that available temporary housing may come at a premium cost in the event of a substantial EQ.

Know the law.

Before buying rental property, read RCW 58.19 (aka Landlord Tenant Act) in it’s entirety and decide whether you can be successful doing business by those rules.

Stay educated.

Subscribe to one of the major rental housing news letters such as On-Site. These journals contain articles which can fill in any gaps in your knowledge. For example, these articles often contain advice on how to handle some of the difficult and/or uncommon issues faced by landlords (fair housing questions, tenant fatalities, bedbug or mold infestations, etc) as well as market status (vacancies, prices, incentives, etc).

Another good source of data for landlords of smaller units is the 5-19 Unit Market Report published regularly by Dupre + Scott Apartment Advisors.

The art behind establishing the cap rate should, in my opinion, take all these factors and more into account.

I put 20% down (half of that borrowed as a 2nd) and have subsequently increased the size of the second to handle a new roof. I have reinvested all profits since purchasing and invested some of my own money. I am just now at a point where maintenance is minimal, vacancies low, rents at market. I expect to pay down my 2nd mortgage within the next 4 years and then will have a monthly cash flow of ~$1K after all expenses and tax effects on gross rents of ~$4k/month.

There is more that could be said about many of these points, but… then it would be a book! Hope this is a helpful starting point for someone.


About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.

40 comments:

  1. 1

    From letter: “See what taxes do to your projected “profit” and also what your “profit” does to the tax rate on your other income.”

    I wonder how many landlords getting into the business this way not only cash flow, but also turn a profit after the (non-cash) depreciation deduction?

    I would also point out that this clearly wasn’t written by pfft. He thinks taxes don’t affect investment decisions! ;-)

  2. 2
    Serafina says:

    Two years ago, we bought two condos in Miami Beach, which we are renting until we can start using one. So I can’t say much about rental properties in Seattle, but I can say this: Being a landlord is a project; it’s not easy money. It’s a part-time job and you need to be prepared to treat it that way.

    That said, I’m happy to have property in Miami Beach, where there are so many landlords living out of the area that there are a lot of relatively inexpensive services for managing properties. Our income covers our costs and we’re building equity. In six years or so, we’ll start wintering in Miami and the rent on one condo will cover the expenses of both. We’re not trying to get rich, and I’m sure we won’t.

  3. 3
    Gene says:

    I don’t understand the comment about how profits will affect the tax rate of other income. If I make an “extra” $20,000, even that causes me to go into a higher tax bracket, only the profit/income that is above the level of the new bracket is taxed at the high rate. It does not have any affect on other income. It’s not a like “all” my income would be taxed at the higher rate (though it seems many people think it is).

  4. 4
    Scotsman says:

    15 years or working and investing to get a net cash flow of $1,000 a month? Unless there’s been a lot of capital appreciation that’s not an investment, that’s a cocktail party topic- “yeah, I have a nice little 5-plex overlooking the water.”

  5. 5
    David Losh says:

    This is a great article, and really the best thing you could have posted lately. We run into so many new land lords, and old, who are rethinking the rental business.

    You do have to go all in, and this story is just a beginning. At the end of a thirty year investment strategy this income should be a retirement plan that keeps pace with inflation. Of course this is a base that can be built on, and in the next twenty years there should be, or could be, many more units added to the portfolio.

    If we ever do get that spurt of inflation, and in twenty years that is a pretty safe bet, then the whole thing becomes a pay off.

    There are excellent points here not sugar coated.

  6. 6
    sally buttons says:

    Contributor wrote:
    “I put 20% down (half of that borrowed as a 2nd) and have subsequently increased the size of the second to handle a new roof. I have reinvested all profits since purchasing and invested some of my own money. I am just now at a point where maintenance is minimal, vacancies low, rents at market. I expect to pay down my 2nd mortgage within the next 4 years and then will have a monthly cash flow of ~$1K after all expenses and tax effects on gross rents of ~$4k/month.”

    Thanks for this perspective. But Yowza…I like/need ’em to be positive from the get…or shortly thereafter. Otherwise tis a dang expensive + grueling gig. Deferred maintenance is realtor talk for needs-fixed-bad. Cap rate is another magic formula designed to keep eye off ball. Maintenance never goes away or becomes minimal for long. One will need to remodel their remodel if held long enough.
    Best to You.

  7. 8
    explorer says:

    This was of interest to me. I am in the process of buying a single family house in Wisconsin to rent out until I retire there in 10-11 years. I not as interested in profit as breaking even and building equity, as I am still renting here. If Icould get a job in Wisconsin for the same salary, I would just up and move there now. I see the Seattle area getting even more out of reach in 10 years for retirees of modest means who have not already gained a foothold in this market by now.

    I rent now, and will continue to do so. I have been looking around Seattle for awhile, as it would be less expensive overall mortgage and tax wise, but definately not price wise. It’s a wash. There is nothing affordable around here available that is worth it, and I don’t see that changing in the forseeable future. The rare one that is not a total fixer, gets in multiple bidding wars I want no part of, or goes pending in a matter of hours. I don’t have the patience or risk tolerance to wait 6 months to a year on a forclosure/short sale that may deteriorate or get squatted while the bank sits on it.

    I look at it as a place to live, or swap for another place, when retirement time comes. Prices are low enough, and the inventory good enough, in decent neighboorhoods in the city I am targeting, along with growing living wage jobs there (in contrast to the rest of the state), that I don’t anticipate a problem with vacancies. I do plan to have a property manager deal with that. I have run all the numbers, make sure the age of the major components/systems won’t be a replacment factor for at least 5-7 years, and will suffer the “investors” mortgage penalty for this. It still seems to pencil out.

    It seems better now than during the bubble, and certainly more solid in comparison to my modest retail investments for my Roth IRA brokerage. Multi-unit investing, unless you have deep pockets today, does not seem to pencil out, at least for me.

  8. 9
    S-crow says:

    My two cents to add: never ever take the cap rate or expenses that are provided in listings as Gospel. Do you own research and generally you can obtain real expense data from utilities. I would also add “Conveniently being around friendly and outgoing tenants of the subject property” when they might be around can yield a plethora of good old fashioned information regarding the property ownership, condition of units, improvement schedules or lack thereof and what actual rents are vs. what can be “manufactured” in the marketing materials or even fraudulently manufactured leases.

  9. 10
    Doctor Dave says:

    Thank you for this posting. I have never been interested in becoming a landlord myself but I have a few friends who have owned or still own rental property. I am sure they learned these lessons the hard way, from experience, but I am forwarding this link to them anyway…Thanks again.

  10. 17
    Jacob Beaty says:

    Anyone have good ideas on comparable market rents in the area? I am a forced landlord (bought in 2006 – 170 LTV – Yippee), and seem to have trouble gauging the rent I should be charging.

  11. 18
  12. 19
    Jacob Beaty says:

    RE: Bingo @ 18

    Gracias…. I think I need to hike up rent 10%, although over the last 4 years the place has been vacant 1 day.

  13. 20
    mukoh says:

    Jacob, use http://www.finestexpert.com/ used to be zilpy for rent comparables. It is fairly ok to get an idea from it.

  14. 22
    explorer says:

    @ Jacob Beaty:

    I found this tool to be pretty good and localized. http://www.rentometer.com/

    Be aware, it’s not just what you THINK the market will bear, but you have to temper the comparables with the median income in any given area too, and obviously the size, number of bedrooms, and amenities it has. Look at the US census stats for median income is my suggestion.

  15. 23
    MMM says:

    Couple words from a fresh investor…

    I’m pretty new on the market. I started last summer, I’m landlord less than one year. I have only one condo and I bought it strictly for investment. Other readers already pointed about having good tenants, maintenance but I will focus on getting a good property and cash flow.

    1) Find the property near big companies or university. These places always will have high demand for renting. Area near Microsoft, Bellevue downtown on eastside, UW area, close to Boeing factories, etc. So location, location, location. It’s your task to find the best Price-to-Earning condo. But try to find something close to your home or work. It will save you lot of time and gas.
    2) Don’t buy new properties, they are too expensive. Find a decent 30 years old apartment. The return on investment is much higher. Your tenant won’t treat your property as his own home. I would invest too much in the interior because you won’t get much of these money.
    3) Look at what you buy, the property standard makes a difference in monthly rent. The higher standard the better, but the property will cost more. Assume you will do only minor improvements, like painting, buying new dryer. It really depends if you can do so items yourself or you need to hire someone.

    Let’s do an example and look at property currently for sale: http://www.redfin.com/WA/Bellevue/14630-NE-32nd-St-98007/unit-2/home/7471 It’s near Microsoft, not new, price is not bad. I haven’t been inside so I don’t know what is there, I will make some assumptions.

    The property is listed at $115,000. It’s short sale (that’s another story) but let’s assume you can buy it for this amount and you don’t have full cash. To get loan you will need at least 25% ($28,750) for down payment plus closing cost plus initial repairs. It can easily gets to $35,000. If you get 30 years fixed loan with 5% rate then your monthly will be $463. Here is a nice mortgage calculator I use: http://www.mlcalc.com. Then you take APN number: 0681001220 and go to http://www5.kingcounty.gov/parcelviewer/viewer/kingcounty/viewer.asp to view parcel. Unit F2 has $1,520 yearly taxes. That’s $126 a month. Not bad. Last thing is HOA dues: $258/month.
    Together it’s $847 per month. That’s the payment you won’t go below. You still needs to assume that there are other costs and maintenance. You can assume that you have to spend extra $100 a month for these extra stuff. And one month a year will be a vacant month.

    Now you can go to http://hotpads.com/ and http://padmapper.com/ to find what is available around the property. Looking quickly I would estimate the rent at $1,400. Most of the time you will get less that managed apartments. Remember this is really just approximation. It’s good to walk around different properties and check their rent and what they offer.

    A little calcuation:
    ($1,500 * 11) / 12 = $1,283.
    $1,283 – $947 = $336

    $336 is the positive cash flow with all assumptions I made. For me they are realistic.

    $336 * 12 = $4,032. Your ROI would be 8.7 years with $35,000 investment. If you don’t know what’s ROI, don’t invest in anything. You need it to compare investments. You may also find this investment is not as good as you may think initially. Usually I don’t touch anything that has ROI more than 10 years.

    This is only financial look at the investment. Read other post/blogs/books because there is much more than numbers. I won’t go into tax detail but I can say it’s possible to postpone fed taxes because of property depreciation. You will have to pay taxes once you sell the property.

    Another factor is to future changes in economy and costs. It makes your investment even a bigger risk and possibly with bigger return.

    As someone mention already there is lot of work before you buy property and after that. I can confirm It is a part time job, although I spent more time on looking for a good property than on maintaining it. Right now the good properties are sold out. If there is anything new it goes away quickly and with multiple offers bid. I believe the best time to buy was around last summer.

    I have a good homework for new landlords. Compare your investment versus 30 federal bonds. You don’t need to maintain bonds so the investment in real estate must give you the extra reward that matches your additional work. Good luck.

    (Sorry for my English, I’m not native).

  16. 24
    2kt says:

    if you want to invest in real estate for income and have $30,000 to $50,000 to invest, buy portfolio of REITs that invest in residential apartments, or even an ETF.
    There are many recently pounded Mortgage REITs that yield 8% to 15% or go with REITs that invest in the apartments and/or office space for 5% to 8%. You can make or lose money all the same, but no phone calls in the evening and if you need to sell, you can be done in about 2 minutes.

  17. 25
    NewHomeOwnerInFremont says:

    By 2kt @ 24:

    if you want to invest in real estate for income and have $30,000 to $50,000 to invest, buy portfolio of REITs that invest in residential apartments, or even an ETF.
    There are many recently pounded Mortgage REITs that yield 8% to 15% or go with REITs that invest in the apartments and/or office space for 5% to 8%. You can make or lose money all the same, but no phone calls in the evening and if you need to sell, you can be done in about 2 minutes.

    I agree with what you said. REITs are a great way to be involved with RE without all the hassles. However, you can’t leverage REITs like you can with direct real estate. You make your money (or lose your shirt in some cases) in real estate with leverage.

  18. 26
    Eastsider says:

    RE: MMM @ 23 – I believe the condo unit in your example is subject to rental cap. So it cannot be a rental! I have found that condos with rental cap tend to sell for much less in this market.

    I agree with you that the best time to buy is last summer/fall. Now with multiple bids you are competing with homeowners!

  19. 27
    Eastsider says:

    RE: ln e @ 13 – If you purchase the property outright with your own savings, you are probably ahead of the game from the get go. With returns generally low everywhere, even big money is getting into SFH rental business. Still, doing your homework and cruching the numbers are key in every business.

  20. 28

    RE: 2kt @ 24 – One other advantage to REITs is they hire attorneys. ;-)

    Seriously, your liability is much less with that form of ownership. Someone is badly injured in a fire, your liability is almost certainly limited to the amount of your investment. Even better, the level of insurance obtained by a REIT is possibly higher, so the victim gets the treatment they need, possibly without even a loss on your investment.

    And yes, as you note, no late night phone calls.

  21. 29

    RE: Eastsider @ 27 – I haven’t looked at that for probably 5 years, but back then the only way most multi-family residential real estate investments made sense was to be highly leveraged. They were counting on appreciation for a return. The return paying cash wouldn’t have equaled a bank account at the interest rates paid back then. Now may very well be different.

  22. 30
    Eastsider says:

    RE: Kary L. Krismer @ 29 – If you believe in hyperinflation sometime in future, rental income will protect you to some extend. With possible QE3, QE4, QE5 looming, that hyperinflation scenario may well come true. When big money is getting into SFH rental business, they must know something. Btw, your savings in the banks are earning negative (real) interest. At least rent is still keeping up with inflation and maybe more.

  23. 31

    RE: Eastsider @ 30RE: Eastsider @ 30 – I’m not saying that’s a bad strategy, but if that’s your outlook, wouldn’t it still be better to be leveraged? Debt is a good hedge against inflation too!

  24. 32
    David Losh says:

    RE: Kary L. Krismer @ 31

    Good Morning Kary,

    First, and foremost REITs fell out of favor because of that attorney action you are advocating. REITs got to be overly complex, and ripe for misleading investors. If I recall it had something to do with tax advantages, but that was then, now REITs are kind of benign in the world of swindles, I think Mortge Backed Securities have taken the spot light lately.

    The thing about rents is that they do track, keep pace with, inflation. The cost of housing is a part of the over all cost of living, rents are a much more reliable indicator than mortgages that are also tied to an “investment.,” or liability.

    You could be leveraged, but there is no need to be. Income is income, and in that inflationary period, with a set of rental units, you would be looking to pay off the building to get your cash returns.

    I know, you would need a good accountant to work it all out for you, but the idea is to have an investment that is paying a return.

  25. 33

    By David Losh @ 32:

    RE: Kary L. Krismer @ 31 – First, and foremost REITs fell out of favor because of that attorney action you are advocating. REITs got to be overly complex, and ripe for misleading investors.

    Are you channeling Pegasus? The market and the economy wasn’t a factor?

  26. 34
    Eastsider says:

    RE: Kary L. Krismer @ 31 – It’s not as easy to “leverage” today compared to the boom years. Banks has tightened lending significantly. Further, if you have built up significant (retirement) savings, investing in rental properties is definitely one option to protect against inflation. All these “cash” buyers in the market are using their own savings. Leverage sounds good on paper until it is not.

  27. 35

    RE: Eastsider @ 34 – It depends on the property and investor. As someone mentioned here earlier this week, it’s still possible for investor types to get financing on SFR (1-4 unit) properties, as long as they don’t already own too many of them. I believe that is correct. Also, I believe Fannie still has investor financing on their REOs. Finally, I don’t have a good source I can disclose for this, but apparently larger multi-family buildings have retained significant value from the peak in part due to low interest rates. That too though is undoubtedly dependent on who the investor is.

  28. 36
    chad says:

    i think it should be 59.18 RCW (says 58.19 above)

  29. 37
    David Losh says:

    RE: Kary L. Krismer @ 33

    I’m sorry, once again Kary what are you talking about? What economy on the investment strategy of Real Estate Investment Trusts would put them out of favor? The risk of a loss in value, or income? or was it because they got to be way too slick, and fancy with promises, and sales hype?

  30. 38
    David Losh says:

    RE: Kary L. Krismer @ 35

    Geez, you’re making my head hurt. Now what the heck are you implying?

    Rental income is a prize. If you leverage for appreciation there may be something there, but I don’t see that as a factor today.

  31. 39

    By David Losh @ 37:

    RE: Kary L. Krismer @ 33

    I’m sorry, once again Kary what are you talking about? What economy on the investment strategy of Real Estate Investment Trusts would put them out of favor? The risk of a loss in value, or income? or was it because they got to be way too slick, and fancy with promises, and sales hype?

    Yes, son of Pegasus, you’re absolutely right. It had absolutely nothing at all to do with the market or the economy. /sarc

    You probably think gold was going up after 2008 because gold traders largely managed to avoid scandal.

  32. 40

    By David Losh @ 38:

    RE: Kary L. Krismer @ 35

    Geez, you’re making my head hurt. Now what the heck are you implying?

    Rental income is a prize. If you leverage for appreciation there may be something there, but I don’t see that as a factor today.

    That wasn’t that tough of a post to understand. For 1-4 unit properties I was talking about the availability of financing today, with the disclaimer that I have not personally checked out the situation recently (e.g. within the past four months). For larger properties I was saying I had heard that they had retained significant value from the peak due to the availability of low interest financing, with the disclaimer that I can’t reveal my source.

    There was no mention of future appreciation or rental income. The a post responding to the claim that financing to leverage was not available. Note I did not address in that post any differences in the extent you could leverage, but that too could depend on the investor. Some people still can get large unsecured loans.

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