So You Want to be a Landlord? Part II: How Do You Actually Make Money?

Hi Guest, you said: "In your example, say your monthly net cash outflow is $507.37 (or $6,088 for the year). Now, assume your original basis in the property is $513,000. This means you would qualify for depreciation of about $19,000/yr (based on the basis of 513K divided by the depreciable life of the property, 27.5 yrs.) "

erm.. in the original example the cost of the property is only 200,000. if your cost of the property is suddenly 513k you'd lose a lot more cash per month if you are still renting at the rate Catherine quoted.

I still think it is only worth it when the rent you can collect is more than what you pay out.

Now, I did not mean to say at Paid Twice that ALL landlords are sleazes. Some are honest people who treat their tenants and their neighbors fairly. In my experience, however, the ones near me would find that description an uncomfortable fit.

The gentleman whom I described as cheating an elderly widow purchased the house two lots west of mine. It was immaculately and lovingly kept by its original owner and was in excellent condition. She apparently did not know a thing about finance -- he told her he would pay for the house "in cash," as though she would not be paid in full if she sold the house to someone else -- and she bought this idea with delight. He told her he would put one of his daughters in the house -- she was pleased to think a young person who would value the home as much as she had would be living there. He got the house for tens of thousands of dollars below its market value, pre-bubble but at a time when houses were selling at a healthy, normal pace.

The instant the papers were signed, the For Rent sign went up.

Around the corner from me, the same gentleman purchased another house, this one somewhat run-down. He signed his name to a document that is registered with the County Recorder's office in which he told the mortgager that he was purchasing the house so that he could move himself, his wife, and his elderly mother out of the house he actually occupied, because the house they were living in had a step in it (true--many of these houses have sunken living rooms), and they were afraid his mother would trip on it and fall.

Again, the instant the papers were signed, the For Rent sign went up.

All of the houses he purchased in this neighborhood were represented to lenders as residences that he or his immediate family members would occupy. These claims are available for anyone to see at the County Recorder's office.

At the old lady's house, he let the lawn die and cut down most of the trees. The house around the corner was allowed to devolve into a slum property. Typically, the first thing he'd do when he got his hands on a rental was to cut down all the trees, because he did not want to have to pay to water them and have them groomed. This is an older neighborhood whose established, mature landscaping is its main appeal. When you hack out the trees around one of these properties, you destroy much of its value.

He rented another house on a lease-to-own basis to a youngish woman who had never owned property. To one of the neighbors, he remarked that he was glad to have the opportunity to unload it on her because the pool was decrepit and likely would require some very expensive repairs. At this house, he cut two spectacular Aleppo pines out of the front yard. Not wanting to pay someone to remove the stumps, he killed the lawn and covered the front yard with gravel, mounding it over the three-foot-high stumps. Neighbors soon dubbed the place "the boob house," for reasons you can picture.

The selling price he worked into the lease-to-own contract was way, way above the house's market value. The woman's option to purchase came due at the height of the bubble -- just as the landlord was unloading his other properties at huge profits. Had the bubble not occurred, the amount the woman would have had to pay would still have been well above market value, but with the wildly inflated prices, she now was in a position to buy it for less than he could sell it for in the overheated market. He tried to negate the deal. She took him to court and won.

So here was a guy who indeed had no qualms about taking advantage of elderly women and naive young buyers. I'm sure he doesn't represent the entire "industry," if that's what it can be called. Neither, presumably, does the owner of the house across the street from me, who persists in bringing Hell's Angels and other unusual folks -- with all their noisy and sometimes threatening accouterments and pals -- into our middle-class neighborhood. But there they are.

Certainly, if you can buy a house cheaply, rent it for something close to the mortgage payments, KEEP the rent coming in (good luck!), and hang onto it without serious incident for a number of years, rental real estate can be a good investment. But the fact remains: a lot of rentals in a neighborhood do not help the area's property values. And since you can get 8 or 10 percent in a good mutual fund, unless you really enjoy hard work, guff from renters and neighbors, and visits from the police and the City's neighborhood improvement office, you might be better off to put your money in a low-expense mutual fund.

In most areas of the country owning ISN'T more expensive than renting, or not much more. For instance I live in Dallas where rents for a 1 bedroom Uptown are $900-$1500. I bought a 1 bedroom condo similar to one I would otherwise rent for $150,000. All costs - mortgage, tax, ins, and HOA total $1300. Right now I could probably only rent my unit for $1100, but my mortgage payment will stay fixed and rents will only go up, so eventually I plan to rent this place and at LEAST break even.

Better example - I just bought a duplex for $130,000. Mortgage (incl tax and ins) is $947/mo. One side pays rent of $700 and the other pays $750, so my total monthly income (assuming it's occupied) is $1450. Sure I have to pay for the lawn to be mowed and for the plumber to come by when there are clogs, et al, but a $500/mo cash flow cushion is a great thing to work with! In ADDITION I benefit from the market appreciation - which averages and is expected to be 4-5% in TX. Tax benefits like interest, depreciation, and maintenance deductions, etc. are a very important bonus. In fact my annual tax burden goes DOWN this year even though my income will increase from $55,000 (salary) to around $72000 (salary + rent income).

I didn't mean to single you out, Funny. That guy sounds like a real first class sleazeball. I have heard the "gullible old lady" theory in multiple places and no doubt it's a common scam, but I wanted to highlight how you can make money renting, honestly, in today's dollars with today's property values and mortgage rates.

There are certainly different investment options out there. The stock market, even mutual funds, can be risky. A lot of people find real estate investment more suitable, and remember I used as a case study an example of a house that rents for less than its monthly costs, and appreciates only modestly. We personally did much better on our rental. 

Catherine Shaffer

Wise Bread Contributor

One of the most hated money saving strategies is to buy a property you can actually afford, even if that means moving somewhere where the living is cheaper.

The same is true for renting. We moved to a very inexpensive part of the country where houses are easily only a tenth of city house prices. That means that we've had no problem buying several of them, no mortgages, and renting them out for enough cash flow to sustain us in a low cost of living town.

People often say, "I can't move there. What jobs would there be?" If you find the right place, with the right strategy, and the right attitude which embraces the concept of "enough" for your daily living, this *is* all the job you need.

I was in a seminar with a high net worth counselor who said that the best thing you can do is pay off your principal residence as soon as possible. Any thoughts on that? I currently do not have a mortgage on my principal residence with an appraised value of $400k.

When considering investing in residential rental property please do not ignore the state's legal environment. Some states are very pro-tenant in their regulations and this can affect the profitability of owning properties. By contrast, in almost all states, commercial rental is relatively free of interference and courts will enforce the deal the parties make.

I agree with what Xin Lu says. When real real estate investors see a negative $500 per month cash flow on a $60K investment they do the logical thing: sit and and wait. I made an investment of $25K in March 2011 into a 3BR Townhome. When rented, I net $280 positive cash flow per month. That is more than 1% ROI monthly on what I invested. I manage my properties myself, but out of that $280 still comes repairs and vacancies. So, I hope to clear about $100/month in the first year or two.

5% assumption for appreciation is really optimistic and not just "barely keeping up with inflation." If you look over time, housing goes up at the same rate of inflation. Because it is still a little overvalued, even in 2011, I assume that over the next 10 years we will maybe have an average of 2% appreciation per year, and I don't assume I will be able to sell(or 1031 exchange) at a reasonable profit for 10 years. This forces me to find deals that pay me now. And the truth is, we can demand this in today's market. If San Diego today, I can find many properties that cash flow with only 10% down. There are certainly areas that still don't cash flow with 30% down. I avoid these areas, they haven't finished normalizing to the trend line yet.

There are FOUR pilars to making money in real estate. Know them well: Cash Flow, Appreciation, Depreciation/Tax Advantages, and Equity Build. Know them well! Good luck everyone!