I’ve been hesitant to write this article about why you should not invest in real estate.
You see … I’m a landlord. I collect rent from several properties I own.
But I’m not a real estate investor by any means.
I’m an accidental landlord. I didn’t buy my properties with the intent to lease them to tenants for rent. I bought them so my family could live in them.
Why You Should Not Invest in Real Estate
A home is rarely a good real estate investment. Before you decide to buy an investment property, it’s very important to know why you should not invest in real estate.
Surely you’ve seen people’s home values sky-rocket to ridiculous levels. In the City of Vancouver in British Columbia, Canada, the market is absolutely crazy.
You’ve heard that investing in real estate will bring in some extra income during your retirement. You might have a relative, friend, or neighbor who owns a rental property or two, and they keep giving you free real estate investment advice:
- Buy a house and rent it out.
- Your tenants will pay your mortgage off and, several decades later, your investment will be free and clear.
- Interest rates are still low, so why not take the plunge? You qualify for a VA or FHA loan? That’s even better!
Do you know what the difference is between the following:
- Buying a home to live in and later rent out.
- Buying a real estate investment property.
If you don’t know, this is why you should not invest in real estate. This article is for you.
Calculate Monthly House Payment
Using the mortgage calculator (from mortgagecalculatorbiz.org) below, enter the figures listed to follow along with my example:
- Home value: change this to 255,000
- Mortgage loan amount: change this to 204,000
- APR (%): change this to 5
- Loan term (# years): 30 (default)
- Real estate taxes (%): 1.38 (default)
- Homeowners insurance (%): .5 (default)
- PMI (%): change this to zero
- Closing costs: change this to zero
Note: Find out your state’s property taxes by [clicking here].
Note: Median home list price in the US in July 2017 was $255,000.
What Does It Take to Be a Landlord?
Let’s assume this is you.
You bought and lived in this home. After three years, you move out but choose not to sell your home.
Instead, you decide to rent out your home.
Rental Income (+$1600)
Obviously, you’ll want to charge enough rent to cover your mortgage and expenses, but exactly how do you do calculate it?
If homes in your area rent out for $2000 per month and they’re similar in location, quality, age, square footage, and amenities, you can expect to collect about $2000 in rent.
Your home will rent for the market rate. It doesn’t matter how much you want or need in order to cover your mortgage payment and expenses.
Note: Median rent price in the US in July 2017 was $1600.
Property Management Expense (-$160)
First, you have to decide whether or not you’ll manage your property on your own. If you continue to live in the area, this is a possibility.
However, I’ve heard too many horror stories of first-time landlords renting their homes out to the wrong tenants and getting burned. These are the people who tell everyone never to invest in real estate even though they were never real estate investors in the first place.
Find a property manager until you know what you’re doing.
- You pay a property manager $800 to
only display a “FOR RENT” sign and list your home on their websitemarket and lease your home.
- Every month, your property manager collects $1600 in rent from your tenant.
- Your property manager takes out 10% and deposits $1440 into your account. Your mortgage payment is $1494 (calculated from the example above) putting you in the negative (-$54).
But the bleeding doesn’t stop yet!
Maintenance Expense (-$213)
You have to pay for maintenance and repairs. If you have a new home, this isn’t too bad. If your home is old and constantly needing repairs, you’re in for a treat! Every home is different. Plus, you have to consider how well or how poorly your tenants will treat your home.
Here are just a few arbitrary costs to replace (includes price and installation) and life expectancies of common, and expensive, components of the home:
- $7000 | 25 years | -$24/mo – roof
- $1000 | 12 years | -$6/mo – water heater
- $1000 | 15 years | -$6/mo – gas stove/range
- $1000 | 13 years | -$6/mo – refrigerator
- $1000 | 13 years | -$6/mo – clothes dryer
- $1000 | 10 years | -$6/mo – washing machine
- $500 | 9 years | -$3/mo – dish washer
Actual maintenance expenses are hard to predict. If you don’t account for them by setting aside funds, it’ll be a painful blow to your wallet when you get the bill.
The One-Percent Rule is an easy way of estimating annual maintenance expenses. One percent of your home, in this example, is -$2550 annually or -$213 monthly.
Utility Expense (-$50)
In some localities, the lessor (that’s you the landlord) is required to pay for water and sewage and some utilities.
Let’s assume this is a nice and even number, so -$50 will work.
Vacancy Expense (-$133)
Do you believe your home will always be rented out? If it is in a highly desirable area, and your home is in good condition, it might. However, you have to factor in time between tenants. After a tenant moves out, your place will have to be cleaned or repaired (maintenance expense), and this may take a few weeks.
The general rule is to factor in one month of vacancy. In our example, we should plan to lose one month to vacancy every year, worst case scenario. Our monthly vacancy expense is $133 ($1600/12).
Miscellaneous Expense (-$50)
Many newer homes are built in communities requiring monthly Homeowner Association (HOA) dues. Let’s assume you pay monthly HOA dues of $50.
Let’s create a summary of your monthly cash flow (or loss) from the example above:
- Total Revenue (+$1600)
- +$1600 monthly rent
- Total Expenses (-2100)
- -$160 property management
- -$213 maintenance
- -$50 utilities
- -$133 vacancy
- -$50 miscellaneous (HOA)
- -$1494 mortgage (PITI)
There are other fringe benefits of real estate investing that I will cover in future articles. For example, you can deduct depreciation of your rental property annually as well as the costs of improvements to your home over the life of the improvements.
Buying a home and renting it out is the easiest way to get started in real estate. However, unless you buy your home with the intent of profiting by calculating revenue and all expenses, you’re not investing in real estate. You’re simply an accidental landlord.
Are you an accidental landlord or a real estate investor?
Please comment below. I’d love to hear your thoughts.