Why You Should Not Invest in Real Estate

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!

Not!

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.

However…

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 website market 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.

Summary

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)
  • Cash Flow Loss (-$500)

Why You Should Not Invest in Real Estate

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.

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17 Comments

  1. Really enjoyed this. I have accidentally landlorded before. Though I got pretty lucky in my situation, this is what I warn people all the time about. You make money in real estate by buying correctly. Sometimes accidents are correct, but many times they’re not. Do you have plans to buy property more intentionally in the future?

    1. Hi Boss!

      Yes, I do plan on investing in real estate more intentionally in 2019. I currently have a property that is fully paid off but in an area where maximum rents bring in no more than 0.5% of property value. I’m going to do a series of posts on how I analyze properties and deploy the money (including financing) to purchase my next properties. Looking at writing about my preparations next year.

      My next property might be a multi-family property but those are really hard to come by in the Olympia area at a decent valuation. Too many investors but more importantly too many wanna be investors who will pay more than what a property is worth driving prices up.

      Thanks for dropping by to comment. I appreciate it! 🙂

  2. Darren, I like how your break out the CapEx as $/month per item. I normally just stick with 10% for capex but your method is going to be more accurate for sure. I think I’ll use it :).

    Now I see one exception to your post, house hacking is a great way for the new investor to reduce many of the risks outlined above. Buy a multi family and live in one unit. There really is no way around managing the property yourself, at least early on, so you might as well keep your tenants in the same building.

    1. Great points! I don’t think I’ll use CapEx and other intermediate-level real estate investing terms any time soon. My intent is to keep this simple so that people who don’t invest can learn how to do so and use as many real-life examples as possible to illustrate how or how not to.

      There are so many better blogs on real estate investing that readers can turn to. I’ll eventually link to my favorite articles as I develop these “series.”

      House hacking… I love it. I do want to write about it in the future but I’ve never done it before. Have you?

      Thanks for stopping by to comment. I do appreciate it! 🙂

  3. I commented awhile back…not sure if it got stuck in a spam box or something. I’m definitely looking forward to a follow-up post about why you should invest in RE. I only have one rental and it is out-of-state because NYC is too expensive. It’s been going okay…there are ups and downs. I definitely agree that being an accidental landlord is not ideal since you didn’t analyze the purchase based on its numbers. Is it possible to sell or does that not make financial sense?

    1. Hi, Andrew!

      Sorry about that! I’m trying to figure out this comment system in WordPress! It might have gotten blocked by AKISMET. I don’t want to moderate comments by frequent visitors either. One of these days I’ll have it down.

      I believe in real estate investing but we have to be very analytical in how we approach it. It’s much easier to invest in the stock market but I know for a fact that real estate investing, if done right, is more lucrative but can also be VERY painful if done wrong. The Mrs. and I own one property free and clear which we bought 15 years ago. We haven’t paid down our other rental home because we focused on the markets instead. Plus it’s hard to justify getting a 3.75% return when the market is shooting up 10 to 15 percent annually.

      Stay tuned and thanks for stopping by. I appreciate it!

      Darren

  4. Thanks for sharing Darren! I’ve read so many horror stories about real estate investments, especially problem-tenant stories. I just don’t have the patience. I don’t have the temperament to be a land lord 😛 I’ll stick with equities =)

    1. Hi Tim!

      There are so many people who are “accidental landlords.” I’m lucky because I bought my homes in neighborhoods conveniently located near Army and Air Force bases. The demand for rentals is high so I’ve always had tenants AND I’ve used property managers. I do not discourage becoming a landlord or investing in real estate. I just want to make sure people do some homework before they get into this, because the painful experiences can be very damaging to their pocketbooks.

      I’m considering selling all my places and buy one small place free and clear when I retire at 59.5

  5. As someone who makes over $200K a year from being a landlord, I would have to disagree. But many people just do not have the skills to be a landlord. They need to work a W2 job so hat they can be told what to do, they have no ambition.

    You need to understand how to buy right, at wholesale prices. Non-MLS properties, and 20%+ discounts. Some half price, and the owner cannot sell to anyone unless that buyer knows how to help them out of their situation.

    I picked up a SFH last year for $38K, rented it for 18 months, and will sell it for ~140K this year. Not bad.

    1. Hello! Thanks for stopping by!

      I’ve followed your blog on and off since 2014. You once posted on a blog I started and stopped called retiredarmyvet.com. Welcome to my new site. This one is for keeps…

      I totally understand where you’re coming from. Actually, I do plan on following up with some posts on why investing in real estate is actually a good idea. However, real estate is definitely not for everyone. I want to make sure that the average person doesn’t rush into real estate without learning a bit more. You and I have heard of enough horror stories.

      I took the most important advice you give on screening tenants to heart: make sure your tenants have a decent credit score. Because I’ve made sure all my tenants had credit scores above 650, I’ve had no issues.

  6. Hi Darren, oh, I agree wholeheartedly! I fancied myself as a real estate investor because I always bought so much property and made so much money in Monolopy. Not so in real life. I bought a lovely duplex on spec early enough that I could choose my own kitchen and bathroom fittings. I adored the place and had fun planting a garden. My first tenant was wonderful and then my circumstances changed and I had to move in for a while. Then I decided to move back to my home town, miles away. This was the beginning of a slippery slope of ill placed or even black listed tenants who trashed the place. I renovated a few times, rent was below mortgage and I found myself paying out every month for a depreciating “asset”. Eventually the bank helped me sell below market value and I cut my losses. Relief. Once bitten, twice shy.

    1. OMG, Lauren!

      I don’t know if there is a foolproof way of finding the best tenants, but I’ve read that your future tenants’ credit score is the greatest indicator of a good tenant (by the way, I’m working on an ultimate guide to great credit). I don’t know if there’s a system like that where you live (there must be, right?), but here in the USA, we have FICO credit scores that measure our “credit worthiness.”

      Thank you for sharing your horror story, because it is exactly why I wrote this article! I know what I’ve written is very basic, but if people don’t know what they’re getting into, they’re in for a rude awakening! 

  7. Hey Darren, I read through everything, and it seems like something is honestly missing. May more of an explanation of your story and how you accidently became a landlord, and how that is going for you? I am sure that most of the people that own one of these extra homes are not making any money, which must be true as you brought out, so how can it be fixed. Any suggestions to this dilema? That would be a great follow up article.

    1. Hi Andrew,

      I appreciate your honest feedback, because it confirms what I suspected: people want to know specifics rather than hypothetical.

      Yes, my story on real estate is missing. I, originally, intended to write exactly about my experience. In fact, I did and even used my own figures but later decided to remove it because it’s a bit too personal.

      This was just an introduction to real estate as an investment. I’m no expert, for sure, but I will follow up with my lessons learned. I’ll have some specific posts about things people should do to valuate properties, how to find property managers, and some legal requirements. There’s a lot to cover, though, so it’ll be a series.

      Thanks!

      Darren

      1. So far, I’ve not had any horror stories but I’m always reading and learning from folks like you as well as a lot of people on biggerpockets.com. I’ve never actually attempted to buy an investment property. I’ve simply bought homes in good neighborhoods near the best schools and close to transportation. I’ve definitely paid a premium and don’t cash-flow like the pros, but my properties will all be paid off by the time I retire.

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