We all make mistakes.
Some are more costly than others. Each contains a lesson.
In mid-2006, my wife and I purchased our first home. The property market in our area was booming. In early 2008, we needed to move to another city for career reasons. Unfortunately, during the time span that separated these two events, the global financial crisis happened. We couldn’t sell our house; we didn’t even get an offer.
With an eye toward making lemons into lemonade, we decided to rent the house out. What we made was more like sour medicine. For nearly a decade, we poured dollar after dollar into a money pit. Ultimately, we sold our former home for a loss nine years after we bought it. We lost money on our capital, we lost money every week we owned it, and of course, we paid real estate fees to get rid of it. The house cost us a small fortune to operate as a rental.
We’ve learned a lot since then.
“Maybe we can rent it out.”
I love to talk about real estate. That’s what happens when you have a passion for something — it tends to work its way into conversation. But time and again, friends, colleagues, and acquaintances tell me that they aren’t interested in “fixing toilets.” The closest a few will come is to say that maybe they’d like to turn their existing home into a rental. In fact, this is a line that I hear often: “I’m thinking of buying a bigger house for our family. Maybe we’ll keep our current house and rent it out.”
Most of the time, it’s bad idea.
I think it’s great that these people are considering rental property, but most don’t know how to make the numbers work. I didn’t know either.
For me, getting through the learning curve involved taking on board a number of lessons that I think are critical for people who want to use rental property as an investment vehicle for their future.
Lesson 1: A rental is a business.
Unlike stocks, which represent shares in a business, a rental property essentially is a business. The purpose of a business is to make a profit. Think critically about this. The rental income from your property must cover all costs with something left over: profit. Costs include property taxes, insurance, ongoing maintenance, capital repairs, property management, and more. They also include the mortgage payments. In my experience, the size of the mortgage is usually what pushes the property from being a good, cash flow positive rental into a cash flow negative money pit.
Put simply, if the market rent that you can easily get for the property does not cover all of your expenses, then the property is not a good rental.
The main issue is this: If you originally purchased the house to live in yourself, then you probably paid too much for it. You purchased it based on emotion — the desire to find a place for you and your family to live comfortably. This was not a business decision. A large percentage of the time, when you look into market rents for your home, you’ll find that the rent you can expect to get cannot cover all of the expenses.
There are a number of reasons for this:
- You overpaid to begin with because you really wanted it and because you were looking at what you could afford.
- The property has many features that don’t increase rent. Marble countertops, plush carpet, top-of-the-range appliances, elaborate decking, swimming pools — the list goes on.
- You paid for a large yard. Land costs money, but yards need to be maintained and renters don’t usually want the hassle.
It’s not that renters deserve less. It’s that, in many cases, they won’t pay for more. But you did.
Lesson 2: A rental is an investment.
Are you looking for an investment or a hobby? A lot of “mom and pop” investors put a lot of their own time and money into the rental. They do this either a) by putting in a very high deposit (or using existing equity) in order to have the rent cover the difference in the mortgage plus other…