Landlord war stories. Landlords love to tell them! I’ve told a few in this blog already. Get a bunch of landlords in a room together, especially if there’s alcohol involved, and the war stories start coming with a vengeance, each one wilder than the next, in a game of oneupsmanship – “That’s NOTHING – wait till you hear what MY tenant left in the closet on Barney St…” (that story is in an earlier blog post, do yourself a favor and go back and read it, it’s awesome!)
We tell these stories to blow off steam. We’re bonding with other kindred spirits. We’re delighting in the knowledge that this crap happens to every landlord, it’s not just because WE are doing something wrong. And some of these stories are highly entertaining, even funny. They weren’t funny while they were happening to us, but now we can laugh about them over Sam Adams & Grotto pizza and it feels good.
Of course if you’re a “civilian” (non-landlord) and you overhear these stories, you’ll run from the room screaming. That’s fine – more rental property for me, then! There is a reason that even after nearly 8 years of putting up with the crap, we continue to be landlords.
Why would anyone want to be a landlord? I can’t speak for everyone, but I can speak for my husband and myself. Our #1 reason is cash flow. If you buy a rental property and the cost to improve and maintain that property is less than the rent you collect from it, you have what is called “passive income.” Now, if you manage your own property there is nothing passive about that income – but the IRS considers it passive, which means it is taxed at a lower rate than the income you get from your paycheck at work. Pretty good deal!
How to own rental properties that cash flow: Do the math right when purchasing a rental property! Don’t just consider the purchase price – consider also the actual cost of repairs to the property to bring it up to your rental standard. Remember if you do the minimum, you’re going to get minimal quality tenants. Decent tenants expect a certain standard of living. Also keep in mind – you don’t want to put a granite kitchen in a tiny two bedroom in the low rent part of town. If you’re only going to get $550/month in that neighborhood, make it look nice but don’t go overboard. Remember to include appliances in the cost of necessary upfront repairs.
From the get-go, we include the purchase price plus the cost of immediate repairs into our mortgage calculation. We always mortgage the property – there’s so much more leverage in using other people’s money. In addition to the mortgage payment, there’s also property taxes and insurance. Take the total taxes and insurance bill for the year and divide it by 12 months, then add it to your monthly mortgage payment. In real estate terms, that’s known as PITI (payments, interest, taxes, insurance.)
Now that you have your PITI, add to your monthly expenses the costs of any utilities the landlord is responsible for every month. Ideally, you’d have everything separate, and the tenants will pay all utilities. But a lot of the property in Northeast PA is older housing stock. We own 9 buildings, 6 of which only have one water meter, so we pay those water bills. One of our 6-units has one big boiler in the basement, so we pay that huge gas bill (and adjust rents accordingly.) Some of our units have “foreign wiring” – meaning the common hallways, exterior lighting, laundry room, etc. is wired into the box that also serves a rented apartment. We pay the electric bill for that tenant – and charge more rent for that apartment, because electricity is included.
One note here – be wary of foreign wiring. A lot of these old buildings have it, and you may not realize it. But if you rent an apartment where the tenant pays utilities, and they figure out they’re paying for the laundry room lights, they can call PPL or UGI for an investigation. If the utility company finds there is foreign wiring, they will refund the tenant all their electric bill money from the beginning of the lease – and stick it to you, the landlord. So have a licensed electrician check it out!
The maintenance and vacancy pad.
Your PITI plus utilities = your FIXED monthly expenses. But wait, there’s more! Maintenance will consume some of that monthly income. Maintenance includes calling the handyman to unclog a toilet, fix a leaky faucet, etc. It includes the cost of keeping the grass cut and the snow shoveled. And it includes the cost of “turning” an apartment after someone moves out: cleaning and painting. Sometimes you’re hauling garbage and old mattresses out of there, too. If you do maintenance yourself you’ll save cash, but don’t forget to include the cost of your lost time, gas in your car, etc. Because of this, I don’t give any discounts in my Cash Flow math for DIY maintenance.
Vacancy is another factor you must consider. It would be great if 100% of your rentals were rented 100% of the time, and every tenant always paid their rent. But this isn’t fantasy land. You’re going to have a unit sit empty for a month from time to time – someone moves out at the end of May and you show the place but don’t find a qualified tenant who wants it until the middle of June, and they won’t move in until July 1. You’re also going to have deadbeats who don’t pay – my advice is to harden your heart and start the eviction process by the 5th of the month. If they pay, they can stay – eviction cancelled. Tell them it’s nothing personal. (I know, easier said than done, but this is a business, folks.) Evictions in Pennsylvania take at least a month to carry out if the tenant decides to wait until the constable escorts them out the door. The sooner you get the process started, the less the vacancy will cost you. But you have to take the cost of evictions into account when running your numbers, because they happen.
I borrowed a formula from a landlord named H. Roger Neal – his book Streetwise Investing In Rental Housing inspired me back when we first got started – check it out: http://www.amazon.com/Streetwise-Investing-Rental-Housing-Independence/dp/1882877039/ref=sr_1_1?ie=UTF8&qid=1436029896&sr=8-1&keywords=h+roger+neal+streetwise+rental
Take all the rents you expect to collect every month from your building in a perfect world. For my first building, a 6 unit, those rents are: $665, $555, $550, $525, $525, $500 = $3320
Then, take 30% of those rents - $996. That is our 30% vacancy and maintenance pad for that 6 unit building. Now, I’m not going to spend $996 every month on vacancy and maintenance. Likewise, I might have a bad month where I spend a lot more than $996. But 30% of gross expected rents is a good safe number to plug into your math to make sure your building cash flows.
SO let’s review – PITI + utilities + your 30% vacancy/maintenance pad = your property’s expected monthly expenses. If you hire a management company, they usually take 10% of your rents, so add that in as well. Also consider any leasing fees they charge, they usually take a whole month’s rent every time they fill a vacant unit, so assuming that happens once per year, add another 8.3%. I can see now why H. Roger Neal likes to self-manage!
Now, add up all the rents you hope to collect from the property per month, minus your expected monthly expenses. If that number is not negative, you have achieved Cash Flow. H. Roger Neal expects to collect $100 per month, per unit. That doesn’t sound like a lot. But depending on how many units you have per month, it adds up. Our 25 units profit $2500/month under H. Roger Neal’s formula, that’s after everything else is paid for. That’s $30,000 per year. A full-time salary in the Wilkes-Barre area!
Going full-time as a real estate investor. My husband went full-time in 2009, when we only had 16 units. He was working for WVIA when they were doing their massive lay-offs, and he actually stood up and voluntarily put his head on the chopping block. Why prolong the agony? By the time his unemployment ran out, we had 24 units, and he had taught himself how to buy from the tax sales. Our 25th unit was the house we lived in – it became a rental property when we moved into our current home, which we bought in 2010 as our first “flip.” It took us two years to flip it because we were learning on the job and had no idea what we were doing. But it turned out pretty darn nice and now flipping houses for sale is another thing Steve does for a living, although he is still a novice.
I was going to join him as a full-time investor by my 40th birthday, on September 10, 2010. I had my retirement party planned in my head already – all my colleagues from 98.5 KRZ wishing me well with a big blow-out at the Woodlands. But shortly after my 39th birthday, I got a little surprise. Her name is Savannah.
So I decided not to quit my job at KRZ – health insurance suddenly became important, as did a steady paycheck. And when a round of lay-offs ended my tenure there in 2012, I still didn’t take the leap. Having a child changes your priorities. What I did was take a job I can do from home – no commute, extra time with the kiddo, full benefits, and a split shift that lets me work on our business during the work day. I’m a traffic reporter for six radio stations from a studio in my attic! One day I will make the leap as a full-time real estate investor. But it’s no longer just about me and Steve – Savannah has made the stakes much higher. I will be growing our business very carefully, with slow, calculated moves. This is a good thing!
And if you read this blog you can take the journey with me.
Curious about real estate investing yourself? Join us the second Wednesday of every month at Grotto Pizza, Wyoming Valley Mall Wilkes-Barre at 7pm.. $5 includes pizza and soda. Steve, Savannah & I will all be there. I’m thinking of getting business cards printed up for our youngest investor.