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Before Purchasing Rental Property...What You Can Learn From My Mistakes

Buying a Rental Property

Purchasing rental property can help you build wealth…but before you consider buying rental property I want you to be well aware of what you are getting into and what to watch out for.
In the first part of this article, Selling Rental Property, I showed you the financial results of one of my rental properties and why I decided to sell it even though it was making money. In this part I want to go over the lessons learned and the mistakes you should avoid before purchasing rental property.

First off, I paid too much for the house. This of course I only know now. Back in 2008 I thought I was getting it at a good price but then again I had no idea the market was going to keep declining for the next 4 years!
Lesson for you: Buy below market value. Yes, this is easier said than done. In 2008 I thought I was buying below market value. But the point is that I see investors (especially right now, April 2013) buying at or slightly above market value because of increased competition. NO!

purchasing rental property

Second, between the few mortgage payments I had to make when the house was vacant due to tenant turnover and then the repairs that had to be made over my period of ownership that pretty much wiped out all my cash-flow and the reserves that I built with that cash flow.
Lesson for you: When purchasing rental property AT THE VERY MINUMUM, it has to be cash flow positive from day #1. As you can see from my experience, even that is not guarantee of profitability, but imagine what would have happened if I had bought a barely cash flowing property like so many investors do thinking they will make their money when it appreciates…
Third, I had to do quite a bit of work to the house over my period of ownership. From the first repairs that I had to do to get it rent ready to when the AC broke last year. Owning property costs money…
Lesson for you: Consider not only the repairs needed when first purchasing but based on the age and condition of the house set an annual budget for maintenance and repairs. Before purchasing rental property do a projected annual cash flow analysis where you consider both the income that it will generate and the expenses you will incur.
These include (but are not limited to):

  • Mortgage payment: principal, interest, taxes and insurance
  • Vacancies – assume at least a one month vacancy per year
  • Repairs – for when stuff breaks
  • Maintenance – for things that just wear over time
  • Property management – if you intend to hire someone to manage it for you
  • Utilities – I highly, highly recommend not buying a rental property where you are responsible for any utilities
  • Advertising and marketing – for when you have to find a tenant
  • Eviction and/or legal – it’s not a matter of if but when you have to evict a tenant, pay to get their stuff removed, court costs, attorneys, etc.
  • Income losses – for when a tenant does not pay in time and/or in full
  • Turnover costs – when a tenant leaves and you have to prepare the property for the next one. At the very least you will always have to clean and do touch up paint. At worst …well anything is possible but you could end up painting the whole thing, replacing all carpets and much, much more…

 Oh, and make sure you save that cash flow, you’ll need it!!
Fourth, landlording is not a whole lot of fun. It can create wealth, it can make you rich over time, it can be done by anyone…yes all those are true, but it's just not fun. I don't get anywhere near the same enjoyment out of it that I get from rehabbing and flipping.
Lesson for you: Don’t let this dissuade you from purchasing rental property but be aware that landlording can be a hassle. Just make sure that you (and your spouse) are prepared for what’s coming. Its not always bad as I have a very good relationship with my other tenants but there is plenty of room for bad times in this business.
Finally the reason I sold the house was not because I have given up on land lording. But I sold it because of how much I paid for it.
Think about it…
The true finish line with rental real estate is to get that property paid off and then get to enjoy 100% of that cash flow. In order for me to do that with this house I would have to pay off close to $248,000 (loan amount + interest) in order to get to enjoy monthly income of $1300-1400.
However right now I can go out and find me a $70,000-80,000 house that can give me about the same monthly rent and cash flow. Therefore I would rather pay off $135,000 (loan amount + interest) to get monthly income of $1200-$1300 rather than $248k. Wouldn't you?
Other things I learned:

  • Screen your tenants. It's better to have a vacant property than a bad tenant.
  • Keep track of income/expenses accurately in order to be able to make a factual analysis. Don’t go off memory or perception
  • This was my first “rehab” this house made me see that I could be a rehabber and look at what I have done since. I think that alone made this house worth it.
  • I learned the importance of financial analysis in real estate investing. The numbers don't lie...

One of the skills that any investor must develop is knowing when to let go of an investment, either because it has performed well and you want to realize your profit or because it has performed poorly and you need to cut your losses and it is better to put that time and money to better use. I think this house was the latter case…we'll see.
QUESTION: Is purchasing rental property worth your time and money? Yes/No, Why?

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