Q & A: Case Study #1 Edition

Flickr photo by alexanderdrachmann

Welcome back! In case you haven’t been following the discussion, my first case study has gotten a lot of comments! One commenter, Drew who blogs over at EpicFinances.com, left me a great, well thought-out comment expressing some of his concerns about landlording. I wrote him a big ol’ response but since his comment expressed what a lot of people feel about landlording and real estate, I decided to format it into a post so that others can benefit.

1. What about costs to prepare for the next tenant (repaint / clean / repair / etc)?

Turnover is something that we haven’t experienced yet, though we are about to. One of our tenants is moving out this month so I’m sure I’ll have a post detailing our experience with this. I think the highest cost during turnover is replacing worn out carpet. For that reason, we’ve opted to do laminate in the common areas and carpet in the bedrooms only. We’ve got a decent deposit on all of them so that should cover a lot which isn’t wear and tear.

2. What about your bottom line if your tenant doesn’t pay and holds your property for 2-3 months and decides to trash the place before he leaves?

Texas is a very landlord-friendly state. Here’s a sample schedule for what you could realistically expect regarding evictions:

Rent is due on the first, late on the fourth. Send a 3-day “Notice to Vacate” on the 2nd and they will get it on the 4th.
If they haven’t paid or moved out by the 7th, go to the JP court and get a court date in 2 weeks.
On the 21st, go to court and win (they didn’t pay, you have the lease – you’re going to win). They have 7 days to move out.
On the 28th, if they haven’t left the sheriff shows up with a moving truck.
If you were really good, you would have another tenant lined up the move in within a week. :)

You have to know the local laws regarding eviction. I know in some parts of the country it’s a lot harder to evict but in Texas we don’t take kindly to that kind of behavior.

3. What about costs if your AC or furnace goes out?

Our strategy from the beginning has always been to sell the house within 5 years, ideally to the tenant, and roll the money into another property. At some point in the future, we’re going to get into apartment complexes and that’s probably what I will end up retiring on. I’ll go into that in another post. So when we bought the house, we looked at it and asked ourselves: what could possibly break in the next 5 years? Then we fixed or replace that. If something goes wrong, we do have some cash reserves to cover it but so far maintenance has been very low.

4. What about legal costs to defend against lawsuits or threat of lawsuits? I have friends who own rentals (lots of them) and they say its only a matter of time..

This has been on my mind more and more lately but really I think legal risk can be significantly reduced through management. You have to consider why you might get sued and most of the time it comes down to mismanagement. Accidents do happen and that’s why we carry a $1M liability policy above the $250k liability policy on the property.

5. (Paraphrasing here) Why not use an LLC to hold your properties and reduce risk?

LLCs might be better in other states but in Texas they are weak. If someone is going to sue you for negligence, they will sue your LLC and also you personally, so there isn’t a lot of point. This is in addition to the other issues with LLCs: you have to use (expensive) commercial financing and commercial insurance.

6. How much do you value your time? I would argue you should subtract (Number of hours) * ( what you time is worth) out of your profits. That includes repairing, showing, leasing, everything.

The amount of time it takes to manage a property is more or less a function of your management style. I spend some time on the phone less than once a month. 2 out of 3 prefer email communication and pay their rent electronically. The other one has taken more time because we’ve had to chase after her for the rent, but she paid for this time with late fees. Management itself can be outsourced if you’re willing to pay for it.

Finding suitable properties and getting them into shape also takes some time but some of this can be outsourced as well. You can spend as little or as much of your time as you want.

I look at our real estate investing as a business: we’re basically self employed property managers, who happen to own the properties we are managing. Framing it this way sets us up to treat it like a business and not just a source of “passive income”.

7. What about costs for screening tenants / gas and wear and tear / misc home depot runs for repairs?

Prospective tenants pay an application fee which pays for their background checks. We do group showings and thus far have only had to do one showing per property to get a tenant. When we have maintenance issues, we hire it out to a local handyman who charges a reasonable rate to take care of little stuff. We try to do as much of the repairs upfront to keep ongoing maintenance low.

Bonus Question: Do you really think that you will get that 25.8% return?

Overall, I think we will probably come pretty close to that return if we sell before anything serious can break. As you mentioned, this return does include managing it ourselves but it doesn’t take that much time if you do it right. Even if something happened and we cut our return in half, it would still be a respectable 12%. I’ll take that any day.

How about the rest of you? Got any burning questions or topics you’d like me to cover in the future?

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10 Comments

  1. Posted February 10, 2012 at 4:47 am | Permalink

    Great questions and thoughtful answers, DD. Also a reminder as to why I gave up the active RE investment biz.

    “we’re basically self employed property managers, who happen to own the properties we are managing. ” that’s it exactly and somehow novice RE investors often miss that part.

    Since I was focused on my career, it didn’t take me long to decide I didn’t want this part time job and the repair and tenant hassles.

    In fact my limited experience with tenants was, with one minor exception, pretty good. but when you are in the land lording biz you meet other landlords. It seemed they all had major tenant horror stories. I figured it was only a matter of time for me. But this was also in tenant friendly Chicago.

    But the financial potential is certainly there. you’ll do very well and soon will need to worry about how to give it all away. :)
    jlcollinsnh recently posted..How to Give like a BillionaireMy Profile

    • Dollar D
      Posted February 10, 2012 at 10:45 am | Permalink

      Late night TV and other websites tout real estate as “passive income” and it can be. But at the small-time level we are at now, it’s definitely more like self-employment. This is good because it can be systematized and outsourced to some extent. But ultimately it’s like a part-time job.

      Lucky for us, Mrs. Dollar will be our part-time property manager going forward. She’s even got a few other properties from fellow investors that she will likely be taking over.

      Every landlord has that one tenant who is a pain and I’m no exception. I’m going over there today during lunch to deliver an eviction notice. I’m ready to be done with her and find someone else.

      I hope you’re right. :) My plan has always been: to have so much money that I don’t know how to spend it before I die. Which is actually the opposite of most retirement planning: to hope that you die before you run out of money.

      It’s been an adventure so far!

  2. Posted February 10, 2012 at 11:17 am | Permalink

    Wow I feel honored that you took the time to response to my comment! Thank you so much.

    I wish I would have a taken a little more time to prepare it :P

    All of your answers are very informative, but I know I will never truly know what it is like to be a landlord unless I make the jump. Right now I have about $14k cash and about $25-30k of realizable equity, and I’m simply not liquid enough to make the plunge — yet.

    My biggest problem is that I usually do fairly well in the stock market — So well that I would only be attracted to real estate if I was sure I could earn 20%+ return on my money. My biggest problem now is that I simply do not have the starting cash and I am impatient to see my money grow.

    What I am leaning towards now is selling my home and buying an owner occupied duplex. Have one tenant and have them pay your mortgage and toss all of that savings into my brokerage account.

    I hope you don’t take my comments and blog posts to be aggressive. I am a giant fan of landlords who are transparent with their finances and duties, and your site is very entertaining!

    Thanks again!

    • Dollar D
      Posted February 10, 2012 at 11:45 am | Permalink

      You’re very welcome! I think your comment really reflects a lot of people’s concerns regarding rental property so it was fitting that it should get it’s own post.

      I’m a very analytical, type-b personality so it took me a long time to really feel comfortable. Even after we pulled the trigger and bought that first house, we still didn’t know everything (and still don’t) but we have a network of people we can turn to when we have questions. I credit that network with a large part of our success.

      One great reason I love real estate is that you can make money in multiple ways: tax benefits, appreciation, mortgage pay down, and more. With all of these combined, 20%+ returns are not hard to achieve in some parts of the country (like mine :))

      Buying a duplex and living in one half is a strategy I have read about but I have two concerns:
      1) I’d rather not live next to my tenant, or let them know where I live. We have a PO box if they want to mail us stuff
      2) Duplexes are harder to sell and the only buyers are other investors. My long-term strategy is to get into apartments so single family houses make sense since they are more liquid than small multifamily like plexes.

      Trust me, I don’t take offense at anything you’ve said.
      I’m glad you enjoy reading since I sure enjoy writing it :)

  3. Posted February 10, 2012 at 11:22 am | Permalink

    “My plan has always been: to have so much money that I don’t know how to spend it before I die. Which is actually the opposite of most retirement planning: to hope that you die before you run out of money.”

    wonderful phrasing!
    jlcollinsnh recently posted..How to Give like a BillionaireMy Profile

    • Dollar D
      Posted February 10, 2012 at 11:33 am | Permalink

      Sad but true!

  4. Jonathan
    Posted February 13, 2012 at 12:17 pm | Permalink

    Our experience with landlording (though very limited so far) has been even easier than Dollar D’s. We bought House 1 in October 2010, and got a tenant just over a year ago. In that time they have contacted us about 1 single maintenance issue (very very minor), which they offered to fix themselves and we never heard about again, and asked us to help put a lawn in the backyard, which we did. Total time spent for the year – maybe 10 hours, most of which was driving to the bank once a month to deposit the rent. Of course now they’re asking for a rent reduction…So far this is our toughest test to date because we are denying the reduction but we want to keep the tenant and we want them to still be happy tenants. So we’ll see how it plays out.

    Incidentally the houses we buy (we just got our second and are interviewing applicants now) are only 5 years old so major repairs are unlikely in the near term.

    • Dollar D
      Posted February 13, 2012 at 12:28 pm | Permalink

      I’m glad your experience has been so easy! The first and third tenants have been awesome but the second one was a big mistake (one we are correcting this month).
      I’ve never heard of a tenant asking for a rent reduction but I’m sure it’s bound to happen eventually. I’d be interested to see how that works out for you.

      Are you getting a good deal on these fairly new houses? I’d be interested to see your numbers if you wouldn’t mind sharing. We try to pick up houses from the 1980s with the oldest one being 1978.

  5. dave
    Posted February 18, 2012 at 11:55 am | Permalink

    Re: 6. “…How much do you value your time? I would argue you should subtract (Number of hours) * ( what you time is worth) out of your profits….”

    I love how the “paper investors” (stocks, bonds, etc.) never subtract the countless man hours they spend studying/researching the best place to invest their cash from their “profits/returns”.

    The fact is that to make smart, profitable investments you need to spend the time to educate yourself… real-estate investors spend the time to educate themselves on the current market such that they will be able to recognize and act upon a deal when it comes up….In the same way smart stock investors do the same thing…

    That same smart stock investor, on an ongoing basis, is spending time (man hours) regularly watching and monitoring their investment allocations and market swings to ensure that their investments remain as profitable as possible… The smart real-estate investor does the same. ( neither are “Passive”)

    Now in both cases you have the option of hiring someone that will spend the time to do this for you so you don’t have to, making them both passive income streams. In both cases this will have a cost, in both management fees, and potential mismanagement of your assets.

    • Dollar D
      Posted February 19, 2012 at 1:41 pm | Permalink

      I think when comparing the amount of time required between two different investments, we have to look at education time, setup time, and on going time. The combination of these three factors determines how “passive” or “active” it is.

      The true “passive” investment is savings account interest. That’s probably the LEAST work you can do – so if we wanted to measure against something that would be it. A quick online search to find the best account (education), an application form to fill out (setup), and checking the balance as little or as often as you want (on going).

      I do think that the whole value-of-your-time debate comes up a lot when people talk about real estate. More so than with paper investing. Landlording in particular is more business than investment which means there’s plenty of ways to take yourself out of the equation if you’re willing to accept a lower return.

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