Sunday, April 7, 2013
Rent? Own? or Own to Rent? (Part II)
When I first started learning about money I was already aware that rental property could be a good investment. Once upon a time my father bought a small house for this purpose. He had a low cost, high quality employee taking care of some of the maintenance and repair issues. That would be me. The more I read about buying rental properties, the more I decided this was just not right for me. As I have grown older I am less willing and less able to take care of maintenance and repair in my own house, let alone taking care of a stranger’s broken toilet in the middle of the night. When the young woman mentioned earlier in the article was buying her new home, I revisited the issue. Given the situation in that city, I could buy a house for $100,000. Let’s say I could get $700 a month in rent, the going rate at the time. That would be $8,400 a year, less $840 for management fees, less $2,000 in taxes. That is still $5,560 in income, a little more than 5.5%. Try getting that in today’s bond market. In addition there are certain tax deductions associated with such a venture including depreciation. I am not an expert on taxes. I pay my wonderful CPA to make such problems disappear. I consider it some of the best money I spend on expert assistance. Even though there was a good probability of both decent income and the potential of capital appreciation associated with rental property in that market, once again, the specter of broken toilets in the middle of the night, particularly broken toilets in another city dissuaded me from following that course of action. We have all heard the get rich quick, no money down pitch on late night infomercials. One more time. Say it with me, “If it sounds too good to be true…..” This is how Dave Ramsey first became a millionaire. It also landed him in bankruptcy court. Using leverage is exceedingly dangerous. As long as everything is going up in value it works fine. If things head South and your creditor wants his money—NOW—you are in trouble. This is not limited to small time players. I know a very wealthy man, perhaps the richest man I have actually met who is fighting this battle. He was in the process of developing a large retirement community around a world class golf course using borrowed money when the market crashed. That development filed for bankruptcy. What looked like a gold mine turned into an ugly political and financial nightmare. It looks like the local taxpayers are going to end up footing a large portion of the bill. Many of his other large commercial properties are in danger. He is scrambling like mad to meet his cash flow requirements. Although these properties are worth a fortune, they are underwater. He can not sell them for enough to cover his debt in the current market. Given what I know about this man, he will persevere and overcome, but he is in a fight for his financial life. The term landlord conjures visions of Snidely Whiplash, eviction notice in hand, throwing a helpless old widow out into the snow on Christmas Eve or his more modern cousin, the slumlord riding in the back seat of his long black Cadillac making the rounds with Sammy Four Fingers, his all purpose driver, bodyguard, and leg breaker. However, sometimes perfectly innocent people become landlords in spite of their best laid plans. I know of two young couples who owned their own condos. They managed their money diligently, saving for that big house in the suburbs. The day came when they had 20% in hand and the necessary cash flow to easily meet the bank’s requirements to buy the house of their dreams. In both cases there was one fly in the ointment. Their condos were underwater. If they sold, they would have to sell at a loss, making up the difference with cash. In both cases they wisely decided to become landlords, renting out their desirable condominiums until the market recovers. I believe the market will recover. I don’t think anyone who can hold out for the long run will lose any money on residential real estate in suburban areas around Washington, DC. I don’t see the Federal Government getting smaller or less important. So far they have been lucky. They have been able to find acceptable to excellent tenants. Their condos have not sat empty for long periods of time, causing those dreaded cash flow problems. As far as I can tell, renters are the biggest problem with rental properties as an investment. Some of them are destructive deadbeats. From what I have seen, at least in Maryland, the laws and the court system work in favor of the renters. Evicting a bad tenant appears to be an expensive time consuming process. Perhaps I don’t have a balanced picture of landlord rights. To be honest there are not a lot of evicted tenants who work at a government research laboratory or attend a conservative middle class Protestant Church in suburban Maryland.