Wednesday, May 17, 2017

Go Big or Go Home? A Landlord Story.


Can you make it big as a landlord?  Well, sure, just as you can make it big as a Lawyer, Engineer, or even a Pizza Delivery Driver.

A reader asks if I think it is possible to become fabulously wealthy as a landlord.   Well, it is possible, to be sure.   But it is possible to do that in any field.   There was a guy in Washington DC who started out driving for Domino's pizza.  He became a store manager, bought a franchise, then bought another franchise, and by the time he died (sadly, at an early age) he had well over $10 million to his name.

You can become fabulously wealthy at nearly anything.  It requires a lot of hard work, common sense, hard thinking, and a little luck.   You don't get ahead in any business by being a nice guy or through weak thinking.   And often this means working for 10-20 years without a break or a vacation.

The landlord business is a case in point.  Yes, there are mega-landlord companies that rent out hundreds if not thousands of apartments.   As you might imagine, they don't put up with a lot of shit from their tenants and are often not known as nice guys.   Hey, you can't excuse late rent when you have millions in debts to banks.   And most of these sorts of landlords start out as Real Estate agents, such as those here on our island (who in addition to listing and renting other people's properties, also rent out their own properties to tourists and residents).

A friend of mine tried to "go big" in the landlord business and ended up bankrupt.   Perhaps his is a cautionary tale or just a case of special circumstances.   During the go-go 1980's, Fairfax County Virginia was growing by leaps and bounds.  There were still people farming there (no more!) and large tracts of land were bought by developers and turned into mini-mansion estates and condo nightmares.   He bought the early houses in these developments, which often went for fairly cheap.  Developers want to sell some units early-on to cover their expenses - including their construction loans - so my friend could buy a house for say, $250,000 as one of the first houses completed in the development.  Most buyers don't want to be the first one to buy, and it helps to see occupied homes in the development when you are trying to sell houses.

(I had a chance to buy a townhouse in Arlandria for $280,000 from a developer friend who needed to make a construction loan payment.  Nothing down!  Close in a week!  It scared me to death.  I could have sold it two years later for over $450,000.   Being risk-averse does mean missing out on some "deals" but also means you don't lose your shirt as often, either).

He would rent out the houses to Patent Examiners, usually packing in several new Examiners who needed a place to stay, and the income would more than pay the mortgage on the place plus expenses.  Since they were new homes, the repair costs were nil.

By the time the development was nearly built-out, housing prices were up by 30-50% during that era, and he could sell the house for a tidy profit - and then buy two houses in the developer's next development.   By then, he had a good relationship with the banks, and of course, his six-figure income as a Patent Attorney was good insurance he could make the mortgage payments.

He kept up this model, which worked in an era of a building boom and booming prices (housing prices went up 20-30% every year from 1985 to 1989 - guess what happened after that?) and he was making so much money he quit his job as a Patent Attorney.

The mistake he made was to take the money he made and spend it on a huge (300+ unit) apartment complex in a very, very bad part of town.   He borrowed heavily to purchase the place and the tenants were all problematic section-8 types.  The only tenant who paid their rent regularly was the DEA who rented an apartment to do drug sting operations in.  It was that kind of place.

Since he was thinly financed, he could not afford to remake the place as luxury apartments or condos and then sell it or rent it for premium rents.  He bit off far more than he could chew, quite frankly, and he found that being landlord to 300+ tenants was a lot different than renting houses to friends from the Patent Office (who all had steady jobs and paid their rent on time).

Then 1989 hit.  It was all over at that point.   There was no demand for new housing, and he was stuck with a money-losing low-income property that he had paid far too much for.  The last I heard, he had to declare bankruptcy, although he had the property in the name of a sub-chapter-S LLC, so he probably didn't lose any of his 401(k) money or home - but he did lose a lot of money - including the money he put as a down payment, nevertheless.

He went back to work as a Patent Attorney.

Years passed and eventually the real estate market picked up again - with a vengeance, much as it is doing today in the DC area.  A well-financed developer bought the property, bulldozed all that low-income housing, and built new luxury condominiums and sold them for a tidy profit.  Today, it is considered a nice neighborhood.

The problem for my friend was he didn't have the experience, contacts, and access to capital that an experienced developer would have.   He also took a huge risk hoping it would pay off big, but got caught in a real estate bubble that in retrospect was pretty predictable.

And that is the conundrum for us little people.   I bought a condo for $38,000 and in retrospect wished I bought five more - or ten or twenty.  But the risk scared me.  And it would have been a full-time job managing all of that.  I would never be able to leave the area on vacation, lest some tenant's kitchen sink overflow - unless I wanted to pay someone to manage things, which I have learned pretty much wipes out any profit from a rental property.

And if the market went down?  I would be on the hook for all that debt.   Yes, in retrospect, I would have made a million more dollars.   But time-machines are tricky things and getting them to work just right is hard to do.  Mine is still out for repair so I can't go back in time and buy those condos just yet.

I am content I bought one, at least.

The point is, you can be wildly successful in almost any endeavor.  I know Patent Attorneys who make $500,000 a year or more - some make millions.   I am not one of them.  I made a living at it.   And that is OK by me.  Some of those people who made a lot of money in this business are the most miserable people I know.    Even some of my friends in this business who "merely" make $250,000 a year or so tell me they are jealous of my lifestyle as they work 60 hours a week to pay for a mini-mansion they don't really like and for child support for kids from two previous marriages ago.  Careerism can take a toll on your personal life!

And there are Engineers in Silicon Valley who form start-up companies and end up Billionaires.  Although most of these are money people, not Engineers per se.  And for every Billionaire, there are probably thousands who go bust.   But the vast bulk of Engineers just work for someone else, draw a salary, and hope to retire on their 401(k) someday.   Few get fabulously rich.

And that is why I am not one of these 1%'er-haters.   A lot of people who have no money assume that people who do have it somehow just found it under a rock and got lucky.  The reality is, a lot of people who become wealthy do so by sacrificing huge portions of their lives to the almighty dollar.

Landlording is even trickier - you have to risk capital and borrow huge sums of money to do it.   So in addition to working like a dog to "strike it rich" you are risking capital and could end up bankrupt.  Again, something the "Occupy Wall Street" people fail to appreciate most of the time.

Hard work and risk should be rewarded, doncha think?   And you don't have the stomach for hard work and risk (as I don't) the rewards should be less.    Seems like a fair system to me.  And most of the time - not all of the time - rewards are proportional to risk and work.  But no system is perfect, and going to a system where everyone gets equal rewards regardless of work or risk (as they do in communist countries) has been shown time and time again to be a shitty idea.

So if you want to be rich, go for it.  You will have to work hard and risk a lot to get there.  And like my Patent Attorney Landlord friend, you can end up losing your shirt if you bite off more than you can chew and have a little bad luck (or lack of foresight).  And that is one reason I never "went large" with my landlording business.   I bought a few properties and made some decent profits - more money that I made in my career as a Patent Attorney, as it turns out, but that's not a lot of money, quite frankly).    I remembered the experience of my friend, who invested a decade before I did, and was more cautious and took fewer risks.  And keeping his experience in mind, I sold out of the market when it seemed to be going crazy as it did in 2007.

And that is the conundrum - are we headed for another 1989 or 2009?   Methinks the former, in some overheated markets.   But that is just the problem right there - you have to take risks, and a downturn in real estate is just such a risk.

Oh, right, silly me.  The Real Estate Bubble of 1989 never happened, according to some folks!  Those who don't learn from history - or outright deny it - are destined to repeat it.

1 comment:

  1. A reader writes: "well he didn't risk his own money, but the bank's money!"

    The reader doesn't know how Real Estate works.

    In order to buy the apartment complex, he had to put down a down payment which was in the hundreds of thousands of dollars - perhaps close to a million.

    When the project went bankrupt, he lost this down payment. The bank took over the property and got most, if not all of their money back.

    My friend ended up going back to work as a Patent Attorney, his dreams of being a big-time real estate investor dashed - at least temporarily!

    In my case, I was in fact able to risk only bank money - by doing a "nothing down deal" with a local bank (two notes, one at 9% and another personal note at 11%!!) which I then refinanced, took cash out and used to buy other properties.

    But every one of those commercial notes, which were CALLABLE and variable rate, required me to PERSONALLY GUARANTEE the note, even though they were loaning money to my LLC.

    So, if my small real estate empire went belly-up and the bank foreclosed on the properties, they could come after me personally for any difference that remained due after they sold them at bankruptcy sale.

    This would mean I would be on the hook for close to a million dollars, and risk losing my house, after-tax savings, cars, and whatever. Personal Bankruptcy would preserve only my 401(k).

    The reader is sadly misinformed about risk-taking!

    ReplyDelete

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