Monday, February 1, 2010

Should You Buy an Investment Property?

A duplex we bought in foreclosure back in 1998 - on the day we sold it in 2004.
Sold before the bubble for nearly triple the price!

The Real Estate market collapsed, for the most part, because amateur investors got into the markets and paid too much for Real Estate, on the premise that someone else would pay them more down the road.

South Florida and Las Vegas were awash in a sea of unsold condos in 2009 that were once touted as sure-thing investments for the average upper-middle class Joe to buy, just a few years earlier.  And a lot of those upper-middle-class Joes are now bankrupt. It is a sad story, but it need not have been that way.

I knew people who bought investment properties and never rented them out. They thought that just buying the property would make them rich. Or they would be lazy and leave a property un-rented for four months at a time, thinking that they could "afford" the overhead. You can't, though. You have to flog a property and make it work for you. Laziness is not a good quality in any landlord. It is not easy money - it can be hard work.

When I got into Real Estate investing, I had a simple mantra: Do the Math.

If a property can earn, in rents, more than it costs, it probably is a good bargain. Odd as it may seem, most of the people who got into the overheated market never did this simple math - adding a column of Figures - and ended up in deep trouble. They just assumed that because the prices were going up, they would continue to go up, and they would make money.

Less than two years after this debacle, people are doing the same thing, only this time jumping on the Gold bandwagon. Prices are going up, right? So they must always go up, right? People, it seems never learn.

Doing the math is not hard. You do not need to know calculus - just how to add a column of numbers:

Take all of the expenses first, and add them up.
Mortgage Payment
Property Taxes
Most of these numbers are easy to calculate. A simple mortgage calculator program online can tell you what the monthly payment will be, for a given balance. Property taxes do go up, usually when a property is sold.

You can look at like properties nearby which have sold in the last year and see what their taxes are, usually online at the County assessor's office or by calling them.

Your insurance agent should be able to give you an estimate of insurance costs as well.

For utilities, ask to see historic utility bills. The seller should be able to provide this information to you. If you are planning on renting the property and it has meter-able utilities, this may not be an issue, as the tenant may be responsible for paying utilities.

Repairs can be a tough nut to crack, and can make or break you. If you are handy with tools, many small repairs, and even some larger projects, you can handle yourself. I would not recommend buying investment properties unless you can do some basic "sweat equity" yourself, such as painting, plastering, and simple plumbing and electrical repairs.

If you have a good feel for homes and building construction, you can look at a house and understand what costs will be involved. Will the roof need to be replaced? What about the appliances or furnace? Appliances and roofs usually last about 15 years. If they are over that, be prepared for a midnight phone call from an angry tenant.

If you have no clue about these things, well, either educate yourself, or forget about it.

As for income, see what rents are going for in the neighborhood, and then drop this amount by 10% or more. Most folks say you should factor in 10% vacancy into your equation. It will take time to rent the property and if you change tenants often, you will have the property off the market for at least a month or so.

And speaking of which, my philosophy about rent is to charge slightly less than market rates and look for good, long-term tenants. Getting absolute top dollar for a place is nice, but people paying too much rent on a place will be more likely to up and move (probably buying a home of their own) rather than stay. Attractive rents, on the other hand, encourage people to stay, which reduces your vacancy rate and the amount of time you will spend "prepping" a property for rental.

We've had tenants stay as long as five years, and that really makes being a landlord a painless experience. Others we know ask a hundred dollars more a month, and end up having to get new tenants every year, with the property vacant for one month every year. Who comes out ahead in the long run?

Plus, when you ask a high rent, and the tenant says "OK" without much thought, chances are he's not intending to pay it, anyway. When you get a prospective tenant who tries to cut you down $50 on the rent, that is a good sign - they are actually thinking about paying you.

One area that many amateur landlords fall on their face is in tenant relations. There are con artists out there who troll for amateur landlords, and with their "stories", try to weasel their way into your property. Once you let them in, they never pay rent, and they never leave, and you'll end up hemorrhaging cash trying to evict them.

One lady I know fell for this. She was a Christian, and the tenant picked up on that, saying "Praise Jesus" and "Bless this" and "Bless that". When the tenant said "We'll have to pray on this", the landlord was sure she had a good, Christian tenant! But of course, it was all an act - they were drug addicts and had a record a mile long, including a trail of broken amateur landlords.

When you interview tenants, do a credit check (get the fee up front). Make sure they have a credit history. Sometimes a bad credit history is better than none at all. For example, a young couple just married applied for a place. He had run up some debt, but she was responsible and came from a wealthy family. They ended up being a good bet, and they stayed a long time.

Walk away from tenants with "stories" and reasons why they can't come up with the security deposit. Walk away from tenants who offer to pay you in cash, under the table. If you take it, expect it to be the last money you see.

I could go on and on about the subject. It is not easy, and if you are not prepared to be hard and strict, it could get you into a lot of trouble. As tenants ourselves, we complained of the landlord's "strict" policies. But once you are a landlord, with a mortgage of your own to pay, you start to understand why these policies are in place. You have a lot of money at stake here, and could lose it all with one bad tenant.

In the next few years, there may be some strategic buying opportunities for investment properties. Keep an eye out and you may be able to find one. But if you are not cut out for the Real Estate business, then don't jump in just because it looks like other folks are making money. That's how this country got into trouble 2 years ago!