Note from Paula: This is the final installment of my three-part series about my building my real estate empire, one lopsided rotting house at a time. Check out Part 1 — picking a house — and Part 2 — funding it — before you read this conclusion: Is it worth it? Would I do it again?
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More than 2,000 years ago, Roman statesman Cicero said that “refusing to set aside trivial preferences” is one of the most common mistakes mankind makes.
Clearly Cicero was a landlord.
I’ve been a renter my entire adult life. So when I bought a three-unit property and started showing it to potential tenants, I assumed I’d be an ace at knowing what tenants want. After all, I’m a renter myself – right?
Turns out, my “trivial preferences” are totally different than everyone else’s.
I’ve always looked for spaces with character. I love cheerful, bright colors that burst from the walls. It’s flavor you’ll never find in a mass-produced market.
So when Will and I had to replace our home’s exterior siding (it was old and starting to rot), we painted the outside a vibrant, uplifting shade of blue. It’s a beautiful contrast to the drab colors on cookie-cutter homes – or so we thought.
But renters are startled by ‘something different.’
“Gee, that’s sure bright,” the polite ones would say. “Wow, it looks cartoonish,” the blunt ones would say.
Oh sigh. Here was my first lesson as a new landlord: homes are “cookie cutter” for a reason. Neutral tones are boring, but they’re socially acceptable. They sell better. They increase your chances of finding a tenant. Unfortunately.
This sounds like a small lesson, but it strikes at the emotional core of owning a home: To succeed as real estate investors, we have to set aside our “sense of ownership.”
When you buy a home, it’s natural to want to put your personal stamp on it. But this isn’t our home – even though we own it and we live in it. This space doesn’t belong to us – it belongs to our “clients,” the renters.
So Will and I had to stop thinking of this as “our” home. As we make upgrades we have to refrain from stamping our personality onto it. We must restrain our “trivial preferences,” as Cicero would say.
This space belongs to the renters. We’re just the guardians, the caretakers.
WHO CARES IF THE FLOORS ARE LOPSIDED?
Cicero’s lesson actually works to our advantage.
As I described in the previous chapter of this series, the house is lopsided. The floors and walls slant towards the center, and the foundation is sinking into the ground.
I worried this would be a turn-off to tenants. Who wants to live in a lopsided house?
Turns out, tenants don’t care about that. Tenants and owners have different interests.
Owners care about the structural stability of the foundation. Tenants want to know how much the utilities cost each month.
If I could make one major upgrade to the house, it would be to get the floors and walls as level as possible. If I could make a second major upgrade, it would be to replace the piping or to move some walls around so that the human traffic flow is more intuitive.
That’s not what tenants want. Tenants want a nicer dishwasher.
Which is great news for me. A new dishwasher is easy to install. A major foundational shift is much tougher.
This makes it easy to rent the space. Washer and dryer in every unit? Done. Motion-activated security lights? Done. More insulation so that your utility bills are lower? Done.
These are relatively cheap and easy upgrades – and these are the upgrades tenants care about the most.
CREATE WIN-WINS
Cicero also said one of mankind’s mistakes is “the delusion that personal gain is made by crushing others.” Two millennia later, bestselling author Stephen Covey (7 Habits of Highly Effective People) rephrased this more succinctly: create win-wins.
This is the key to good real estate investing. Always create win-wins between yourself and your tenants.
Two months before the former owner of the building sold the place, he re-signed one of the tenants into a lease at a steeply discounted rate. Her rent was far below market value – and far below the rate that she herself paid the previous year.
After Will and I bought the house, we asked her why she drove such a hard bargain.
“My heating bills in the winter are ridiculous,” she replied. “I need the cheaper rent to make up for the high heating bills.”
We let her keep her below-market rent for the rest of her lease – we had to; the lease was signed and there was nothing we could do. But we showed good faith by installing $1,000 of new insulation in the attic above her unit. We added weatherstripping to her windows and re-sealed her ducts.
Ten months later, when it became time for her to sign a new lease, we raised her rent $100 per month. She agreed happily.
This is a perfect example of a win-win. We’ll “earn back” our insulation cost in less than 1 year. She enjoys lower heating AND cooling bills year-round.
OKAY, LETS TALK MONEY.
Now for the question on everyone’s mind: Paula, spill your numbers.
We had a few financial upsets. City of Atlanta water prices are among the highest in the nation – we averaged a $350 monthly water bill when we bought the place. Our efficiency upgrades (low-flow shower heads, aerators on the faucets, glass jars in the toilets) lowered our water bill to around $250. Another win-win between our wallet and the earth.
But our insurance costs spiked. We thought we could buy ‘homeowners insurance’ for the building – and apparently our insurance company thought so, too, since they covered us for the first few months. Later our insurance dropped us when they decided we’re a ‘commercial’ property. Our new commercial insurance totals an astronomical $250 a month – far higher than we budgeted.
I nearly fell out of my chair when I opened my $1,200 bill for city trash service. Although we’re just a sectioned-off house, the City of Atlanta charges us for trash as through we’re three separate households – tripling our trash bill.
So our total monthly costs – higher than expected – amounts to $2,500, excluding repairs and upgrades. It fluctuates depending on the water bill and variations in property tax, but that’s a reasonable average.
For the sake of budgeting for emergencies, we assume each unit will be vacant for one month a year – which will cost us $3,100 per year in vacancy loss. We also set aside $3,000 in “standard” maintenance costs per year (such as replacing the roof or hiring a property manager if we ever move away from Atlanta). This means our total yearly costs come to $36,100.
The rent brings in $1,650 for the three-bedroom unit ($550 per bedroom), $700 for one of the one-bedroom units, and $750 for the other one-bedroom. That’s a yearly gross income of $37,200.
In other words, this home is cash-flow positive at a rate of only $1,100 a year. This doesn’t sound like much, but remember: I’m using ultra-conservative numbers. I’m assuming that we lose $3,100 a year to vacancies. So far – knock on wood! – we’ve never had a vacancy.
I’m also assuming that we pay a property manager. Right now we manage it ourselves, which costs us time rather than money.
This means that our “actual” positive cash flow is about $6,000 a year. After setting aside some money for emergencies, we reinvest the rest into fixing up the house.
This creates another win-win. The tenants get to live in a progressively nicer house. Their rent money goes directly into improving their living space. And we get to fix the many (many!) problems in this 100-year-old building.
WHAT WE DO — FOR A LIVING
I should add that we live in one of the units, and every month we “pay rent” to ourselves. This requires discipline. It would be easy to forgo paying rent and blow our money on junk (or on another trip to Italy, which is tempting). For all the hours of unpaid work we put into this house — at least 15-20 hours a week — we could easily justify that we “pay rent” through our time.
It’s harder – but better – for us to ignore the value of our time, pay ourselves rent, and reinvest that money into the house for the benefit of everyone.
Oh yeah — and in case you’re wondering, we live in the cheapest unit. We share the three-bedroom unit with two roommates: one grad student and one recent college grad.
Will is 32 and I’m 28, so our friends ask: “Aren’t you too old to still be living with roommates?” By the time Will is 52 and I’m 48, those same friends will be asking: “Aren’t you too young to retire?”
There’s a stress trade-off to what we’re doing, though. We “live in our work.” We sacrificed quiet evenings at home. We spend almost every evening and weekend working on the house. If you calculate the amount of time we pour into this place – if you put a dollar value on our time – it’s a losing investment. For now.
But that’s how business start-ups work. In the beginning, you pour in hundreds of hours of unpaid work. Later, you reap the benefits.
So right now, we throw all our spare time at this project. But in 3 to 5 years, our hefty time commitment will be almost finished. As the decades roll by and inflation kicks in, our rental income will increase but our mortgage will stay the same. And in 30 years – okay, 29 years from now — we’ll pocket an inflation-adjusted equivalent of $17,000 a year (after expenses like taxes, water, trash and insurance) in passive income.
WHAT’S NEXT?
We want to buy another place. This house doesn’t qualify as our “primary residence” – even though we live in it – because it’s a “commercial property.” In theory, Will and I should each be eligible to take out a mortgage on a primary residence.
Last year the bankers told us to reapply for a “primary home loan” after 18 months of work history with the same employer. Will reached his 18-month mark in November. (I’m self-employed, so the banks want to see 3 to 4 years of self-employment history, which I don’t have yet.)
But we’re wavering on when to apply. We’d have to live in our primary residence, and we’re not ready to move out yet – not until we’re done with our “part-time job” on our current fixer-upper.
In the meantime we’re saving for a down payment on another house. Will we qualify for a loan? Time will tell. But if we do – WHEN we do – you, my readers, will be the first to know.
I’d Like to Thank the Academy:
- Thanks to the Carnival of Personal Finance for naming my post as an Editor’s Pick.
- Thanks to the Festival of Frugality for naming a different post of mine as an Editor’s Pick!
- HUGE thanks to Trent Hamm for giving me the best, best birthday present I’ve ever received — my very first recommendation and link from The Simple Dollar, a blog that I read daily. Trent, that means so much to me!
Awesome series! It’s really interesting to see how all the details turned out.
If I’m doing the math correctly, you could almost be living in the your own house payment free (even though you said you are paying rent) just by collecting the other rents from tenants. That’s pretty cool, considering you’re building equity at the same time.
I’m not ready for homeownership yet, but I could totally see myself going this route once I am. Thanks for sharing!
Great post! I love it that you’re living in one of the unit. I wish I did that rather than buying my first home. We just acquired a 4plex and it is tough to get cash flow positive right away. One unit is still vacant and we need to fill that ASAP.
With a positive cash flow of $1,100 and the time you both spend working on the home, it hardly seems like a positive cash flow. in a prior post “what does this woman earn” you calculated her salary based on commute time, preparing for etc. It seems you should do yourself a favor and make sure you calculate the true cost of your rentals with time and materials included and then ask yourself your ruthless question “what is the true cost of this rental”
I loved this series because in every step you looked beyond the obvious, you didn’t take no for an answer, made a great purchase price, worked hard with the bank. But you disappointed with your bias cost accounting for the rental.
How about you repost those numbers a little more honestly, time and materials include and lost income becuase you worked on a rental property instead of you self employment or other income producing activities.
@Homefree — That’s such an important question that it deserves its own post. I tried to answer it here: http://afford-anything.com/2011/10/24/how-i-make-70-per-hour-working-from-home/
Great post! I am interested in real estate investing. It’s the first step that is the hardest. I don’t know anything about fixing houses or at all handy but I am not discouraged. I’ll get there some day. I have a goal to buy a house with a rental suite by the first quarter of 2013. I hope to find a property that will become cash flow positive when the entire house is rented out. These are hard to find but not impossible. Hearing your story motivates me to get there one step at all and don’t take no for an answer. Thank you for sharing.
@That Thing — One year ago, I knew NOTHING about fixing houses. It’s amazing how quickly you learn! Have you ever heard the expression: “When you have a hammer, everything looks like a nail”? Well, when you have a fixer-upper, everywhere you look, you start seeing examples/ideas/solutions.
Great article! Don’t let anythig discourage you. I made a lot of money in income property. At one time, I owned a 9 unit, 10, unit, 24 unit and a shopping center. I achieved financial freedom at 38 years old. That was 26+ years ago. I was ale to do the things I wanted to do like starting businesses, consulting and now teaching. Keep it up!
@krantcents — Wow, my dream is to own major buildings (like a 24-unit) and a shopping center. I’ll have to pick your brain on that … how did you do it??
Wow! What a risk taker! I hope it all works out for you. It sounds as though it has so far…
@Mike — Thanks!!
So far, so good!!
Great series, Paula.
One thing: How did you come up with the $3100/yr in maintenance? I would expect much higher on such a large and old house. You’re probably familiar with the commonly used “50% rule” which states you should prepare for total operating costs to be 50% of your rents. If that’s the case, you’re severely underfunded. Perhaps it’s less of an issue because you guys are doing the work yourself, and I would guess using high quality material.
My REI is completely passive now, but I’m continuing to study others in case I decide to jump in.
@Brave New Life — Great question. I answered it in-depth in today’s post: http://afford-anything.com/2011/10/24/how-i-make-70-per-hour-working-from-home/
You make such a TRUE point.. renting isn’t about me.. it’s about the masses and what they would want. Sad, but true.
@Lindsey — I struggled with this for a minute — “Oh no! This means I have to conform and become cookie-cutter!” — until I realized that I, personally, can decorate and live any way in which I want to. But I’m preparing this house for someone else, not for myself. It puts me in a bit more of a “giving” spirit — thinking of others rather than myself.
@Brave New Life: If the 50% rule is for operating costs, as you seem to be implying, rather than repair costs, then it doesn’t make much sense to compare the $3100 annual maintenance.
Put another way, Repair budget is not equal to total costs.
Factoring out the cost of mortgage payment, the annual budget for “costs” are more than 50% of the rental income.
Great post. I can’t believe I didn’t see this last week. My wife and I are starting to save our down payment for the first rental property! We’re excited! Reading this series (in one sitting) makes me even more anxious to start investing.
Thanks for sharing.
@20′s Finances — I’m really excited you’re saving for your first rental! I’m a huge fan of owning rentals. As the series shows, it’s not always glamorous, but it is fulfilling — and it’s a great investment! Keep me posted on your rental experience.
One of the best series I have read in a long time. Thanks for all the interesting insights into home ownership and fixing up places. In order to reach your goals, sometimes you have to sacrifice the comforts of your own private home. I would love to live with another couple for awhile to save up money to buy a house or renter property.
It will pay off in the long run… If I could have bought a duplex or something, I so would have…
Wonderful post! Actually, I don’t have skills in fixing houses, I’d rather hire someone to do that for me. I am saving money to buy new house as a gift for my son and soon to be daughter-in-law.
@Tony — It’s important to know what you’d rather do and what you’d rather hire out to someone else! I don’t mind fixing my house, but I’d definitely hire someone to do my online technical support. Fundamentally, you just have to decide: What am I good at and/or what do I want to become good at? and — What do I not want to waste my time doing?
Best of luck saving for a house, and congratulations on your son’s upcoming wedding!
A very good series. Best of wishes with your landlording and real estate empire.
@cashflowmantra — Thank you!! I’ll be posting updates regularly: the good, the bad and the ugly! I suspect this blog will be a bit of a stress reliever …
Great articles – just ‘found’ you recently. I’m considering purchasing my first rental property (two unit / a single bed and a double bed with apartment above 2 car garage – my place until I could move out and rent that too) Could you address any other incidental costs such as advertising (banners, business cards, print / other media), licensing (I assume Atlanta requires this), home inspection, etc. and their impact on your gross / net return, please?
Thanks and congrats.
@Ballastboy — Congrats on your decision to move towards buying rental properties. I’m a huge fan of this strategy and I hope it will do well for you.
I spend $0 on advertising. I use one and only one thing to find tenants: Craigslist. I write a darn good ad with lots of detail, and I upload as many photos as Craigslist allows (4). My inbox is always flooded.
I also don’t have a license; the state of Georgia does not require this. I did form a property management LLC to officially handle the tenants; in Georgia this costs $100 one-time to register, and around $50 per year to renew.