What should I know before buying a rental property?
September 19, 2010 6:40 PM   Subscribe

What should I know about buying a rental property? I have a down payment put together and am considering it. I have various anxieties about this detailed below.

I'm considering buying near a local private college and renting to college students. There are rental houses and small apartment buildings (4 apartments, say) both in my price range in the area. My husband and I are both attorneys (both with some experience in landlord/tenant law), so I feel confident about that part. We've lived here long enough that we have HVAC people, plumbers, handymen, etc., that we feel do good work, though neither of us is personally super-handy. I am currently an at-home mom working part-time in the evenings, so I would be available 9-5 and could manage the bookkeeping and so forth.

I guess my big concern is taking the plunge and losing my shirt, either because I'm terrible at finding tenants or there's something huge I've overlooked.

My specific concerns include:
*How do I pick the specific property? Are there red flags? I've read getting a place that HAS tenants is better than one you have to turn around and rent right away.
*What's a reasonable income stream to look for? (I know this depends on specific prices, etc., but what's a good way to figure it? What are some examples?)
*Should I create a company or just own the house myself?
*Am I better off buying a single house or a multi-apartment building?
*People either seem to love or hate renting to college students. Do you have advice?
*Should I go ahead and buy it with a mortgage just like I did with my house, or should I look at different financing options than that? Or only buy if I can pay for it all at once?

I have read a few books but they all seem to go off into the crazy at some point and suggest things I think are probably bad ideas, but I think I'm having some Dunning-Kruger effect ... I don't know what I don't know! I guess I'm just nervous about taking the plunge, as nervous as when I was a first-time homebuyer on my own behalf!

Personal anecdotes very welcome; I feel like these may help me understand a bit better what I would be getting into.

(I did see this prior question.)
posted by Eyebrows McGee to Work & Money (12 answers total) 7 users marked this as a favorite
What are you doing it for. Are you bored? Do you need the money?

As to being bored, this could take up all of your time. As for the money aspect, it can take up all of your money as well. Think about all of the money you have put into your own house. Now think about all of the money you will have to put into your second house that is infested with college students. Yes, you will get a good tenant here and there, but overall, it's gonna be typical college students.

Also, have you looked into the tax end of things. Being a landlord myself, I can tell you that what you end up paying the government can be a substantial amount. So anything you do end up making off of the rental is going to end up going to the government.

Please let us know WHY you want to be a landlord... a landlord to college students no less. And then ask yourself, is this what I really want to spend all of my time/energy/money on. If the answer is yes, then I'd say go for it.

I have great tenants and can't ask for a better setup in the house that I built for my wife and myself, but we had to leave because she got a residency across the country.
posted by TheBones at 6:58 PM on September 19, 2010

I have had rental property - a single-family house. Do your calculations on your ROI - often stocks or REITs are better investments with fewer headaches. A REIT (real estate investment trust) will give you the real estate exposure but spread out the risk.

Plus, college students will be rough on an apartment. You will have very high repair and maintenance costs.

In the past, a single house would have both income from rent as well as the appreciation from rising real estate values. This is not the sure thing that it used to be, however. Also, when I went to college, the houses were where all the best parties were held, which is something you may want to consider when it comes to potential wear and tear on the property as well as liability issues.

Definitely set up an LLC. It takes less than an hour and can be done online in Missouri; not sure about other states. Set up separate bank accounts, too. Keep everything separate - it makes things so much easier at tax time.

I personally would never want to be a landlord to college students, and I think that my landlording days are probably behind me. I like REITs much better! If you want to consider REITs, Lexington Property Trust is a good one - they specialize in single-tenant office and industrial buildings nationwide.
posted by Ostara at 7:20 PM on September 19, 2010

I became an unintentional landlord, as many do, so I cannot answer many of your particulars as you are in the process of becoming an intentional one. It was due to two relocations for employment, both were great opportunities for work, yet the landlording was a bit mixed.

By 'mixed' I mean that in hindsight we should have sold out before the market crash, but nonetheless we did much better than many (in that we came out financially fine).

One book to recommend is called Landlording and has a lot of very good information in it. It will give you a no-nonsense baseline of the kinds of things to think about, as well as lots of practical advice from someone who has been landlording for many years.

We still rent out one house, our first place, for a nice cashflow every month. One other house we sold earlier this year, enabling us to move to a much larger and much nicer place. (Selling that second house is a long and difficult story, however!)

The best advice I could share is to invest the time and money (it's a little money to do a credit check and a little time to make several phone calls) in vetting your future tenants. Lots of stories here of people who should have been great ("on paper") who ended up being a bit crazy, others who should have not qualified ("on paper") who ended up the best tenants you've ever had.

It sounds like you are looking to buy close-by, in your local RE market, which is a good thing. IMHO getting the smallish rental house over multi-unit apartments is the way to go - houses tend to go for longer lease terms (minimum six months), while apartments may be quite the headache for minimal return. (Disclosure - I grew up in a household where there were 30+ apartment units we had to take care of, and it is not a fun way to spend evenings and weekends dealing with all the attendant problems that crop up. (Yes, as an adult for several years I did handle a lot of stuff first-hand, including paying a couple $300 to move out that night and renting a truck as well as lending them a hand in moving out, to a very scary part of town, just to avoid all the eviction costs and more importantly time. This is in a highly-rent-controlled city with plenty of laws favoring deadbeat tenants.) It could reasonably take 5 months for the eviction process to run its course, it's crazy.

With a house, you may have more of your finances tied up in it, but starting small with one tenant and then building from there may make a lot of sense. (See the Landlording book - I believe the author promotes that idea there as well.)

We've thought about selling our rental but run afoul of the tax law (regarding tax-free selling if you've lived in the place 2 out of the last 5 years), so would have to deal with the 1031 exchange business, after which it doesn't make sense for our current situation... something else to consider. Houses (and apartments) are very illiquid, so you need to really understand what you are getting into beforehand.

If you could meet several in your area who are successful at landlording that would be most helpful - perhaps through a local apartment association, just an idea.

Good luck - it's an exciting adventure, to own the roof over some else's head... Financially it has become a cornerstone of our financial well-being.
posted by scooterdog at 7:27 PM on September 19, 2010

You want to rent to grad students, not college students. Also, you'll want to check craigslist to get a feel for your local rental market pricing if you have not yet done so.
posted by sebastienbailard at 7:34 PM on September 19, 2010

Response by poster: It may perhaps help to add that I'm in a market that's reasonably stagnant but hasn't crashed; property values have held pretty steady and risen at slow, modest rates.

This also isn't all our money; I received a small windfall I've been sitting on for a while (thought about getting a new car), but isn't part of our 401(k), household emergency fund, or investment account. So it would be illiquid, yes, but it's sort of "extra" money just hanging out there.
posted by Eyebrows McGee at 7:41 PM on September 19, 2010

For what it's worth - which isn't much because I'm nowhere near the market you're in - I essentially live in one of the houses you're looking to buy to rent to students. We bought this house with the notion that should we ever need to relocate, we could rent it very easily because this is the main residential road for the university. 80% of our neighbouring houses are populated by students.

Things I now know about renting to students:

* In my area, three and four bedroom houses rent far faster than two bedroom houses or apartments because they are cheaper per student.
* Do not expect to give the security deposit back.
* Do plan to go in at the end of every year with a skip, cleaning supplies and some paint.
* If you are renting the house furnished, invest in second hand instead of new furniture.

Generally, the rental rate is pretty much set by your market - students will be looking for housing in a certain price range which shouldn't be hard to figure out from local listings.

I actually don't think this is a terrible idea if you understand the market and therefore the tenants. These are people who are generally enjoying new freedoms whilst simultaneously learning to live on their own and they are not going to regard your investment with the same respect you do. If you're not attached to the property and are accepting of the overhead of labour and refreshing that will have to happen every year, I'd give it a lot of thought if the money adds up.
posted by DarlingBri at 8:17 PM on September 19, 2010

Investing in real estate is similar to any other investment, it's all about the cash flow. How much return can you get for your investment? To answer some of your specific questions:

Buying property with existing tenants means you've given up your opportunity to make sure they meet your specifications. We don't do that, ever, because we are very picky about who we put in our houses.

This is really a numbers game with HR elements thrown in. As for your return, research property values in your area, and then the rents. Subtract the mortgage payments if you have them, plus property taxes and insurance. A LOT OF INSURANCE. Take another 10% out of the monthly rent for maintenance, maybe more if you're not doing it yourself. Are you left with a reasonable return on your investment, comparable to others? If not, you need to invest that money in a different area.

Renting to students means you have to repaint and repair every year, which is usually counter-productive in this business as the ideal tenant is one who stays long enough for you to recoup your renovation costs.

Create an LLC for your property and get advice from a good CPA. Keep excellent records, and do all the stuff he tells you. The tax benefits will be a pleasant surprise.

Buying an apartment building means bigger cash flow, but comes with increases in headaches. Apartment ownership would take more time, effort, and money but would also generate more rent. Up to you as to how deep you want to jump in, I think the best advice would be to start smaller to make sure you are suited for this type of work.

Whether to get a mortgage depends on your financial situation. Property ownership IS NOT LIQUID, especially now. Keep in mind that mortgages are also very difficult to obtain these days, especially for investment property. Investigate this beforehand to make sure you can even get financing.

And keep in mind that you will be actively working for that return, it won't just show up on a statement every quarter. This is an hands-on investment, you will get calls on Saturday afternoon at your sister's wedding. Tuesday morning at 6 am when your kid is sick. Midnight on Sunday night. For broken heaters, no electricity, stopped up toilets, fires, floods, and pest infestation. Do you have the temperament for that sort of thing?

In the end, I'm not sure that only one property will give you enough revenue to make it worth your effort. Feel free to contact me if you'd like. My husband is a landlord.
posted by raisingsand at 6:32 AM on September 20, 2010

Expect to do a lot of hand-holding. Half the tenents in my last building didn't know how to change batteries in a smoke detector; our landlord actually made installing your own window A/C unit a violation of the lease (they had a one-time charge of $75 that got you both the unit and the installation.) My sister had a landlord who was so stressed by how college kids treated the properties that tenants were forbidden from plunging the toilets.

Meanwhile, don't be shocked when someone tackles someone else and accidentally breaks through a wall and demolishes a couch. I worked a summer rehabilitating dorm rooms, saw the wall in question, spent hours trying to get detergent off so we could paint. You will soon be familiar with the myriad ways to make glow-in-the-dark messages, by the way.

The only successful-ish renting situation I'm personally familiar with is one of my stepdad's tenants. They take good care of the place because they're hoping to buy it soon. Despite this, my stepdad has sunk a minor fortune into it; the rules for their loan dictated lead paint inspections and there was a kid who threw something through a picture window and and and.
posted by SMPA at 6:40 AM on September 20, 2010

I do not own any properties, but I do have commercial real estate experience, albeit not directly with student housing, which is its own particular market. My advice:

Make sure your pro-forma makes sense. Real estate can be very lucrative, but it is very capital intensive and can be a great way to lose money quickly.

For a smaller building (3 - 4 units), you need to be confident that you will be leasing all your units. If you don't lease one of your units at the beginning of the term, you will in all likelihood have that unit vacant for the entire year. This will be a unit that you will still need to pay taxes and debt service on, but which will not be generating any income. Additionally, you need to make sure that you factor in a rise in vacancy during the summer. (Probably not 100% vacancy as people will stick around for jobs/summer school, but still I would expect occupancy to drop off.)

Even normal apartments experience a lot of wear and tear. Expect needing to budget at least $300 / unit / year for capital reserves (e.g. saving up to replace a boiler). Know how old your boiler, roof, etc. is before you buy, by the way. In addition to this, repairs and maintenance could easily be at least $750 / unit / year for student housing.

Know what an acceptable return is, and make sure you are being compensated adequately for the risk you are taking. Make sure that in calculating what your return is that you make allowance for vacancy as well as management fees. These management fees you should treat as an expense, as you are essentially taking on a job, and need to be deducted before calculating what your return on investment actually is. IMO if you aren't generating a return on your equity at least in the low 20s it probably isn't worth it.

Consider calling brokers, owners, appraisers, etc. that are active in this space where you live. You would be surprised how willing they will be to talk to you and the information you learn will be invaluable.

Lastly, be picky. If you actually decide to go through with this, you need to treat this as if it is your job. Someone in the acquisitions business will easily look at and model fifty properties and end up buying one. Most of what you look at will be overpriced. Price, in real estate, is probably the most important factor. If you can buy something cheap enough, you generally can make the numbers work. But if you pay too much, and your monthly P&I too much, you won't be able to be competitive on rents and you will be doomed to failure. Good luck.
posted by prunes at 8:48 AM on September 20, 2010 [1 favorite]

For 20+ years I owned either a duplex, 4 unit or 7 unit. My own observations.
1) If cash flow and equity permits contract out repair and maintenance unless you genuinely enjoy it. If not it is hard work and can be frustrating.
2) It is better to have a short term vacancy (30-45 days) than a bad tenant(s).
3) Screen your tenants thoroughly--do not be afraid to ask for a hefty security deposit plus first and last month up front.

Personally I would not buy a property for student rentals unless I had in-house management, a solid building and have the time and interest in doing your own maintenance and repair. On the other hand I have a good friend who does this exclusively but he runs it as a professional business, is a builder by trade and rents primarily to grad students, women, couples or students with very solid references and realistic deposits. He does very well financially.
posted by rmhsinc at 9:01 AM on September 20, 2010 [1 favorite]

I owned and rented a house to graduate students (and was always very picky about choosing only graduate students) for six years. I was also overseas for much of this time, which made handholding nearly impossible.

A few things strike me as strange about some comments on this thread: First the comment that taxes will take all your profit. That's ridiculous. And patently untrue, given how many people successfully live off their real estate rentals. Your profit will depend on your mortgage, your costs, and your local, state, and federal taxes. And if you do the math right, you can indeed make a profit.

Second--and this is a trap I fell into--the 'graduate student' stipulation. Graduate students can be every bit as filthy and negligent as undergraduate students. I would still go for graduate students over undergraduates any day, but it's still critically important that you vet your prospective tenants carefully.

Also, rmhsinc has it right: Use a management company or service if you can.
posted by yellowcandy at 10:12 AM on September 20, 2010

Echoing prunes, people often forget to factor in the costs for capital reserves. The condition of the mechanical and structural elements of the house will be as important to the long term success of the investment as your tenant screening.

Regarding your law experience, do you know what the actual eviction time-line in your jurisdiction is? In mine, best case is 3 weeks after non payment, worst case is 2 months. That is a lot of missed rent if you only have one unit.

College students are tricky to screen because most have little credit and no income. Their previous rental history will be very important. Don't hesitate to ask for their parents to co-sign for more security.

Check out the Bigger Pockets Forums for some first hand experiences:
Rental Property Questions & Landlording Issues
Real Estate Deal Analysis and Advice

The conventional wisdom there is The 50% rule (expenses = 50% of gross scheduled rent, meaning actual operating expenses, capital expenses, and vacancy,) and The 2% rule (rent must be 2% of the purchase price) These "rules" are extremely conservative, but you should keep them in mind. Read about them here.

They have a deal analysis spreadsheet here that is useful.
posted by Crashback at 10:31 AM on September 20, 2010 [2 favorites]

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