I am thinking of becoming a landlord.
July 6, 2020 12:38 PM   Subscribe

I am considering buying a house for the purposes of renting it (not AirBnB). I am not a first-time home buyer, but I don't currently own a house. I plan to speak to a mortgage broker, a CPA, and a real estate agent soon - what should I be asking?

I currently rent a house in a part of New Orleans where real estate prices are high. I plan to buy a home for myself in a few years, but am content renting for now while I continue to build a larger down payment. However, I am exploring the possibility of buying a home in a less-expensive part of the city and renting it out, potentially offering Section 8. This would give me a small stream of passive income and contribute a teeny tiny bit to our affordable housing crisis.

I have a list of the more obvious questions to ask the mortgage broker, CPA, and realtor, but I know there are things I am not thinking of. Some of my questions so far include:
Are foreclosures/auctions too high-level for a newbie investor?
Potential pitfalls for offering Section 8?
Could owning an investment property end up hurting my ability to buy a primary residence for myself in the near future?
Should I start an LLC to do this?
Any other professionals I should speak to?

Relevant details: I am 40-ish, single with no kids, have very little debt (just a small student loan balance and a Peloton), excellent credit, and have a solid job with good income. I would be looking at houses in the <$100k range for the rental property. I am familiar with home buying basics like insurance and down payments and whatnot but have never been a landlord. I do not have many "handyman" skills.
posted by tryniti to Work & Money (15 answers total) 4 users marked this as a favorite
Response by poster: Perhaps I used the wrong term - I am aware that maintaining a house is work and I do not plan to be a slumlord. That being said, if you think using a property manager would be something worth exploring, I'd be open to your thoughts.
posted by tryniti at 12:50 PM on July 6, 2020

I would ask whether the agent knows any great property managers. Unless you are super handy, connected to reliable plumbers/electricians/etc., or ready to drop everything to fix a tenant’s problem at inconvenient times, a property manager may be a great asset to you. It’s harder to find great property managers for properties in lower-income areas (as property managers often get paid by percentage of rent), so getting an introduction is a good idea. Good agents have strong networks with all kinds of people involved in real estate, so they’re a good resource for this.

A more general suggestion: I would read up on real estate rental investing (if you haven’t already). As a start, Long-Distance Real Estate Investing by David Greene has great info on setting up the systems and relationships you need to do this well. It’s geared towards people investing from afar, but the info is equally useful for investors who are close to their properties. J. Scott explains the ins and outs of buying foreclosures (REOs) well in The Book on Flipping Houses, but the book overall may not be that relevant to you (unless you’re buying
a major fixer-upper). Tons of good books and podcasts out there on this—these are just the ones that immediately came to mind!
posted by saltypup at 1:21 PM on July 6, 2020 [2 favorites]

Have you ever done a financial plan with an investment professional like a Certified Financial Analyst? The reason I ask is that, from a financial planning perspective, it would be pretty unusual to put capital into a rental property before doing things like paying off student loans. That doesn't mean you're doing something wrong - "typical" isn't always right, especially for individual facts and circumstances that may be unusual in some way - but at a minimum a financial planner could help you understand how this investment would fit into an overall plan and perhaps how much capital would be reasonable to put into it.
posted by Mid at 1:36 PM on July 6, 2020 [4 favorites]

How comfortable are you with your local handy people/HVAC repair/plumbers/etc contacts and how much do you enjoy interacting with them? If you don’t have a property manager and aren’t handy, you’ll be spending potentially a lot of time interacting with these sort of professionals for your property, particularly if you buy a place that’s not in great shape.

For New Orleans specifically, take into consideration the flooding situation of any place you buy and also know that even if you buy a place that has never flooded, that may change in any given summer rain. You probably know this already since you live here, but I thought I’d mention it.
posted by MadamM at 1:53 PM on July 6, 2020

I help manage a rental property with three 2 BR units for my parents in a desirable area with relatively high rents, but also high real estate costs, so my numbers may be very different from your numbers. Between mortgage, property taxes, repairs, and maintenance (the property is in a place with snow and good snow removal is expensive) the property produces a small amount of passive income and an erratic stream of emergencies that could easily eat up most of the passive income if we had to hire professionals to fix every clogged toilet or leaking faucet. So make sure you have a good sense of what those things cost in your area as you run your cash flow estimates.

Also, think about how you are going to find/select tenants. Make sure you understand how to do this without breaking the law. Good tenants are not just tenants who pay the rent, but also tenants who tell you about a leak on Tuesday when it is small instead of waiting to text you on Friday night when the leak has become an emergency. They also stay for at least a couple years, because turning over a property is a hassle and usually costs some money in maintenance between tenants and lost rental income. Ideal tenants also are proactive about treating things well so that they break less.
Currently we have one set of super tenants. Unfortunately, I have yet to figure out a way to identify super tenants and have never had more than 2 sets of super tenants at a time.
posted by ElizaMain at 1:57 PM on July 6, 2020 [7 favorites]

I would never do this without a smart property manager. I know people who do, and God bless, but I wouldn't.

A good property manager will have lots of knowledge:

- a comprehensive list of vendors (not just handymen but also like HVAC, painters, exterminators etc) who - and this is important - prioritize her calls because she sends them lots of business
- experience in identifying and maintaining good tenant relationships
- legal responsibilities and best practices (some of these are non-intuitive)
- a sense of what property features are attractive to good tenants and worth investing extra for
- domain knowledge in general

and she'll be the one who gets the call at 3am about a burst pipe.
posted by fingersandtoes at 2:51 PM on July 6, 2020 [5 favorites]

It's entirely anecdotal, but my experience as a landlord has been absolutely awful. The tennants are annoying, but are probably doing their best. Everyone involved in the condo association is astonishingly stupid and actively mean. The people iin the real estate business make me worry about the future of humankind. (I've never met a subway grifter less ethical than a mortgage broker.) We've probably broken even. We're trying to sell as soon as possible, even at a loss.

My plan is to get the hell out of the landlord game as soon as possible and invest in index funds.
posted by eotvos at 3:35 PM on July 6, 2020 [3 favorites]

The interest rate and down payment requirements for investment property are way higher than for primary residences. E.g., if I want to buy a $500,000 home to live in I can put 5% down and get an interest rate of 3.125. For a second home I need to put down 20% to even get a loan, and the rate is 3.25%. An investment property is a 30% down payment and the rate is 4%. There is nothing stopping you from buying a bona fide primary residence, living there, and then buying another primary residence. You would get the more favorable rate on both loans. You might even find it hard to get a loan to buy a $100,000 investment property because the amount is so small after the hefty down payment required. I'm not quite understanding your financial goals here. Basically the way people get rich as landlords is by using the value of their existing properties as collateral, in order to borrow money and buy more properties. Do you think you can be a better-than-average landlord? Do you have the capital to ride out big gaps in tenancy or expensive repairs? (I intend no disrespect here, I have asked these questions of myself and the answer is always no.) Mutual funds are super easy and super liquid. The student loans are a passive expense, their guaranteed rate of return may be very favorable depending on the interest rate.
posted by wnissen at 3:36 PM on July 6, 2020 [1 favorite]

I think the notion of a passive income in these circumstances is almost always a mirage. Especially with a house. It’s work to maintain a home, and that’s part of tenants pay for.

The structure you own is exposed to the elements. It needs a roof every 15-20 years, new eavestroughs about twice that often. It has A/C, and appliances, that die and need replacement or repair. Maybe a basement that would flood, or a driveway that cracks and needs replacement. It’s the management of the property you paid to do.

In the investment world, there is an ocean of cash out there looking for a return. There’s no free lunch. Big investment funds own entire companies, airports, highways, apartment buildings, solar farms, bridges. One thing they own very little of is single family rental homes, because they’re too idiosyncratic. Every house is different, it’s time consuming to maintain, its hard to know exactly what you’re getting when you buy.
posted by thenormshow at 7:57 PM on July 6, 2020 [1 favorite]

In California "potentially offering Section 8" is not a choice you get to make as an individual landlord. Source of income is a protected class and it is illegal to consider it during tenant selection.

Edit: sorry, I have no idea how I misread California into your question...
posted by dusty potato at 6:44 AM on July 7, 2020

Anecdotally, by the way, my property manager told me Section 8 is a good bet, as there's no chance a tenant will stop paying their rent, which is always a danger otherwise.

Another thing to understand is that you are unlikely to be making significant "passive income" cash flow from rents, as the mortgage rate for an investment property is higher (so your mortgage is higher) and the wear on the property is higher (so your repair costs are higher.) Of course if you can fix things by yourself then you can save some of that, but there are plenty of things that go wrong that do require professionals.

The investment value is from the (hopefully) rising value of the property over time.

A duplex serves much better than a single family home, as when you lose a tenant, rent income goes down only by half, rather than 100%, during the vacancy period.

By the way I asked about small-landlording on here some years ago and got extremely discouraging advice which was... excessively pessimistic, in the way AskMeFi often is.
posted by fingersandtoes at 7:20 AM on July 7, 2020

If you are a first-time homebuyer saving to buy a home that you will live in, there may be special programs to assist you, including lower-interest loans and savings programs (here's a list by state; you should also check out your local credit unions). If you have already bought an investment property, you may no longer qualify.

Do remember that you'll need to keep a substantial cash cushion -- just saving up a down payment is not enough. This goes double for a rental, where your tenants will be (1) less likely to notice problems early, while they're still cheap to fix, and (2) more reliant on you to make repairs promptly. Problems with plumbing, roof, or HVAC can easily throw you a $5000 or $10,000 curveball, no joke.

In addition, as mentioned above, there will be a constant stream of maintenance needs. If you don't have the skills to do much yourself, then the costs of this maintenance may eat up your passive income. If you've never owned a house before and you don't know much about maintenance, then you are probably radically underestimating these costs.

The reality is that most small-time landlords are not making much (if any) passive income until after the mortgage is paid off. Sometimes, for years-long stretches, they are in the negative. It's a long-term investment, so make sure you have the financial stability to weather the ups and downs.

One additional thought: have you considered buying a duplex? You can live in one half and rent out the other half. This means you still have access to first-time-homebuyer assistance, and also reduces your financial risks and makes maintenance a whole lot easier.
posted by ourobouros at 9:17 AM on July 7, 2020 [3 favorites]

To follow-on the last comment, I was thinking of suggesting a duplex (or "two flat" as they are known where I live). I had a two flat for ~7 years and it worked pretty well. The rental unit had about 1/3 of the square footage of the building, but the rent paid about 2/3 of the mortgage. After allocating costs (mortgage, taxes, etc) to the rental unit, we did not have any profits, but it worked well in terms of defraying part of the cost of the property and allowed us to buy/service a bigger house than we would have otherwise. Being on site was important in terms of maintenance etc. We ended up selling it, but in another world it might have made sense to eventually rent out the whole thing. This might be a good way to put your toe in the water as far as rental properties.
posted by Mid at 10:38 AM on July 7, 2020 [3 favorites]

I think that the single family home rental business is goofy. I do not think it is in fact about "passive income" which I am guessing you are using in the bastardized way that FIRE people do. As far as I can tell most small time landlords who buy single family homes are taking advantage of the fact that they can get a loan on their personal income not on the properties income. This lets them borrow more and pay more for property that isn't really priced as a passive income producing investment but is priced as a consumer choice home. (The sum of condo's in a building sells for much more than the same building as a rental.) The unique thing about being a small time landlord owning single family homes is that frequently you are consistently losing money on paper due to depreciation and it is the only passive investment where you are able to set that loss against your other income, (like from a job,) before you get to tax deductions. This means you are not paying taxes on money you are actually making. The real incentive for people to "invest" in the single family home game is the anticipation of "appreciation" or housing inflation/gentrification/San Fransciscoation in the market that since the investor is leveraged can make some people a boatload of money. I suspect that most small time landlords/speculators do not realize that they will have to pay tax on the depreciation and capital gain or figure that they won't be caught if they don't or are planning on doing a 1031 exchange and kicking the can down the road. Fundamentally I think it is a speculation and is actively at odds with the idea of ameliorating the housing crisis. If you want to ameliorate the housing supply than you will have to charge below market rent or freeze rents and have them go up less year over year.

With regard to section 8 I do not think accepting section 8 is going to help housing affordability as the shortage is not the places taking section 8 per se but rather the shortage of section vouchers and the unavailability of places taking section 8 in better neighborhoods. In my opinion buying a foreclosed house/dump in a lousy neighborhood and then renting it with section 8 does no one any favors.

I think much more important than talking to the "professionals" that you listed would be to talk to other landlords and possibly if they exist in your area professional non-profit housing agencies like community development corporations to get a handle on renting to low income tenants and what pitfalls there are, what laws there are.

(From your post mentioning foreclosures, section 8, and <100k houses I assume you are talking low income.)
posted by Pembquist at 2:31 PM on July 7, 2020

I’ve known quite a few people that made a lot of money buying property in low income areas. They’re absolutely always handymen types and don’t really make money off the income but the appreciation of investment properties. $150k to $500k in 10 years is not a bad investment. I wouldn’t look at the rent as income but something that offsets the cost of ownership.
posted by geoff. at 5:58 AM on July 8, 2020 [1 favorite]

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