Are some properties bad rentals - Posted by brad

Posted by John Corey on March 27, 2006 at 11:25:32:


One great aspect of any RE investing is the owner has a lot of choice for how they invest. There is no one best strategy for all.

If you are comfortable with little or no leverage then that is what makes you comfortable. Stick to what you feel is best for you until something else feels best.

That said I want to make some observations as to the logic of the position. Some might call it shooting the breeze if we were in a social setting. This means that ultimately we do not have to agree.

What makes a person comfortable is not the same as what might be optimal or even correct. It is just want makes the person comfortable. To take this outside RE many people get comfort from eating (comfort food). Long term it might not be the best strategy even if it is comfortable to them at the time.

As the bankruptcy rate shows that the majority of RE investors do not go bankrupt it is hard to draw conclusions from the fact that you know people who have done so. There might be some selection bias in the sample (that they know you, that they live in a specific area where a plant closed, etc). It might be that their use of leverage was the problem so the issue is them and not leverage. Leverage is neither good or bad. A tool that has a purpose. Like a hammer for nails and a screwdriver for screws.

Given that the majority of loans are actually paid off the pricing (interest rate) shows a mortgage as being one of the lowest risk market segments for a bank to make loans.

I would say that you are comfortable with the returns you earn compared to what you might earn ‘cash on cash’ if you used leverage. It works for you based on how you evaluate things; how you choose to view the facts.

Your desire to have no debt is a personal one. Debt is neither good nor bad. Equity is not defined as debt so I will assume you made a typo. Otherwise please explain why you want to redefine equity as debt. Granted equity is trapped and not the same as liquid cash when it comes to flexibility.

Simple math can be used to show how your solution will consistently produce lower results compared to a model that has statistically the same risk but more leverage. What this means in English is a person can provision for cash flow gaps without needing to avoid the use of debt. You can reduce the default risk to such a low % that the use of leverage can be practically as safe as owing income producing property free and clear.

So, if you want to debate the topics I am all ears. If we want to just agree that different styles work or some things feel comfortable we can drop it also.

I just have a hard time with a position that can not be logically supported other than by saying it is emotional decision (feels comfortable). Yes, a personal problem as I ‘feel’ better with the logically correct position.

John Corey

Are some properties bad rentals - Posted by brad

Posted by brad on March 26, 2006 at 21:36:46:

I have a 2BR/1Bath condo that is paid for. It would sell right now for about 120-130K. I only have to pay taxes (700 dolars per year), HOA fees (1500 dollars per year) and insurace on it. The condo grosses about 8000 dollars a year. After paying expenses, we pocket about 5000 dollars each year.

Should I sell this and put the money into a more profitable property or keep it? I think having a small house with no HOA fees may be a more profitable investment, but on the other hand, when the roof needs replacing on a house, I’d have to pay for it myself… HOA’s can be nice sometimes!

What do you guys think?

Thanks for your time!


Re: Are some properties bad rentals - Posted by John Corey

Posted by John Corey on March 27, 2006 at 03:06:42:


Let me address the subject line for the message and not the specifics of the message (at least to start).

There are definitely property that are a great investment but a very poor rental.

I purchased a property that was zoned live/work. This means it could legally be a personal residence and some or all could be used to operate a business. There was a large room with an entrance to the street for the business space and a 1 BD/1BA (plus loft for second sleeping area) with a private entrance to the courtyard.

Great location and lots of positives. It was located in London England but that has nothing to do with the message.

After some changes that I made prior to purchase (new construction) there was a total of 2,100 sq ft. Technically a 1 BD and a 1.5 BA using US terms. As a 1 BD it would not rent for enough to cover the mortgage. As a business space it could be rented for just enough to cover the mortgage. When I sold the property I was paid enough to be able to buy 2 replacement units (2BD, 2 BA) and still have some cash left over. I could more than double the income, have cash in the bank and I would own units that would attract tenants any time an ad was placed. I had purchased the place for less than 50% of the sale price just 4 years earlier (2 years prior to construction and 2 years of ownership while I lived there).

So, there are definitely property that are great investments financially which can be very poor rentals.

Some investors take the view that a 3 or 4 BD property with a minimum 1.5 BA and maybe a garage is optimal. You end up with a property that is bigger than the majority of apartments (2BD being the largest most of the time), you tend to attract families who move less often given children in schools. A family also has more stuff so is less interested in packing and moving.

There is no optimal in all cases. I have a bias for condos as they are easy to manage in a predictable fashion (landscaping & structural items, lower crime when off the ground floor). If you are outside of a major city, etc you will find that condos do not do as well as SFR when it comes to appreciation. This is true more than half the time but can be just the opposite some years.

Enough about the property types.

One big issue you are having is the poor use of the capital. You have no leverage so your returns are much lower than if you had a 50% LTV loan. The risks caused by a 50% LTV 1st are trivial given the cash flow and prudent management (having a reserve for vacancies, etc). You can go higher but I wanted to make a point about how a little leverage can change the returns.

  1. Property type
  2. Financial structure

Both impact the returns and both can be evaluated independently.

If you are a sophisticated RE investor assume that you could lend money out at 10% or better. Use that as a benchmark. If you sold the property, paid the tax and then earned 10% per year by collecting monthly payments and no responsibility for maintenance or liability would you earn more? If so why invest in the property?

You have to be comfortable with your selection. Consider the alternatives and understand what makes them different.

John Corey

Re: Are some properties bad rentals - Posted by brad

Posted by brad on March 27, 2006 at 08:10:37:

Thanks for the informative response John.

I’m more comfortable renting than selling and loaning money, but maybe one day that’ll change. I should have mentioned that this is a college town with lots of renters. It’s in a good location, close to campus so it’s easy to rent. I was really more concerned about the HOA fees, etc versus a SFH.

I undersatnd what you mean about leverage… I guess I’m either too smart or too dumb. I never have understood why people who leverage themselves are seen as being sophisticated. Many I know have gone bankrupt. I see leverage as more of a risk than an advantage. Equity, to me, is debt, not wealth. I like the idea of owning things outright. I realize that not everyone can do that right away, but IMO, it’s something to strive for… maybe that’s not sophisticated, but I’m comfortable with doing that than borrowing money :slight_smile:

Thanks again,