Both personally and financially, my involvement with real estate has been an important aspect of my life. My first home was an investment property that I acquired in my late teens in a rather unusual manner. I certainly was not planning to buy a rental property at an early age, yet a serendipitous chain of events changed the course of my life. This is my opportunity to share the experience of residential rental properties and describe my humble beginnings, having had no prior knowledge of how to run this kind of business.
In our seven steps to reach FI and retirement, Step 2: Create a Passive Income Stream, is one of our most-read articles. It has generated many comments and emails on the subject of rental properties. It’s time to describe how my initial interest in rental properties developed and take a closer look at my first home purchase. This is not your typical approach to investing in rental properties.
My mother was a renter, not a property owner
My parents married at a young age and I was born in the first year of their marriage. A short two years later, my brother was born. Unfortunately, after six years my parents divorced. It was a difficult upbringing, with my mother raising my brother and me on very little income with virtually no support from my father. We moved every few years to find a better school or location to live. Each time, my mother was barely able to afford the rent. She worked two jobs for many years to make ends meet.
We would visit my father occasionally. My mother remarried seven years after the divorce, and my stepfather became the primary influence in my life moving forward.
However, in my early teens I spent time with my father, working in his woodshop on home improvement projects. I had a real interest and aptitude for working with my hands and woodworking.
The real estate market tumbled and interest rates spiked
My father was a “natural” at putting together deals. He became a successful realtor and joined forces with two partners to form a construction company. They operated this southern Colorado business in the early ’70s and were successful. They built many homes as well as some commercial buildings.
When I was 16, I began working on one of the construction crews during my summer break from high school. I started at the “grunt” level, cleaning building sites and running various errands. The following summer, I worked my way one level up to the “bottom” of the framing crew and new construction duties were assigned to me.
The construction business experienced a downturn when the housing market and economy tanked. This was at a time when the company had nearly fifty new homes for sale. This primary cause of the change to the economy was the Saudi oil embargo, the resulting gas crisis, and home mortgage interest rates hitting levels as high as 18%.
The construction company had difficulty selling any of their houses and quickly faced cash flow issues. It needed to generate cash to pay the construction loan interest and cover employee payroll. The company crews were cut in half in an effort to keep the business going.
My humble start with rental properties
Each of the construction partners in this company had several children. They ranged in ages from ten up to the mid-twenties. Since the partners had been good friends before creating their business, I knew all of them.
I believe my dad one day brainstormed an idea with the other partners, to sell a home to each of the children—setting it up as a passive income business from the start and teaching each child how to manage rental properties. They went with the idea and sold eight houses, giving each child a foundation for his or her own business. (For the younger children, their fathers managed the properties until their kids could drive and take over for themselves.) This became a great opportunity for my dad to immerse me in the rental properties business.
When I wasn’t working in construction during the summer, I worked at a local fast food restaurant the rest of the year. At age 16, making $3 an hour flipping burgers, I suddenly had a $304 month mortgage payment. (I legally could not own the property until age 18, therefore it required my dad to co-sign for the mortgage.) I was responsible for keeping the place rented, in good condition, repaired when needed, and for paying all the bills.
“If you do not like real estate, all you have to do is make hamburgers, build a business around that hamburger, and franchise it.” –Robert Kiyosaki
Talk about motivation—the mortgage was more than I made from my part-time job in a month! That was a 100% debt-to-income ratio. I could not afford to allow the property to remain vacant. This was my start into the cycle of debt that, more than 35 years later, I have nearly completed.
A high-level review of my first rental property numbers
This was not a typical way to buy a property. However, I would like to share the income and expenses I incurred during my initial learning experience with rental properties. The good news is that I bought the brand new home at construction cost (at least that is what I was told) and I enjoyed years of maintenance-free ownership.
Here is a quick breakdown of the numbers I could find or remember:
- Purchased for $36,500 and sold ten years later for $46,900 before commission.
- $350 per month rent in the beginning and up to $400 at the end.
- A 100% financed mortgage with a payment of $304 with about a 10% interest rate. I never did refinance this property—or would have qualified, for that matter.
- Taxes and insurance around $50 per month.
- Repairs, maintenance, and improvements about $3,500 total over ten years.
- Cash flow of about $46 loss per month. Once the rent was raised to $400, it was breakeven before tax.
- I captured a tax loss each year but, due to my low earnings, I had little income to shelter.
- An estimated $11K net profit from my quick “back of the napkin” analysis.
- The property was most recently sold in 2011 for $113,000.
What I learned from my first rental property experience
Our original goal with the Just One More Year blog was to talk about personal finance issues with a slant toward building passive income with rental properties. It is amazing that, with nearly 50 articles to date, I have barely touched on this subject, with only one article. I plan to go much deeper in future articles, the next one describing the purchase of my second property about 20 years ago.
I learned some valuable lessons with my first property.
The rent is not actually “paid” until the check clears the bank. (ARB can give you some background on banking and how the rules have changes over the years.) I was relying on the tenants paying their $350 rent so I could cover my $304 mortgage payment. I operated with little reserve in my business checking, expecting the rent to be deposited. When it was not, I had several mortgage checks bounce. I had several tenants’ rent checks returned due to insufficient funds. Finally, I was late several times on my mortgage payments and paid the resulting late charges.
Advice: Have a reserve to float a couple of months or more.
When you own a rental property, you are the boss. You are also the repair person, rent collector, painter, gardener, and rental and business manager. It requires work. The more sweat equity you put into the property, the fewer expenses you’ll have and the more profit you’ll make. It was also an invaluable experience to learn how to find new tenants, what to ask them, how to write a lease, and finally how to manage the books.
Advice: Do everything possible yourself to understand how the business operates. You will end up earning the real-world equivalent of an advanced degree in property management.
Tenants don’t always tell you the truth. Mean people suck! A couple fellow rental property owners and I have shared war stories over the years. Granted, I have had many excellent tenants, some of them for nearly 20 years. But early on, I believed that every tenant would do what he or she promised. After many years of disappointment, these days I take a “wait and see” approach.
Advice: Expect the best from people; however, let them earn your trust by repeatedly delivering on their word. You won’t really know how good a tenant is until the lease ends—then you can look at the payment history, take into account whether proper notice was given before moving out, and have a look at how well (or not) the tenant took care of the rental property.
This is my “thank you” to my dad for giving me my start and education in the business. He passed away three years ago.
Conclusion
This was a great learning experience for me—some of the lessons learned through the school of hard knocks. I learned new skills such as bookkeeping, writing and reviewing rental agreements, advertising, repairs, maintenance, banking, working with vendors, taxes, mortgages and using OPM. Those early skills developed the foundation for my professional career with employers as well as buying and managing the rental properties we own today.
This background story explains how I became accustomed early in life to owning homes and doing as much of the work as possible myself. Eight years later, I began buying rental properties again—ironically in the same city, even though I was living out of state. I have not left the rental properties business since.
The intention of this article was to show how I started with my first rental property. You might agree that it was a great opportunity for me in the unusual way I entered the business. I had no real concept of how to manage a property before that time. This is not the approach I would recommend for those people interested in building a business of rental properties as a passive income stream. The recommended due diligence and analysis will be reserved for future articles, beginning with the next step in the journey: purchasing my second rental property.
Financial Velociraptor says
I still can’t convince myself to take the real estate investing approach. I have a lot of exposure to US real estate already through MORL (which has been a great investment!) I find it is not too much work to earn 12+% returns on liquid assets with high yield, fixed income, and options writing strategies. I’m just not sold that the risk adjusted (especially adjusted for the leverage in RE) is justified for my personal situation. I keep looking at it though. The tax benefits are attractive.
Bryan says
There are some attractive tax benefits to rental real estate. However, if you do sell a property at some point, the depreciation is recouped to determine the cost value and profit. The rest of the normal business expenses are deductible.
For me real estate worked well because I had little money to invest, however I had great credit. This allowed me to leverage favorable financing terms and work toward paying off properties as quickly as possible. It forced me to focus on the properties and maximize our cash flow.
ARB says
Thanks for the mention, Bryan, and thanks for sharing your story. It’s good that your father started you early on this. Most people don’t have this influence, going through life instead as employees and renters rather than property and business owners.
Being a landlord requires wearing many hats, and I wish I had the handyman skills necessary to be a landlord. Fortunately I do have the customer service skills (ugh) to deal with difficult tenants if need be. While I can’t speak from experience as a landlord and business owner, I know that one key difference between dealing with customers vs tenants is that in the latter, you’ve got be firm because what YOU say goes. There’s no being “customer service nice” (as opposed to “normal human being nice”), or worried that you’ll break some arbitrary company policy, or that the person will complain to someone above you. What you say goes and your word is final (assuming you are operating your business in a manner consistent with the law, of course). As you said, YOU are the boss, not some supervisor. YOU are the one who’s right, not the customer.
If you are an employee making the jump to being a landlord (especially if you are a retail or service employee, like most young people), it is vital that you internalize this mindset and attitude. Working at a shoe store or as a restaurant server, you may be required to let the public push you around (double ugh). Here, you can’t do that. It’s your way or the highway. Which I must say I do like.
Of course, you can always hire a property management company to do everything for you. It will eat into your profits, of course, but it may be worth it rather than doing subpar repair jobs, spending your non-existent free time begging people to live in your vacant rooms, collecting rent and dealing with people who refuse to pay, etc. Some people lack the business, maintenance, or people skills to be successful landlords, but can easily pay someone else to do it all for them. Being a landlord and collecting passive income sounds easy and fun until you have to evict a family of four and have to fight with the angry father and the crying children the whole time.
If the idea of being the mustache-twirling evil landlord throwing children onto the streets makes you morally sick or gives you heart palpitations, you may want to consider a property management company if you insist on being a landlord. Ditto if “how to screw in a lightbulb” is something you would actually have to type into a Google search.
Thanks for the great article, Bryan. I definitely would love to read more stuff by you on the subject.
Sincerely,
ARB–Angry Retail Banker
Bryan says
Are you sure you haven’t been a landlord in the past ARB? It sounds like you have some experience and definitely understand the dynamic. Your’re right, the customer is not always right. To also expand on your point, you are not only the boss, but you are the business owner! 🙂
I think this might be a nice side hustle for you. You certainly have heard many excuses from your retail banking customers with your work. I believe you can read their body language, size up their comments, and pick out the “nuggets of truth” to their stories. The financing and business aspects would be a breeze for you. You can always hire cheap repair people to do to the other work you don’t want or can’t do on your own.
Quick rental horror story: We are animal lovers and have had at least one pet for a while. A deadbeat tenant abandoned three dogs (he was allowed none) at his house and skipped on the rent. He left most of his belongings behind as well. We got a call from some neighbors several days later mentioning that the dogs looked like they needed help. We went over and found them, quickly giving them water and food. Unfortunately the dog pound had to pick them up, we hoped they were adopted. How could someone abandon his or her pets?