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.
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.