Is being a landlord a good idea? Is there a lot of risk?

Question

A few days ago I asked a way to generate a passive income. It seems the best I can expect is about 2k from a 50k invest at a low risk. However, if I can buy a house for 150k and rent it out, I can generate over $10,000 a year according to zillow. I am not sure if this is a good idea or not. I live in Texas and thinking about buying a home in Azle. I'm nervous, but thinking about doing this. Who knows, maybe I can be successful because of this. If worse comes to worse, I will live in the house myself. Any tips or suggestions is appreciated.

P.S. I know this isn't a passive income because I will have to work even if it is a little bit.

Edit: Also, I heard Texas is a land lord friendly state so this might work to my advantage.

Answer 1

Risk is the capital you have staked in pursuit of profit. The danger is that you lose what you have risked.

For some bets (risks), you can get insurance to cover for losses.

Now the "game" of Landlord and Tenant requires you to play fully by the rules set forth by your legislators. In your case, that is the legislators of the State of Texas.

Without knowing those rules, you could be liable (open to civil prosecution) for violating those rules. Tenants could be savvy to those rules or savvy enough to hire someone, a lawyer, who knows those rules.

As well, in the game of Landlord and Tenant, you must ascertain the creditworthiness of your would-be tenant. If the tenant fails to pay rent, that tenant can detain the residence. You will incur additional outlays to gain possession of your property (ownership in your rental).

Now the game of Landlord vs Landlord is different. You can't pick up houses easily enough and even if you could, likely the expense of doing so could wipe out any would profits from having the house as a rental.

So, in Landlord vs Landlord, you get constrained by where your rental sits. Thus you must forecast what will the neighborhood look like in five, ten, fifteen years.

• Will population swell and rents outrun the effects of cash accretion by the banking system (aka inflation)?
• Will population fall and along with it employers and jobs? Will there be more rentals than needed for a shrinking head count?
• Could landlords move into the area in a few years, build new rental units that offer more at a better price than I can?
• What will a capital improvement schedule look like to keep my rental unit competitive vis-a-vis other rental units?
• How will the sum of a capital improvement schedule and other outlays affect return? Will I earn any profit at all? How does a 10-year future of earnings compare to taking the same sum and buying 10 year Treasury bonds?

Answer 2

I have been a landlord in Texas for just over 3 years now. I still feel like a novice, but I will give you the benefit of my experience.

If you are relying on rental properties for current income versus a long term return you are going to have to do a good job at shopping for bargains to get monthly cash flow versus equity growth that is locked up in the property until you sell it.

If you want to pull a lot of cash out of a property on a regular basis you probably are going to have to get into flipping them, which is decidedly not passive investing.

Also, it is easy to underestimate the expenses associated with rental properties. Texas is pretty landlord friendly legally, however it does have higher than usual property taxes, which will eat into your return. Also, you need to factor in maintenance, vacancy, tenant turnover costs, etc. It can add up to a lot more than you would expect. If you are handy and can do a lot of repairs yourself you can increase your return, but that makes it less of a passive investment.

The two most common rules I have heard for initially evaluating whether an investment property is likely to be cash flow positive are the 1% and 50% rules.

• The 1% rule says the expected monthly rent needs to be 1% or greater of the purchase price of the house. So your hypothetical $150K/$10K scenario doesn't pass that test. Some people say this rule is 2% for new landlords, but in my experience you'd have to get lucky in Texas to find a house priced that competitively that didn't need a lot of work to get rents that high.

• The 50% rule says that the rent needs to be double your mortgage payment to account for expenses.

You also have to factor in the hassle of dealing with tenants, the following are not going to happen when you own a mutual fund, but are almost inevitable if you are a landlord long enough:

• Tenant calls at 3am with a plumbing leak, you have to get out of bed and track down a plumber in the middle of the night.
• Rent check is getting later and later, and the sob stories pile up from the tenant about how their car broke down, or they lost a job, etc. Meanwhile the bank expects you to pay the mortgage like clockwork.

• For whatever reason you have to go to court and evict a tenant. A tenant that probably lost their job, or had major medical issues. The nicest tenant you ever met with the cutest kids in the world that you are threatening to make homeless. Every fiber of your being wants to cut them some slack, but you have a mortgage to pay and can't set an expectation that paying the rent on time is a suggestion not a rule.

• or the tenant, who seemed nice at first, but now considers you "the man" decides to fight the eviction and won't move out. You have to go through a court process, then eventually get the Sheriff to come out and forcibly remove them from the property, which they are treating like crap because they are mad at you. All the while not paying rent or letting you re-let the place.

• The tenant isn't maintaining the lawn and the HOA is getting on your butt about it. Do you pay someone to mow the grass for them and then try to squeeze the money out of the tenant who "never agreed to pay for that"?

• You rent to a college kid who has never lived on their own and has adopted you as their new parent figure. "The light in the closet went out, can you come replace the bulb?"

• Tenants flat out lying to your face. "Of course I don't have any pets that I didn't pay the deposit for!" (Pics all over facebook of their kids playing with a dog in the "pet-free" house)

Answer 3

If you are able to buy a 150K home for 50K now that would be a good deal! However, you can't you have to borrow 100K in order to make this deal happen. This dramatically increases the risk of any investment, and I would no longer classify it as passive income.

The mortgage on a 150K place would be about 710/month (30 year fixed). Reasonably I would expect no more than 1200/month in rent, or 14,400. A good rule of thumb is to assume that half of rental revenue can be counted as profit before debt service. So in your case 7200, but you would have a mortgage payment of 473/month. Leaving you a profit of 1524 after debt service. This is suspiciously like 2K per year. Things, in the financial world, tend to move toward an equilibrium.

The benefit of rental property you can make a lot more than the numbers suggest. For example the home could increase in value, and you can have fewer than expected repairs. So you have two ways to profit: rental revenue and asset appreciation.

However, you said that you needed passive income. What happens if you have a vacancy or the tenant does not pay? What happens if you have greater than expected repairs? What happens if you get a fine from the HOA or a special assessment? Not only will you have dip into your pocket to cover the payment, you might also have to dip into your pocket to cover the actual event!

In a way this would be no different than if you borrowed 100K to buy dividend paying stocks. If the fund/company does not pay out that month you would still have to make the loan payment. Where does the money come from? Your pocket. At least dividend paying companies don't collect money from their shareholders.

Yes you can make more money, but you can also lose more. Leverage is a two edged sword and rental properties can be great if you are financial able to absorb the shocks that are normal with ownership.

Answer 4

Based on what you've said I think buying a rental is risky for you. It looks like you heard that renting a house is profitable and Zillow supported that idea. Vague advice + a website designed for selling + large amounts of money = risky at the very least. That doesn't mean that rental property is super risky it just means that you haven't invested any time into learning the risks and how you can manage them. Once you learn that your risk reduces dramatically.

In general though I feel that rental property has a good risk/reward ratio. If you're willing to put in the time and energy to learn the business then I'd encourage you to buy property. If you're not willing to do that then rentals will always be a crap shoot. One thing about investing in rental property is you have the ability to have more impact on your investment than you do dropping money in the stock market which is good and bad.

Answer 5

Buying a property and renting it out can be a good investment if it matches your long term goals. Buying an investment property is a long term investment. A large chunk of your money will be tied up with the property and difficult to access. If you put your money into dividend producing stocks you can always sell the stock and have your money back in a matter of days this is not so with a property. (But you can always do a Home equity line of credit (HELOC))

I would also like to point out landlording is not a passive endeavor as JohnFx stated dealing with a tenant can be a lot of work. This is not work you necessarily have to deal with, it is possible to contract with a property management company that would place tenants and take care of those late night calls. Property management companies often charge 10% of your monthly rent and will eat a large portion of your profits. It could be worth the time and headache of tenant relations. You should build property management into you expenses anyway in case you decide to go that route in the future.

There are good things about owning an investment property. It can produce returns in a couple of ways.

• Cash flow: Probably the one people care about most. This is the difference between your monthly expenses on the property and the rent you bring in. (Do not forget to set aside a portion of the rent for repairs and capital expenses)
• Equity Growth: If you have a mortgage on your property (I hope you choose to leverage other people's money) you are making payment to principle and interest that portion contributed to the principle should be included in your return on investment.
• Taxes/Depreciation: Be sure to consult with a CPA but depending on your tax bracket you can be protecting a portion on your income from being subject to federal (and state though not in Texas) income taxes.
• Appreciation: Do not count on this one but it sure is nice. Lets say you put your 50k into 200K property financing 150K of it. The whole property appreciates even though you only own 25% of it. Lets say it goes up in value 1% this year that is a 4% ((200*.01)/50) return on your 50k in addition to all the other benefits.

If you choose this route it can be lucrative but be sure to do your homework. You must know the area you are investing very well. Know the rent, and vacancy rates for Single family homes, look at multifamily homes as a way of mitigating risk(if one unit is vacant the others are still paying).

Answer 6

Rather than thinking of becoming a landlord as a passive "investment" (like a bank account or mutual fund), it may be useful to think of it as "starting a small part-time business". While certainly many people can and do start their own businesses, and there are many success stories, there are many cases where things don't work out quite as they hoped.

I wouldn't call starting any new business "low risk", even one that isn't expected to be one's main full-time job, though some may be "acceptable risk" for your particular circumstances. But if you're going to start a part-time business, is there any particular reason you'd do so in real estate as opposed to some other activity? It sounds like you'd be completely new to real estate, so perhaps for your first business you're starting you'd want it to be something you're more familiar with. Or, if you do want to enter the real estate world (or any other new business), be sure to do a lot of research, come up with a business plan, and be prepared for the possibility of losing money as with any investment or new business.