How I Didn’t Follow My Own Advice

Do what I say, not what I do.

About half of my clients have brought up the idea of buying a rent house. From what you hear about rent houses it seems like a no brainer in terms of a good investment.

You buy a property, of which most of the purchase price is borrowed from the bank. You rent it out and someone else pays off the loan for you. When the whole loan is paid off you get to keep all of the rental payments, or you sell the house and keep the equity. Since real estate values go up over time, the value of the house will be higher when you sell it than when you bought it. 

So what could go wrong?

I usually answer clients with the following items that they are not accounting for:

• This is a leveraged investment. That means you borrowed money to make the investment. That’s not a problem if the value goes up, but it can become a huge problem if the value goes down. Did you know Dave Ramsey has been bankrupt before, and this is exactly how it happened? A lot of people don’t realize you can borrow money to invest in the stock market also (called buying on margin). However, margin comes with a lot of extra risk, which is why I do not recommend it to clients.
• Real estate values do not always go up. Over very long time periods, they usually go up. But they go up at a lower growth rate than the overall stock market. Values can also go down, and they may be down when you decide you need to sell the rent house.
• Real estate is an illiquid investment. If you need money out of the stock market, you can get your cash within a day or two. If you need to sell a house, it will likely be months before you can get your cash.
• Putting a lot of money into one property is not properly diversifying. With $3,000 I can buy you a mutual fund of 3,500 stocks. $3,000 will not get you very far in real estate investing. You have to put down a lot of money on a rent house, and you are not diversified in terms of asset type or geographic location.
• Owning a rent house is like getting a second job. You have to fix up the property, find a good renter, collect rents, and deal with issues as they come up (like the often storied water leak at midnight on Christmas Eve). It is a very high-maintenance investment. You can hire a management company to handle the maintenance, but that eats into your revenue.
• There are all sorts of costs you are not thinking of. Property taxes, insurance, repairs, vacancies, etc.
• When you sell that property, you will have to recapture the tax benefits you received while you owned the house. You will also lose around 8% of the property value through the transaction cost of selling the house.
• You open yourself up to liability. What if a renter sues you? You can form an LLC to own the house, but that is a lot of extra paperwork, meaning more maintenance.

I usually make the argument that if you want to own real estate you are much better off buying something like a Real Estate Investment Trust.

So why did Kaimey and I just buy our first rental house? Well, this time it’s different! (famous last words)

We actually entered this investment opportunity very hesitantly. In fact, we said no multiple times before we actually said yes. I know all of the arguments above and have talked multiple clients out of buying rental properties. We didn’t really want to do it. 

However, here are some specifics that make this situation unique.

• The property is next door to our home. For various reasons we had concerns that a new owner would build something on the edge of their property that would be an eyesore or block our current hill country view.
• The property was not maintained well, did not show well to potential buyers, and went through multiple price drops while it sat on the market for months. The sellers were very motivated and willing to negotiate a lot.
• The house is a one story house right next door to us. If 10 or 20 years down the road either of our parents needed to move closer to us, this would be an ideal house for them.
• Our family is excited to work on the house and improve it. It has been a great opportunity to teach our kids home improvement skills, work ethic, budgets…we’re really involving them in the whole thing and are grateful for the manual labor they bring to the table!
• The real estate market and interest rates are at lows right now with the economy.

So we did it. We went in with a low offer, and the sellers were willing to make it work. Although almost every evening and weekend has been spent doing yardwork, picking paint colors, and replacing light fixtures, we’re still excited about this adventure.

Maybe we’ll love it, maybe we’ll hate it. But it doesn’t have to be a forever decision. We’ll let you know how it’s working for us in future posts.

Do you want me to talk you out of (or in to) buying your own rental house? Reach out to me and let me know!