patrick.net

I haven't done this, but here's a thought experiment I've been running in my head that might be useful to you:

Suppose you had a friend whom you trusted perfectly to look after your best interests. Let's call him Duane. Let's say Duane similarly trusts you. You also have identical taste in homes, identical finances, and two identical homes just came up on the market for identical prices (say they're new constructions in one of these mass-produced home-hives that are so ubiquitous these days.)

Is it better for you and Duane to each buy your own homes next door to each other and live in them, or for you and Duane to buy your own homes and rent them to each other for the exact same PITI-cost?

The only difference I can see (that can't be assumed away through collusion so perfect it can only exist in a thought experiment) is that in the latter case you can both deduct depreciation and in the prior case you cannot --either way, you can deduct mortgage interest.

You don't have a Duane, but nor do you need one. I think the experiment shows that it's perfectly sane --in some senses optimal-- to rent while you're a renter. The other problems you raise are valid, particularly the long-distance landlord one, but I wouldn't worry too much about renting while playing landlord. Unless you really want to own just-because and are worried about deferring that; which would be reasonable, but would also be a value-tradeoff that random dudes on the Internet couldn't really help you wrestle with.

We did it for a while. Very similar boat you're in. Bay area - too expensive to buy. Bought elsewhere and have been renting them out. A property manager is taking care of them, so pretty hassle free so far.

I view it this way - do you invest your money in stocks, bonds, etc. while you are renting? If so, investing in RE is the same thing just a different investment. The main thing is making sure it is a good investment. Just like there are bad stocks, there are bad RE investments.

MTHOM,
thanks for your reply. Can you share more details? location, how much the property manager charges ..etc

"I can pick up a decent rental property in these areas with a hefty down (40-60%) and be cash flow positive by renting them out"

You should check out the capitalization rate and make sure this is worth it. 40-60% is a lot down, and you might be able to get better returns elsewhere. It doesn't sound like these are good rental properties if you're having to put that much down.

Other than that, it is very difficult to be a long-distance landlord. Many people would recommend using a management company, but it's also a lot harder to keep tabs on the management company when you live far away. Sacramento isn't that far away from the Bay Area, however.

In addition, you should consider whether it pushes forward your life goals. If you want to buy a house eventually, it might not make sense to use your potential down payment on an illiquid investment with poor return.

Also, maybe you should consider somewhere with better cashflow and return on investment like Oklahoma instead of Arizona.

I have actually done this. I lived in NYC and rented out a house I already owned in Alabama. A few experiences / thoughts -

1) I did not use a property management company, but would do so if I had it to do over again. While I thought I had a great renter, at one point the check didn't come and she did not answer the phone. Then the phone was disconnected. I had to fly down and check it out. She moved out without informing me - but at least she repainted and laid new tile in the kitchen. I bumped into her years later and with embarrassment she explained she got in a financial bind and did what she could to 'repay me' for the missed rent. The moral: even good people get in trouble and they might not pay. So, either hire a management company (and) or plan on months where you have NO rental income at all.

2) Arizona? Do you really know the rental market? I am guessing post-bubble there are lots of places where houses appear to be very cheap and you might assume you can get positive cash flow. However, there could be many, many vacancies and good renters may be hard to find. Are you sure you'll get the rent you want? Worse, can you even find a decent, reliable renter at any price? I would be leery of markets that were extreme bubbles and therefore appear cheap but are really more of a mess than an opportunity.

3) Similar to #1, most landlords will tell you never buy a rental that is far from your home. Sure, you can get someone to manage it or hope to find a really, really good renter who you trust. But generally, it is a bad idea (in my opinion) to be an absentee landlord. Too much can go wrong. I have an acquaintance who leveraged that 'sweet, sweet CA equity' to buy something like 26 rentals in other states. He recently got crushed. He had one case of a rental management company collecting rent and telling him they were empty. Others were stripped an vandalized. Others he wanted to sell, and was underwater. It strikes me that there are a good deal of CA people who are true believers in real estate and 'rich dad poor dad' and it doesn't always work out as planned.

In short, in theory or philosophically there is no problem renting your primary residence and owning a rental property. I just wouldn't go into it too naively and make too many assumptions.

My first post!

There is some slightly misleading information in this thread. Thought I could help out.

I rent in San Jose but own a place in Florida. I've been doing this for 3 years.
Most of the advice above is sound.

The one point I'd like to make clear is about the deductions. A primary residence allows you to deduct the interest + property tax from your personal income tax. The rental will let you deduct losses (including depreciation if you want) from personal income tax, but ONLY if you make less then 150K (AGI) a year (or have Realtors license). I learned this the hard way as my salary has gone up over the years.

If you hit the 150K limit, then you can carry forward the deductions for when you sell the house.

Check out this link for details on the deductions:
http://moneygirl.quickanddirtytips.com/real-estate-deductions.aspx

permanent_marker says

MTHOM,
thanks for your reply. Can you share more details? location, how much the property manager charges ..etc

We bought in CO. The property manager takes 50%, but they do short term rentals and pay for all of the advertising etc. It's a little cash flow negative with the down economy, but not too bad. We only have about 12 yrs left on the mortgage so it will be paid off soon enough and then will obviously be cash flow positive.

Normally from what I've heard, a long term property manager takes 10-20%.

I like this calculator to determine if a property is a good investment:
http://www.goodmortgage.com/calc_investment_property.htm

Roberto, are these parts of Phoenix ok areas (crime-wise)? In the BA, cash-flow positive houses tend to be in the 'hood. Could you name some of the parts of Phoenix that rent well and are low crime? Sounds worth looking into.

robertoaribas says

many parts of Phoenix cashflow like crazy.

Yes, it's kind of shocking how much gross rents can be as a percent of purchase price. I'll spam my own forum here - check out the numbers for Phoenix in Patrick's Property Finder

I have done it for 10 years, you can make it work if you really do your homework.

I would strongly recommend buying in an area you have lived and know the ground. I find it takes about a year to really learn you way around an area. Don't even think about an area that doesn't have landlord friendly eviction laws.

Good rental agents are not that hard to find, ask around. Hospitals are a good source. They deal with a lot of transient doctors/nurses and as a result deal with a lot of rental agents. For the cost of a good lunch or dinner the person who deals with this can give an unbiased opinion on who is straight up. They can also be a very good source for rentors. Agents dealing with long terms are usually about 10%. Mine only charges for occupied months.

Being cash flow positive due to a 40-60% down payment means nothing. If a rental is super amazing, it would be cash flow positive with a 0% downpayment.

Since you are out of town, you'll have to hire a management company, and you'll also have more crap to deal with if you are trying to rent it out. You'll be dependent on realtors, etc. In general, sounds like a bad idea unless you really know what you are doing.

While it may make sense to buy a rental somewhere else/rent where you are currently living due to the market conditions, in general it's better to buy your own place. This is because any income received from renting is taxed as income (you can depreciate the property/deduct your expenses but any excess cash flow is taxed).

In contrast, when you buy a house, the money you save is after-tax income. So basically, if you save $1000/month from buying vs making $1000/month from renting out a house, the saving $1000/month is better siince the making $1000/month is only $700/month or so after tax (depending on bracket/state taxes etc.).

"Normally from what I’ve heard, a long term property manager takes 10-20%."

That's an estimate on the high side. In areas where it's easier to rent and safe, you may see some property managers going down to 7% or so. 9-10% is not bad generally. For dangerous areas, you may get more than 10%. 20% sounds really high for a non-vacation property, although maybe in some really bad neighborhoods you might see it. Vacation properties require a lot more efforts and have a lot more trouble and turnover, so that's why property managers of those properties take a bigger cut.

I own two rental properties although I am living in one of them right now because I sold our last primary residence to cash out the peak and I have yet to find our next home.

The property I am currently renting is 200 miles away. I am renting to a Dr. and her family. The house is in an area that we like to vacation in... ROI is about 6% and I manage it myself although I have a maintenance guy I know personally who lives nearby and will handle any day-to-day issues with just a call and his prices are fair. (I know fair because I used to be a professional property manager and construction project manager and construction electrician.)

I am also eyeing Phx but every property I go look at is in need of major repairs or not something I would live in myself which is one way I evaluate a property. I think there is opportunity there but risk, as well. (I'm sure there are opportunities in other markets, as well, but I only know Phx and my local market so can only comment with any authority on those.)

I agree with those who write that a would-be investor should know their target market really well and that managing from a distance is different from being able to lay boots on the ground yourself (without a plane ticket involved!); that is, in general, usually more costly amd complicated. Margins, in my experience, are slim and any additional cost can sink you.

And, regardless, I have decided (I think!) that two rental properties are enough for me; additional income is not a priority for me (which feels weird to write and read but at some point you have to declare victory, right?)

I like real estate but only to achieve a particular end and not too much of it simply because I only want a certain amount of additional responsibilities so I have the time to pursue my non-real estate goals.

This is a great idea but not so much from the investment p.o.v but from the perspective of having a property all ready by retirement age. Realize, no one wants to be a renter in old age.

Now that the bear market has started, real estate will not be going up at 3-5%, year after year, but will be flat for another decade or two. Thus, if you shop around, you should do fine in getting decent rental property, somewhere. In general, it's good to be near university towns or medical centers, as they tend to have a lot of mid-term transient residents.

I'm thinking about the same thing. Quite cheap to buy in the Georgia town back East where some of my family lives. I despise management agencies though, they have little interest beyond doing the minimum necessary to keep checks coming in. If I pull the trigger, it will be with family members able to maintain the property and keep an eye on it for me.

Don't do it! I live in Seattle and have a rental property in Whistler. The biggest problem is not being able to get to the property to inspect the property or meet/interview new tenants. This has lead to many problems - tenants who are not who they seem to be based on phone interviews, unreported damage and repairs needed, and getting ripped off by contractors and tenants. I recommend waiting until your local market makes it worthwhile to buy in your area, then buy a place that you want to move into eventually yourself.

My wife and I almost bought a place in the South Bay in '05, but decided against it because it didn't make financial sense. No government bail-outs for us making the right decision. We then bought out-of-state rental property.

We fell into the Robert Kyosaki trap back in '05 as he played up all the deductions you can take as a real estate investor. Unfortunately, as RG pointed out, your deductions phase out as you move closer to the 150k AGI and once you pass that bar.....NADA. I haven't been able to take any deductions for 4 years now, but I continue to incur the expenses (losses). We were renters in Los Gatos, CA and bought a 5 apartment + office space multi-use historic building for $150k in '06 in the Saint Louis area where I grew up. BTW - it's on the market if anyone is interested. You are absolutely at the hands of local people whether it be your property manager (10% fee) or repairmen (A/C, plumbing, etc). The hassle and time to me isn't worth the income.

If I had to do it over, I would not buy rental property until the foundation of my own financial house was strong, which to me is owning the roof that's over my head..my primary residence. You build equity, hopefully it appreciates, but not guaranteed, and the mortgage interest deduction reduces your AGI. Rental property should be part of your asset diversification, but not all of it, and after your foundation is solid.

The adage of "too good to be true" still holds true. Consider your opportunity costs. I wouldn't consider a 40-60% down payment for cash flow to be the deal of the century. Consider all your costs such as vacancy and your time (it is valuable). Also plan on having a maintenance/emergency fund for when things do go wrong whether it's caused by the tenant or just age (roof, AC, etc). One of my ex-bosses used to say, "Proper planning prevents poor performance."

Good luck!

I'm looking to buy some more properties remotely. Just do a lot of research.

What percentage of your assets(not including primary residence) should be rental income property?

Ralph says

... Realize, no one wants to be a renter in old age.

Really? No one? Renting in retirement is precicely what I am contemplating.

I will be mortgage free next year. Big deal. Owning is still nowhere near free. I still have property tax and maintenance costs.

I am so sick of the responsibility and costs that come with owning. What if that overgrown tree branch falls on the neighbor's garage? Fork over hundreds of dollars to trim the trees, or $1200 each to cut them down. $8-9K for new roof. $10K+ to remodel the bathroom because it looks old and will hurt the value when I sell.

If I rent, I'll let the landlord worry about the roof. If the bathroom meets my needs I don't care if it's outdated. If there is something I don't like or if I just want to live in a different town, I finish out my lease and move.

Related but embarrassingly ignorant question: let's say I own my first (starter) home and then rent it out to tenants when I buy my second (family-raising) home. The second home is purchased with a mortgage whose monthly payment is equal to the rent my tenants are paying me.

In your state, would I be able to have the tenant pay my mortgage directly, or would the money have to pass through my hands, with income taxes being taken out, before I could pass that money on to my bank?

robertoaribas says

many parts of Phoenix cashflow like crazy.

Yes, it’s kind of shocking how much gross rents can be as a percent of purchase price. I’ll spam my own forum here - check out the numbers for Phoenix in Patrick’s Property Finder

That all sounds great on paper. But personally I know someone who's a landlord in Phoenix and they cannot find a tenant. It's a brand new place too so they are currently out something like $1200 a month out of pocket until they find a tenant.

No actually they're trying to rent it for something like $800 it's a brand new townhouse
in Scottsdale.

Can't find a tenant because there are too many investors coming in trying to rent out properties.

that sounds decent... we rented a condo for about that much (but included some utilities)

looking at a few townhouses in scottsdale for purchase (same hoa for all 3)funny thing is the prices
63k
39k
159k

all for 3 bd 1 ba and the most expensive one isn't even an end unit. all look to be in good shape.