When I talk to friends who don’t own rentals, or even when I speak to those on their own path to financial independence, Real Estate Investment (REI) is always a contentious topic. For those with a bad landlording experience in the past, or for those who have never investigated REI, there are a few common questions.
Isn’t real estate too much work? Doesn’t real estate represent too high a risk?
The answer to both is a conditional no, and I’ll explain why.
Real Estate Too Much Work If You Allow It To Be
One of the beautiful aspects of Real Estate Investment is that you can tweak a number of knobs to achieve your ideal mix of profit and passivity. Whether you are a complete couch potato who is looking for a near-totally passive investment or a weekend warrior looking to do all management and repairs themselves, real estate is an option for you.
Let’s take the case of our lazy landlord. I’m the first to admit: This is me. As much as humanly possible, I want to have little to do with the everyday administration of my properties. I want to check at the beginning of the month that all transfers have arrived in my bank account, approve expensive repairs, and ensure that good tenants are placed quickly. Therefore, I have hired property management for my properties, and have given them clear instructions regarding the latitude they have when it comes to performing repairs and placing tenants. In this case, I have turned down the profit knob and turned up the passivity knob. That is to say, I have accepted that part of the money that I earn is going to my property managers, because I prefer not to have to chase late rents, place tenants, or get middle of the night phone calls if a pipe breaks.
There are a number of reasons I opt for this arrangement. The principal reason is that because of where I live, no local cash-flowing properties are available. I must invest significantly out of my area in order to find an acceptable return in real estate. In fact, it may surprise you to learn that I have never set foot in any of my rental units, nor have I seen any of them in person. I rely on my rigorous analysis, referrals, and independent inspectors and contractors to evaluate a property. It’s not as scary as it sounds– since real estate is so heavily regulated, it’s actually fairly easy to be sure that a transaction is aboveboard. Besides- I’m no contractor! While walking through a property might give me peace of mind, it gives me no particular insight as to the invisible condition of the property. Additionally, since our early retirement goals involve slow travel abroad, this passive approach is simply a dress rehearsal for the rest of our lives.
Now let’s discuss a landlord who has easy access to good rental properties, and the right demeanor and skills to perform all management and/or repairs him or herself. This landlord has cranked the passivity way down relative to someone like me, but they can perform repairs at cost, and spend no money on management. On the same property in the same market, this landlord would be making a lot more money than me.
It’s critical to note that this landlord has given up mobility and a large degree of flexibility until they decide to turn the profit knob down and the passivity knob up. They also have to shoulder the emotional and mental burden of being at the tenant’s beck and call. Regardless, all landlords must build property management into their analysis.
Both extremes are acceptable, and there is plenty of room in between. Perhaps you collect the rent, you hire a realtor to place tenants, and call an inexpensive handyman to respond to all maintenance requests. If you fall anywhere on this spectrum, you can find a mix that works for your desired passivity and profitability.
How To Reduce Risk
There are two incredibly important things you can do as a landlord to reduce your risk, regardless of whether you purchase your properties in “A” or “C” neighborhoods.
Hire Great Property Management – If you’re a passive type investor, you owe it to yourself to thoroughly vet your property management. What do their customers say about them? What do their competitors say about them? Is anyone online reporting cause for concern? Do you see anything in their property management agreement that you feel creates a conflict of interest? It’s best to level with property management about your concerns up front. It establishes you as an investor who is watching out for your own best interest, and puts them on notice that you will be watching closely to see that they are holding up their end of the bargain.
Place Excellent Tenants – There really isn’t any more important aspect to landlording than this. Have a clear, realistic written standard for your tenants, and do not deviate from it. If you utilize property management, make sure you communicate your tenant requirements. Carefully consider whether tenants with prior evictions, shady criminal or rental history, less-than-stellar landlord references, or other red flags are right for your property. Your tenants are not your friends (though you are morally and legally obligated to be a fair and attentive landlord), so treat all tenants as your partners in a legal contract.
It’s a Matter of Exposure
Even if you’ve hired the world’s best property management, and you’ve placed an excellent tenant, shit happens. Pipes burst, roofs leak, and tenants get relocated unexpectedly. If you are a landlord long enough, you will face an emergency repair (like a flooded basement), a capital improvement (like a roof replacement), or an unexpected vacancy (such as evicting a non-paying tenant). It doesn’t matter where you buy or who you are, the statistics say it will happen eventually. If you are stretched thin in the first few months or years of investing in real estate (something I advise against), a major repair or vacancy may eat up most of your early profits.
Two factors work in your favor to reduce this risk: Time and number of units. Time helps you to accumulate more repair and capital reserves with which to weather one of these costs. Unfortunately, time is not something we can control. It marches on despite our attempts to stop it.
Unit count, however, is something we can control. Having a larger number of units helps you to shrug off a vacancy or repair, because numerous other occupied units will remain profitable, if somewhat less so.
The above are some of the reasons that I feel that real estate investment is best for those interested in accumulating at least a moderate sized portfolio (more than one or two units) over the long run.
Of course, owning a property isn’t the only option available if you want to invest in real estate. You could invest in a REIT (Pronounced “reet“) which is essentially a company which holds many properties, and shares profits amongst the shareholders. A REIT is nice in that it is entirely passive, but the returns can be drastically lower than actually owning property.
You can make money as a lender, as a wholesaler, and many other ways. I won’t go into them here because they’re not parts of the business I’m familiar with. If you want to learn about the myriad ways to make money on real estate, head on over to Bigger Pockets.
Bottom Line: How Much Effort?
In an average month, I probably spend about five minutes worrying about, checking bank transfers on, or managing my properties. When I first acquired the properties, I would say I was spending about fifteen to twenty minutes a day on the initial repair arrangements, setting up utilities, and reviewing listings. The initial setup is only a few weeks upon purchase of the property, though, and it quickly drops to near-nothing.
Since we’ll be purchasing more properties before we retire, I see the monthly burden growing to an hour or two on average. It’s really trivial work, mostly accomplished with a quick email. The monthly statements come in, I quickly check them out, I verify that wire transfers occurred, and I’m usually done.
Real estate investment can work for almost anyone, so long as they are honest with themselves in regards to how much work they are willing to take on, and have adequate reserves in case unexpected costs come sooner than later.
Are you a real estate investor? What’s your passivity/profitability mix? Any ideas on how to reduce risk or maximize profit while minimizing effort? Let me know in the comments!