My Rental Property – Investment Performance and a Few Confessions

The Dream?

We achieved the dream and have a rental property that we have paid off – but is this really the best use of our money? This post will walk through how this asset has performed and ask some tough questions from an investment point of view to bring an investment like this into perspective. Not everyone has a rental property but if you are considering one, hopefully this post will be a good reference point.

Our Rental Property Story

My wife and I lived in a condo for 8 years and paid off a secondary mortgage that was on the property and refinanced the unit a few times so that we had options with the property. When it came time to buy a house so we could start a family – we ended up renting the property vs selling it given the housing market 5 years ago was still not fully recovered and the mortgage was manageable. We essentially made a decision at that point the property was an investment.

We found a renter pretty easily and have had the same renter since the beginning and have truly lucked out as some tenants can be horrible.  We hustled over the past several years and got the property paid off as it was negative cash flow for us.   The property has appreciated as hoped and we have lucked out.   This really could have gone the other way pretty bad..

Now we have a rental property….. how’s it performing as an investment vehicle?

Income Breakdown

You might be considering a rental property yourself or just curious but here is how our income has broken down expressed in %s of the monthly rent.

• Rent – 100% a month
• Hoa fees – 45% of rent a month
• Insurance – 4% of rent a month
• Repairs – 12% of rent a month average over our rental time…. obviously this spikes at times but it is fair to say this is reasonable expectation for the future
• Management company – $0/0% – I do it all myself
• Mortgage – $0/0%  – got this paid off!
• Net income – 39% of rent a month I get to keep.

Yes the HOA fees are high but all the maintenance of the outside of the property is taken care of and the building is insured via the HOA. There was a major rehab project that also was needed that needed funding. I always ask for this to go down at annual meetings but after being on the HOA board prior I don’t see this going down $100 or more in the future….. it’s just costly to maintain a property.

The repair number honestly surprised me and has been higher than we were expecting. I don’t think I am over servicing the property – things just break and need to be repaired. I have hired a handy man to do all of the repairs vs doing the repairs myself which I think is the right thing to do  (vs being the landlord that is always in the property).

Even though I could do most of the repairs – the handy man “premium” has been worth it as I haven’t had the time to deal with the repairs myself.  A dishwasher, new microwave, new hot water heater, etc…. always something big each year and we try to do small rehab to keep the tenant happy while these bigger projects are getting completed.

As you can see from the above – any mortgage likely would make this property cash flow negative… which ours was for a while.

Investment Performance Analysis

My wife’s favorite phrase when talking about this property is “That property generates $X a month forever for us”….. not so fast honey. I love her and all but she just doesn’t see all the numbers all the time. It’s only 40% of that!

Given we can exit the property whenever I want since the unit is paid off – the question now is how do we compare this investment vs other options I have for investment vehicles? Yield and raw dollar cash flow of today vs another investment is how I plan to look at this question.

We have the income side of this story complete with my math above.

The property on Zillow I pulled down from Zillow but I know the property is not worth that much as I know the property needs a new bathroom and general touch up to sell in addition to paying 6% in fees to sell the property.   I am going to assume a 20% discount this property to come up with the cash I would receive after everything settled – either through selling the property as is or doing a rehab and then selling it.

I did the math above and netted a 3.1% return a year. If the property is worth more than my 20% discount to Zillow the yield is even worse.   That’s actually a pretty low return given the amount of money that is locked up in the property and what I could get from a publicly traded company 🙁

So What to Do Now?

Like every good financial steward, we need to come up with a strategy.   Just like my post on your primary income we need to have a strategy for our rental property:   Your Primary Income – What’s Your Strategy?

My Options are:

1. Kick the tenant out and sell the property
2. Raise the rent – I have escalators in the contract and would have to redo a contract
3. Cut costs as best I can
4. Establish a HELOC on the property so I can access the equity to boost return over 3%
5. Come up with the game plan when the tenant leaves

When you read down the list my options are pretty limited… I think this comes with a lot of rental properties.  I happen to have all good options at some level but if the tenant was worse or I didn’t have the mortgage be paid off… you can see my options would be very limited and painful. Luck has a BIG part in where we are at now.

So What Am I Going to Do?

I am not going to really pursue options 1 and 2… its not worth upsetting the apple cart the more I have thought about it… capital appreciation hopefully will continue as well to compensate us. For #3 – I put my insurance out to bid to see what happens here but this won’t yield much.  I’ll ruble rouse at the next HOA meeting.. we’ll see if that does anything.   I am going to be a bit more tactful on repair costs otherwise but don’t think this will yield much either.

I am going to pursue a HELOC on the property so I can access the equity for emergencies, paying for a new bathroom later when the tenant leaves so I can spruce up the property if I sell it, and as an investment driver.   Most professionals at work that have rentals that I have talked to all seem to roll equity from one property to the next…. I’ll summarize what they are doing in another post.

So with #4 solved shortly with a HELOC – I need to conclude on a plan for #5 which is basically answered by “rent again or sell.”

Using Zillow.com – I have concluded I can’t rent my property for much more than I am renting now… there are a lot of new units going up near my property and I just don’t see this changing.  Knowing your neighborhood is critical for this type of decision.  The rent escalators will be enough to maintain the property’s competitiveness. So it looks like I would sell it.

The Plan

So my game plan nets to:   Selling the property when the tenant leaves, having a HELOC in place for the rehab that will be needed, and using the HELOC between now and selling to see if I can amplify gains beyond my 3.1%.  To be explored in a future post. Caveat of course: I would re-evaluate the market at the time the remnant leaves to see if I came to same conclusion.