Five Mistakes That Will Cost You Money as a Landlord
In the world of real estate investment, there are two general strategies for making money with property. The first is simply to buy a property, make any necessary repairs and then sell it for a profit. The second method, which is purchasing properties in order to rent them out, focuses on building up long-term streams of passive rental revenues.
On paper, renting seems like a wonderful way to make money and create a lasting revenue stream. However. there are some very common mistakes that stop property investors from making good money as landlords. Here are five of the most common and most costly of these mistakes.
Paying Too Much for the House
Many landlords end up paying far too much for homes that will only produce moderate cash flow, thus realizing what is ultimately a poor return on investment. Say that an investor purchases a home for $150,000 and rents it out for $1,500 per month.
On paper, this would seem like a great deal, as the annual gross return is 12 percent. However, the positive cash flow has to be taken into consideration. On a home rented out for $1,500 that is mortgaged and managed by a property management company, the total positive cash flow after fees, taxes, payments and maintenance costs may be as little as $500. In this example, the property would only yield an annual return of 4 percent.
For this reason, it is essential to find properties that can command decent rental prices for the lowest possible buying price if you want a reasonably high annualized return on your investment.
Failure to Diversify
Diversification is essential in any business, and real estate investment is no different. Many landlords end up building a portfolio of rental properties in just a few neighborhoods and in just one pricing bracket. The problem with this strategy is that it can result in losses if the neighborhood suddenly begins to deteriorate or if the income bracket that is targeted as your main occupant demographic is negatively affected by economic conditions beyond your control in your local area. Building a portfolio that has both high and low income properties in a variety of different neighborhoods will keep you from being disproportionately affected by this kind of event.
Taking the Short-Term Approach to Maintenance
To many landlords, the cheapest solution to a maintenance issue is always the best, because it prevents cash flow from turning negative in the short-term. However, there is a problem with this mindset. In many cases, landlords end up doing maintenance work that only delays, rather than solves, the problem.
A good example of this is a house with severe plumbing problems. A landlord who is thinking about profitability in the longer view will have the entire house replumbed. This will, of course, come with a high initial cost, but will keep the plumbing in good shape for years or decades to come. A landlord who is simply looking for a quick fix might replace a piece here and a piece there, but never solve the underlying problem of aging and deteriorated plumbing.
While this landlord will save money in the present, he or she will end up paying for more and more visits from plumbers to solve issues that will continue to arise. Over time, the total cost will mount up to being higher than simply replacing all of the plumbing at one time.
Worse yet, there’s a good chance that the plumbing will eventually get bad enough that that landlord will have to do a complete replacement anyway. Take the long-term view into account when you decide whether or not to do large and costly maintenance projects, as they can often save you money over time.
Not Taking Vacancy Months into Account
A major mistake that is made by investors who are new to being landlords is failing to take into account the loss of cash flow that months spent in vacancy can produce. When order to find a new tenant and get him or her settled in and paying rent.
During that time, your property will still be costing you money in taxes, management fees and a mortgage payment, if you have one. For this reason, the rental price you put on a house should take into account the fact that it may or may not actually produce income all 12 months of the year.
As a general rule, you should prepare for the possibility that a rental unit may only provide income 10 months out of the year. If you find a house that can provide reasonably good annual cash flow on a 10 month basis, you’ll only be that much farther ahead during the years that you actually have a tenant in place and paying rent for all 12 months.