Ask Brian: What are Some Rental Investing Traps and Pitfalls to Avoid?



Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to askbrian@realtybiznews.com.

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Question. Buster from Omaha, NE asks: Brian, I’m a weekend warrior investor in rental houses. I currently own two but have bought, rented, and sold two others during the past 6 years. I’m not getting filthy rich but I’ve done reasonably well and the extra income buys my family a few extras. My strategy is buying vacant houses that need some cosmetic repairs but nothing serious. New wood flooring is the biggest renovation I’ve tackled. I do the work myself with some help from my wife and son. After cosmetic repairs, I’ve been able to rent the houses for about 16 months before they go vacant. I sold for a reasonable profit that gave me a chunk of cash for both personal use and to repeat the process. I bought two more but not at the same time. I did cosmetic repairs again and now have those rented. One of my current renters has mentioned moving on. I’m pretty much planning to stick with my strategy to fix, rent, sell, and buy another rental. I’m not sure exactly what I’d like to know from you but I guess a few tips to fine-tune my strategy couldn’t hurt. Thanks.

Answer. Hi Buster. It sounds like you’re a happy investor even if you’re not chasing Andrew Carnegie’s belief that “90% of all millionaires become so through real estate investing.”The Omaha area is currently a solid place for your investing style. According to Zillow, the median price for sold single-family homes is $185,600 and rents are about $1,300. Average prices appreciated about 6% over the past year and are anticipated to go up another 3% this year. The numbers indicate this is a good time to sell an improved home and buy another needing repair. Buster, you probably already know that the $185,600 selling price and average rent of $1,300 doesn’t work with the rule of thumb that rents need to be 1% of the value of the house. But it can work with your strategy when you buy a fixer for about $130,000 that you’ll be able to rent for $1,300.

A common mistake investors make is looking for properties with the highest profit yield. These are great when you can find them but there is always a risk to reward factor. Chasing the highest yield can give you rose color glasses that cause you to overlook other important factors. In the big coastal cities, you see investors pursuing this investment strategy by trying to guess which downtrodden neighborhoods are ripe for urban renewal. You could score big if you guess right or lose big if you guess wrong. A solid and reliable rental strategy should focus on cash flow and equity growth. The neighborhood ingredients that feed this are job growth, population growth, and affordability.

Buster, another important part of a solid investing strategy is accurately accounting for costs. Of course, you should always have an emergency reserve fund for the unexpected but having a good understanding of your repair costs and other expenses is how you avoid the unexpected. A good way you do this is by giving yourself plenty of options both going into your investment and exiting your investment. Going in, create a volume of possible investment properties to consider. Instead of using a strict list of requirements that meet your exact investing criteria, create a checklist or spreadsheet that you can use to quickly evaluate a large number of possible properties. Many will be disqualified quickly and you’ll end up with a shortlist of the best properties for a more thorough due diligence. Don’t’ get overly concerned with having to make a fast offer in a strong market because there will be more properties available next week.

The number is the number and you should never go over it. If your comfort zone is houses needing paint and carpet, don’t suddenly start considering houses needing a major kitchen renovation. If you decide to expand your investment scope, take plenty of time to create a detailed plan and get to know that market segment well. Ripping out the kitchen sink and moving the plumbing to a kitchen island is how you create unexpected costs. You have an investment plan so find properties that fit your plan. Don’t create a plan on the fly to fit the property.

But that doesn’t mean you shouldn’t think outside the box. Since you have a solid plan going in, thinking outside the box is best for multiple exit strategies. Maybe you accidentally get into a property where high repair costs can’t be recovered from rental cash flow in a reasonable amount of time. Instead of doubling how long it will take to recover your costs, you can consider selling the property before a renter moves in (flipping). You might not make much of a profit but you can get right back into a house with better cash flow.

Another exit strategy that you can keep in your hip pocket is selling while a tenant is still in the house. You should at least run the numbers for comparison to doing another cosmetic repair before selling a vacant house. Buster, another cost problem some investors get into is doing too much costly rehab. A good exit strategy could be doing less rehab before renting and more rehab before selling. The thought is buying and rehabbing at investor costs for a rental but more rehabbing to sell at a higher retail price in the end.

Finally, maybe it’s time for you to consider growing your investment business now that you have experience. Since you already have two rentals, you can probably leverage your way into a third without selling the ones you have. But when you do this, you need to stop being a jack-of-all-trades. More houses mean more maintenance, more tenant hassles, and more administrative accounting. Even if you do the initial cosmetic repairs yourself, you may want to consider a property management company. You can factor in the management cost from the beginning to determine if you want to do this. Creating a new plan might be how you build a bigger rental portfolio.

Please share your comments about what you think will be successful in the evolving small investor rental market. Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to askbrian@realtybiznews.com.

Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 12 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, near a national and the Pacific Ocean.