Want To Own Rental Properties? Ask Yourself Four Questions First
This article was originally published on the Forbes website.
Owning real estate to build wealth is a tangible dream for many investors: They figure they can find a broker, buy a few properties, sit back and collect rents. Or perhaps they could flip properties for a quick profit. But the reality of owning rental properties and trying to sell them at a gain is far different from the dream. Being a landlord is much harder and riskier than it seems.
Many property investors start out thinking they can manage their own real estate investments, overlooking one simple fact: the skills that brought them wealth aren’t likely to bring them success in real estate. Being a banker, lawyer, doctor or other business owner gives them the funds to invest, but not necessarily the knowledge to make sound decisions about those investments — let alone the time and know-how to execute. As Bill Gates once said, “success is a lousy teacher. It seduces smart people into thinking they can’t lose.”
Eventually, many property owners end up hiring advisors, property managers and other experts — or they get out of the business entirely. The reasons why can offer valuable lessons for investors who aspire to be landlords. Anyone seriously considering direct investment in real estate should make a frank assessment of their qualifications and ask themselves the following four questions:
- Do I have the expertise? Owning rental property requires you to be educated in the intricacies of direct investment, and first and foremost is valuing real estate correctly. Assessing your ability to buy and manage an asset means thinking about every scenario that could impact its value. Are you qualified to do this on your own — from making bank payments and collecting rents to handling maintenance and repairs? What will the overhead cost you? If you don’t know the right questions to ask, then you aren’t qualified to do this on your own. What’s more, if you’re not a seasoned investor, you’ll likely be bidding for properties against others who are.
- Do I have the money? Ostensibly, maintaining a rental property on your own allows you to cut costs. But it can still end up costing many dollars. Acquiring and improving a rental property is capital intensive. While you may be able to buy a property, can you build a portfolio of properties without taking on too much risk? Taking out loans can expose you to acute risk, as a recent Brookings study notes. Inexperienced investors typically lowball their expense projections and paint a picture around income projections that is far too rosy. They’re brought up short when tenants give notice, maintenance is deferred too long or urgent repairs pop up. If the venture doesn’t go as planned, the cost of a turnaround can be sizable. With only one or two properties, it’s hard to fall back on other income streams. You may need to borrow money to keep the property competitive.
- Can I find good property managers? An underappreciated aspect of hiring for rental property expertise is how hard it is to find good property managers. A property management agency assigns its best people to its best clients, and it’s hard to be a top client if you own one or two properties. As a result, a property investor with a small portfolio may be taking a chance on untested or sub-par performers. Turnover is on the rise too, especially among on-call maintenance personnel. An established firm will likely be better at recruiting, supervising and retaining talent. Even so, landlords will find distinct differences between managers of large and small properties. If you’re dissatisfied with your property manager, better options may not be at hand.
- How much is my time worth? Buying and owning rental properties successfully requires constant focus, which is difficult for anyone as a sideline or hobby. Managing an asset is a distraction that takes you away from other business or personal interests. What will you be giving up by spending time on real estate activities? Instead, you may end up paying a caretaker, property manager and trade workers to take on time-consuming tasks. Are the fees and your time managing the manager worth it? Even so, don’t underestimate the time it will take to manage the managers. Even that job may be more than you bargained for. If your goal is to learn the business, have a serious avocation or a combination of both, then owning and managing your own rental properties will work for you. If your goal is to maximize your investment dollars, there are better ways to do that.
Alternatives To Direct Investment
Generating rental property income is a high-overhead business. It’s my belief that the idea of earning passive income by owning rental property directly is an oxymoron — the need for active management of the property will make itself clear very soon. While the potential for gain is great, management costs and other fees often strip away those benefits.
I tell friends that if they’re not willing to go all in on an investment property and actively manage it full-time, they’re better off putting their money in the public markets or private equity funds. However, if you can’t find good real estate managers to generate passive income or stomach the volatility of the public markets, it’s better not to invest at all.
Those of us invested in private equity know the pitfalls of direct investment. In a competitive market, it’s often true that someone else can do it better, so shop around for the best investments.