Part I and Part II of this series began the tale of my
odyssey as a real estate investor ultimately leading me to believe dividend
stocks were a superior investment vehicle.
Real estate looks easy on paper.
Unfortunately, you have to manage the property which entails more than is
captured on paper. The landlord part of
the equation is one a prospective investor should not discount! The tale continues…
Spreadsheet models built and analyzed. Check.
Financing secured.
Check.
Property selected and purchased. Check.
Kick back and watch the rental income arrive in torrents,
right? Right?
The venture started well.
It didn’t take long to get a renter lined up. The fellow paid cash from his construction
business and was consistent with his payments.
Consistently late. I tolerated
this for about 18 months, then let him know he needed to change his payment
ways or move along. He moved along.
From then on, renters departed at the end of every 12 month contract. The rental market was declining and renters
could find more economical rentals at every turn. Not only did my turnover rate meet or exceed
my expectations, but the price at which I could re-rent the property declined
with each transition.
Turnovers required more repairs and refurbishment than
anticipated. Complete carpet replacement
because the renter changed the oil on his motorcycle in the living room;
repaint to mask the smell of pets or cigarettes; plumbing issues from
water-soaked bathroom floors or leaky pipes in the wall to leaking water
heaters were not uncommon. Several of
these issues were non-trivial. In total,
the frequency and scale of expenses was well above my originally “conservative”
estimate.
Adding insult to injury, it was an hour round trip to the
property to address these issues or show it to prospective renters who, often
as not, would no-show the appointment. Did
the $35,000 operating abyss include time spent traveling to and fro? Nope.
That’s frosting on the cake of economic loss.
Costs were mounting.
Valuable time was consumed. Net
profit had evaporated. But I still had the
tax deduction, principal pay down, and property value appreciation going for me. Can I get an Amen? Didn’t think so.
The tax savings piece was in play because of the almost monthly
cash deficit. Coupled with the
depreciation expense, the tax savings component was playing out better than
anticipated. Negative cash flow will do
that. However, the tax savings showed up
once a year while cash losses could be monthly depending on the status of the
rental i.e., rented, in transition, under repair, etc.
The principal pay down worked only during the months in
which rent was being collected.
Mostly. Unfortunately, market
conditions were sliding and rental rates were going south. At one time, market rents were down nearly 35%
from where they opened when the property was first acquired. This meant rental income was no longer
covering the full bank note, let alone expenses. The equity bucket was being filled by yours
truly as much as by renters.
Surely you’re thinking the property value appreciation was
making up for the rest, even if it wasn’t compounding at 5% annually. If so, that would have helped the ROI, at
least on paper. Even if it had it wouldn’t
have resolved the negative cash flow. But
even that wasn’t the case. The reason
rental rates were tanking was because the market as a whole was collapsing. In fact, the value of the property dropped by
nearly 25% from its purchase price.
To be brief, the net profit (cash) was negative, the principal
pay wasn’t materializing, and the property value appreciation was off the
charts on the down side. The only thing
working out well was the tax dodge component because of the continual
losses. That’s not how you want to operate
a rental property, business, or even your dog’s budget. So why not exit? Ahhh, the sweet spot is next.
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