Most people seeking early retirement or financial independence have toyed with the idea of owning rental property. I’m a firm believer that rental income can be a great source of income, especially if you buy a property that cash flows from the beginning. One of our goals is to have rental income that can cover our basic expenses within a decade so that we can choose to retire if we want. So far, Jim and I own one residential property and one commercial one. We have a different strategy with each, and I’ll share some of the costs of owning a rental property.
Think About More Than the Mortgage, Taxes, and Insurance
Most people think that if rent covers the mortgage, taxes, and insurance, you’re in the clear. I think this is a good place to start, but also know that you will have vacancies plus rental maintenance and repair costs along the way. So far, our residential rental has done really well this year, averaging $319 in positive cash flow per month after all expenses. Considering that we bought this property for under $70,000, this makes me very happy.
We just had our first set of tenants move out, but got someone in right away without any period of vacancy. We are no North Dakota, but we do have a fair amount of workers coming in for Kinder Morgan and their CO2 operation, so decent rentals usually fill quickly. Often rentals do have months of no vacancy, so if you can’t swing the monthly costs without going into debt, being a landlord might not be for you.
Cost of Repairs and Maintenance
While our residential rental hasn’t needed much so far, we know that the furnace, washer or dryer, and windows could need to be replaced over the next few years. You also never know when a pipe might break or a roof might leak, so you have to be prepared for those expenses. We put all of our rental income in a savings account and have never spent a penny of the surplus on non-rental expenses. We have enough in there to take a nice vacation at this point, but we are saving for a rainy day, literally. I would recommend having a cushion of at least $10,000 if you are going to be a landlord. We could also use our HELOC if we had a big expense, but I really don’t want to go into debt that way, even if it is low interest.
Our Commercial Building Does Not Cash Flow!
If you remember, we purchased the commercial building that houses my old optometry practice at the end of 2013. We didn’t get a traditional mortgage, but did a seller finance with the former owner. As a result, we put the loan on a six year term, which is kind of insane for a commercial investment. As a result, the rent almost covers the payment each month, but comes up $4.77 short. We also have to pay for other expenses out of our own income or savings at the moment.
We have a huge expense coming up next month with replacing the furnace and adding an air conditioning system. The former owner was not into repairs unless something did not work at all. The current system is OK, but not efficient and not cool at all in the summer. I decided to make the upgrade now while we have the savings to do so. I know there will probably be a large plumbing expense sometime in the next decade, but after that, the building should be in good shape to sell or continue renting for as long as the practice wants to stay there.
I would normally never encourage anyone to buy something that doesn’t cash flow, but the huge appeal of this deal is that we own it outright in about 5 and a half years. If the tenant stopped paying, it would certainly hurt to have to cover the mortgage ourselves, but we could cut back on other things if we had to. Hopefully it won’t come to that, but it’s something you need to always consider when thinking about rental property.
Our commercial investment will be very solidly in the red this year and probably for the next few years. I’m OK with it because it helps our taxes and is building huge amounts of equity for the future. Some people might think that’s crazy, but I guess that’s the way we roll sometimes.
How Much Money Do I Really Need To Be a Landlord?
I know these numbers seem daunting. Coming up with a 20% to 25% down payment plus banking an extra $10K for emergencies is a lot of money. I know there are many big time property investors who never have this much cash on hand and keep leveraging investments to buy more property or make repairs. If that strategy works and you’re comfortable with it, by all means, do it.
My rental posts will always be geared toward the more conservative investor, someone like us who is looking for multiple streams of income, but not willing to put all eggs in the rental basket. I do believe you need to have at least this much in cash before buying a rental property. I don’t like the whole house of cards that having several properties that are leveraged to the hilt creates. I never really worry about our rentals because we are conservative with them and have enough money to cover expenses if our tenants bail. Losing sleep over needing a tenant yesterday is not a road I want to go down. If you don’t have the money, you can always invest in a REIT fund.
Being a landlord can be a wonderful experience if you do it the right way and don’t over extend yourself. Before you leap, always consider the costs of a rental property that might not be apparent at first and be ready for anything. We haven’t had a meth cook yet, but I think we’re prepared for whatever comes our way.
Would you buy a property that didn’t cash flow if it meant greater returns down the road? Any rental horror stories to share?