Every weekend, I share a collection of articles that I’ve discovered over the course of the week, and it’s always interesting to see which article my audience clicks on the most. Last weekend’s most widely read article came from Jim at Route to Retire.
That popular article appears below, syndicated with his permission, of course. It’s all about how he did fairly well with a couple of rental properties, but after the better part of two decades, he’s decided to move on.
I’ve toyed with the idea of owning rental properties myself, but have instead opted for more passive real estate investments. If you want most of the upside with fewer hassles, I suggest checking out some of the top real estate investing platforms, most of whom I’ve invested with.
This post originally appeared on Route to Retire.
Owning Rental Properties Is Smart, but I’m Out, Jack!
That’s right, folks – after owning rental properties since 2003, I’m now completely out of the game!
In 2018, I sold the house I had bought as an investment property in 2003. A couple of weeks ago, we closed on selling the duplex we had purchased in 2015.
Here’s the weird part – if you’ve been following my blog over the years, you know that I’m a strong advocate of owning real estate rentals.
Each property can provide a solid asset, another income stream, and a hedge against the stock market. This can be truly invaluable for anyone on the road to building wealth.
So why in the world would anyone who values the benefits of real estate so much want to get out of owning rental properties?
Why I went down the path of owning rental properties
When I was in my early twenties, I found Robert Kiyosaki. I wasn’t exactly looking to start owning rental properties – essentially, I was trying to figure out how to get out of the rat race.
Although most people cite Rich Dad Poor Dad as the first Kiyosaki book they read, I actually started with a lesser-known one called Rich Dad’s Prophecy. That pulled me in enough to read some of his other books, including Rich Dad Poor Dad and CASHFLOW Quadrant.
Love him or hate him, these books were a real eye-opener for me. I didn’t think of them as a step-by-step directive, but rather more understanding that there are other options in life. Although working for someone else is fine for many, building wealth is more difficult to come by that way.
Real estate intrigued me, so I did some more reading on the subject. Then I bought my first rental property in 2003.
I was young and motivated but still stupid when it came to the subject of real estate. I didn’t understand the game or the numbers well enough when I jumped into it. Looking back, I made three big mistakes:
- I bought the house in a rough area (there was even a shooting right in front of it while renting it out).
- I had done some math to figure that if the rent covered the mortgage payment (with taxes and insurance), I should be good.
- The house was old – almost 100 years old. That made repairs and improvements difficult, especially considering I was never good at that kind of stuff.
Nonetheless, I got fortunate. Lisa and I lived there for several years while we worked on fixing it up. Eventually, we moved out and got renters in 2009… and somehow, they stuck around until 2018. Our cash flow wasn’t huge, but we brought in a little more than what we owed on the mortgage each month.
Once they moved out, however, we decided to sell the place. It was destroyed, and learning from my mistakes knew it wasn’t worth giving it a second round. We ended up selling the place at a loss, but it was good to be done with it.
Take 2… the duplex
In 2015, I got the itch to buy another rental property. This time around, though, I had experience under my belt and had read many more books on the subject to broaden my knowledge. I also was fortunate to have my financial mentor in my corner assisting me along the way.
Long story short, I was able to buy a 1967 duplex in a good neighborhood where all the numbers worked very well. Notice that all of those factors are the opposite of what messed me up on the first rental property. Not only that, but it was rent-ready with only a couple of minor tweaks that I could knock out myself.
The cost was $98,000, and I obtained a 30-year fixed mortgage for $73,500 at 4.75%. That made my total monthly payment $673.09. Expected rents were $750-800 per side (with one side currently filled).
If you’ve heard of the 1% rule of thumb when determining if the property is worth looking at, it essentially states this…
The one percent rule is a guideline frequently referenced by real estate investors when evaluating potential property purchases. This rule of thumb states that the monthly rent should be equal to or greater than one percent of the total purchase price of an investment property.
This property gave us a little more than 1.5% based on that rule, which I was more than happy with. As a bonus, because this is a duplex, that meant that even one side could cover the payment when I’d have a vacancy.
So I rented the duplex out from 2015 onward. It cash-flowed very nicely over the past 5+ years I owned it. Not only that that, but as I mentioned earlier, it’s nice to have a hedge against the volatility of the stock market.
Sure, I had some repairs and a few goofy tenant issues, but it went fairly smoothly, and my property management company handled a lot of that.
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If owning rental properties is so good, why sell?
That’s the million-dollar question, right? Owning rental properties can be a great asset to have in your portfolio, so why the heck would I get rid of it?
Well, the answer to that culminated from a few different factors. Let’s start with the minor ones;
Big expenses around the corner
One of the less joyful facets of owning rental properties is that you have to account for and keep up with capital expenditures. In the case of our duplex, a big expense that’s going to need to be addressed very soon is a new roof. It’s not leaking, but it’s probably about 20-25 years old now.
I never got as far as getting any estimates, but checking with a knowledgeable friend would likely run in the neighborhood of $6,500 to replace the existing roof!
It comes with the territory, but that’s still a huge chunk of change I wasn’t looking forward to letting go of out of my pocketbook. In all reality, I don’t even know what a pocketbook is!
Some repairs and renovation items were also in need. The windows probably needed to be replaced (single pane), and there were many other punch list items out there. I’m sure it goes without saying that as you spend money, your profit goes down. It’s got to be done, but it still stings.
Owning rental properties can be a headache!
I’m not going to pull any punches – although owning rental properties has some big advantages; it also brings some headaches along for the ride. I’ve always used a property management company to alleviate some of those headaches, but it doesn’t remove them completely.
I’ve never heard of a great property management company. And if you don’t spend time managing your property manager, things will slide… and not in your favor. That can be time-consuming and makes you wonder if a PM is even worth it.
I had tenants on one half of the duplex who didn’t pay rent for almost the entire 2020 year. Why? Because they could get away with it due to the moratorium on evictions during the COVID-19 pandemic. That was their sole reason for not paying.
They took advantage of the system, and it almost cost me almost a full year of missed rent. My property management company finally brought them to court, and we were granted an eviction. But the attorney they used was horrible, and it still didn’t end up happening.
In the end, it took putting the property up for sale and getting my agent involved to figure out what was going on. It turns out their lease ended last spring so that they could have been thrown out immediately—what a mess.
In the end, I was able to recoup most of the back rent owed through the county as part of the CARES Act. I could also cleanly get the tenant out and negotiate a deal with them, which let me keep their security deposit and get a cashier’s check for some of the money they still owed. I still lost about $2,400 (not counting late fees) because of it, but it could have been much worse.
Who needs this kind of headache? I’m getting a little older and don’t want to deal with stupid stuff like this anymore.
These factors in and of themselves weren’t likely to make me sell, though. The income and tax advantages we got from owning the duplex were worth those few annoyances. However, there was one thing that really tipped the scale.
Crazy, unexpected appreciation
Sure, the real estate market’s been hot – I think we all know that.
However, my duplex is an area where there are many multi-family homes like this… a real lot. Locations with many duplexes tend not to appreciate as fast as areas with single-family homes.
A lot of this is because, generally, your only prospects for buyers will be other investors. People don’t usually buy a duplex for themselves and other family/friends. That limits your pool of buyers quite a bit. So the market tends to appreciate a lot slower than other neighborhoods.
I knew that going in and was ok with that. I planned to hold onto the property for the long haul, and you should never buy a rental property simply in hopes of appreciation. Property values going up are just icing on the cake. The important thing is that the numbers work for renting it out, which of course, this one did.
But something strange happened.
The stars seemed to align, and interest rates have dropped to next-to-nothing during a seller’s market. That’s made for an interesting scenario for investors because they can obtain such low mortgage payments even with inflated prices, making the numbers work.
In my case, I ended up selling the duplex I bought only five years ago at $98,000 for $158,000. That’s incredible for a property here to appreciate so much, especially in so little time. That’s over a 61% increase in value in just 5 years!
This is one of those opportunities that may never happen again in my lifetime. And I’ve learned over the years to keep an eye out for these golden unicorns and jump on them when I see them.
So I did. We closed on selling the property just a couple of weeks ago.
So now what?
In the 5 years that we owned the property, I always paid a little more on each mortgage payment. I like to squeeze in what amounts to a little more than one extra payment per year since it reduces the loan by such a tremendous amount over time. That helped bring what I owed to the bank down to $63,017.10 when we sold.
Overall, we ended up pocketing $78,828.43 when all was said and done. That meant that we more than tripled our $24,500 down payment in just over 5 years. That doesn’t even count the profit we made from rental income or the benefit we had to our taxes (depreciation helped us show a loss most years).
Even though I consider that to be “good debt” since our tenants were easily paying it off, it feels weird (in a good way) to have next to nothing on the liabilities column right now. Most of you know that I use Empower to aggregate my accounts, and it’s weird seeing nothing but assets listed.
As for the short-term, I’m hoping to minimize capital gains on this win over the year.
I’m not a tax expert, but my accountant is, so I’ll be relying on him for help. A quick look at a capital gains calculator said that I could ballpark about $6,500 in tax, assuming we do a full Roth conversion this year and we bring in just a little bit of income.
But that’s if we do a Roth conversion. We started moving our money from our traditional IRA accounts to our Roth IRA accounts, utilizing a Roth IRA conversion ladder. By doing small chunks of money each year, we can minimize our tax burden. And then we’re able to freely pull that money from our Roth IRAs without penalty after 5 years.
We’re in a position, though, that we can skip this year’s conversion or only convert a smaller amount. That can help take the capital gains tax down to next-to-nothing. There’s also the possibility of doing tax-loss harvesting to offset the gains of the sale of the house. I haven’t done this before, but it might be worth digging into if needed.
Then there’s the decision on what to do with the money. $78,828.43 is a pretty nice chunk of change. I could double that up with some well-spent time in Vegas! Or not.
I think it makes sense to keep the money in real estate. For now, though, I’m considering putting the money into REITs. Although I lose some of the advantages physical real estate has to offer (like the tax advantages), there are many pluses (more liquid, more diverse, low to no headaches, etc.).
Down the line, maybe I’ll buy another property, but that’ll depend on how the market’s doing, interest rates, and if I really want to go down that road again.
I don’t regret getting into real estate. I’ve learned a lot over the years, and owning rental properties can be an excellent way to build wealth. It’s also nice to have investments not directly tied to the stock market.
However, I’m ready to take a break, and with the possible once-in-a-lifetime jump in appreciation on the property, this seemed like a no-brainer.
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[PoF: To make life easier, let I recommend allowing professionals manage your real estate investments, as I do.]
What do you think? Was this a good or bad decision to sell my last rental property?
17 thoughts on “Owning Rental Properties Is Smart, but I’m Out, Jack!”
Could you say more how the CARES act paid you for lost rent? (I know they provide funds for tenant and business assistance, but didn’t see any programs for landlords.)
I have always been hesitant to buy investment properties because of the ‘unexpected’ capital expenditures. When I think about our own home, there are so many costs that just come out of nowhere (new HVAC, roof repair, etc.) and it is scary to think of having that happen across multiple houses. I prefer REIT ETFs that pay good dividends. I know I’m missing out on the tax advantages of actually owning investment property, but I’ll trade that for the headaches that come with being a real estate investor.
Just my two cents 😉
You can have the best of both worlds if you look beyond REITs to other passive real estate investments. I now have 15% to 20% of my portfolio in a mix of equity deals and RE funds that give you both the tax benefits and passive income.
Thank you so much!!
So if I am reading this right, if my taxable income is 37K for the year and I sell a rental that I have owned for years and gain 300K, I would not have to pay federal cap gains tax on that? I did not know that!
To use the primary residence exclusion, you must have lived in the home for 2 of the previous 5 years. That allows you to not pay taxes on $250,000 in gains per person.
The other way to avoid capital gains taxes is to keep taxable income low enough, regardless of the source of gains or income. That’s a taxable income of about $80,000 for a married couple filing jointly.
This is exactly our plan – if we can keep our taxable income down for this year, we should be able to either avoid capital gains on the sale or keep them to a minimum.
I agree with so much of this because it reflects my experience almost exactly, down to the year in which I started renting out my first property (2003). There are a lot of rewards to be had as a property owner and landlord, but if anyone tells you its easy money, they are lying.
Whether or not you have a property manager, you should expect to put a fair amount of SOME sort of work into buying, renting, or selling properties to build your real estate empire. You should also be prepared for the worry and anxiousness that you will feel when you are in-between tenants or trying to sell that property. It’s like owning a ’77 Trans Am….enjoy the ride, but be prepared to get out and push a couple of times to get to the service station.
Haha, love the analogy! I think you nailed it here that there a lot of rewards, but it does take some hard work to do it right. I have friends that have built nice real estate portfolios, but they busted their cans to get there and they have a passion for it. If you don’t have that passion for it, it’s probably not the right investment to go with… I’ll stick the hands-off of REITs for a while!
Great decision to sell. I’m like you, there is much to be said for having NO LIABILITIES.
I struggled a little with selling an asset like this, but I’m glad I did. You’re so right on the liabilities – not having any is almost an asset in itself! 🙂
I enjoyed this as well, and congratulations on walking away with a tidy profit from the sale of your rental property.
I definitely agree that it can be a headache dealing with rentals even when they’re stabilized. I have one property in my portfolio with a non-paying tenant (likely due to Covid struggles). I’m sympathetic, but it’s tough seeing those mortgage payments going out every month without rental income to offset them.
It’s always nice to have an exit strategy, and it looks like you nailed this one. Congrats!
Sorry to hear about your non-paying tenant – that’s a hard position to be in, DD. I’m not sure if they’re still doing this, but banks were working with landlords to do a forbearance on mortgage payments during COVID if needed. I didn’t go that route, but it might be useful if the tenants continue to not be able to make rent payments.
Thanks Jim, great suggestion. I didn’t go this route because I can cover the payments and am still trying to keep my profile attractive to lenders for refinances and new loans.
Really enjoyed reading this post!
I’m obviously in the beginning of my real estate investing journey and there are no guarantees but I have been a big fan so far.
I think this post highlights two really important things.
1. That proper analysis is key as noted with the first property and
2. There will be some headaches so a strong mindset and a big why to pull you through are extremely important
I’m super excited about my real estate journey but also big respect R2R for following what was best for him and his!
Thanks, PPS – you nailed it on both counts. Best of luck on your journey with real estate! Even though I’m no longer in physical real estate, I’m glad I went down that path because I learned a lot in the process.