Years ago, I read a bestselling book by a famous author who defined a profitable investment property by its price at purchase. I could never really understand how one could know at the beginning of the investment whether or not it would be profitable. Of course, the author was making a point that if you pay too much for an investment; chances are you’ll never make a profit from it when you sell it.
But, is that it? This author’s perspective seems to be missing something important. It doesn’t consider the investor’s impact on the profitability equation from the day he or she invests in a property until the day the property is sold. Does the investor/landlord influence tenant compliance in a prospective manner or only react when there is an issue? Are the investor’s rent rates competitive? How does the investor ensure that expenses are kept to a minimum? All these activities have a major impact on month-over-month profitability from the date of purchase to the date of sale. When you consider that the average real estate investor doesn’t “flip” investment properties but rather he or she keeps properties for many years; month-over-month profitability probably has a significant impact on what that person perceives as return on investment.
For instance, compare what happens to John with what happens to Ken, both age 30. Both have $50,000.00 in savings towards retirement. Each takes $30,000 and purchases a rental house for $130,000.00. Twenty years later, both investors sell their respective properties. According to the author, the return on investment for John and Ken should be equal. But, let’s dig a little deeper…
What follows is John’s experience during the first two years of his investment:
• He sets what he thinks is a fair rent rate ($1,400.00/month) according to what he finds on Craigslist one day.
• He receives a tenant through a referral, likes the candidate and decides to rent to the person by trusting his gut.
• He enters into a 12 month lease agreement using a free lease template from the web. He asks for a deposit of $200.00.
• He receives rent through a PO Box. When his tenant doesn’t pay or pays late (every other month it seems), he drops by the house and asks again. Sometimes, this works and sometimes it doesn’t.
• John’s tenant doesn’t do grounds care as promised during the interview. There is nothing in the lease that addresses this issue and John is hesitant to enforce their “verbal agreement”. So this issue doesn’t get resolved.
• The county assessor decreases the value of John’s property to $122,000.
• At the end of the first 12 months, John is busy so he doesn’t do anything about the lease, which reverts to a month-to-month agreement.
• The tenant decides to move after 18 months of tenancy without paying the last month’s rent or giving proper legal notice… NOT GOOD!
• John is still busy at work and forgets to send out a summary of deposit moneys within the required time period. The ex-tenant takes John to Small Claims court and leaves with $200.00… John has to pay court costs.
• In parallel to preparing for the court case and keeping up with his responsibilities at work, John gets started with the turn. He estimates that it will cost $1,825.00 in labor and supplies. He can’t afford to pay someone else to complete the turn, so John does the work himself, and it takes him three months.
• After three months, John begins to advertise his vacancy at $1,200.00/month on the internet and receives a HUGE response…no kidding!
• After a day of interviews, he is tired and so chooses his second tenant based on his gut…here we go again.
Let’s find out what happens to Ken:
• He sets what he thinks is a fair rent rate according to a formal rent rate analysis ($1,895.00).
• He develops a standard for tenancy and a process that he applies to all prospective tenants. He decides to rent according to his predetermined standard to the person that completes his process first.
• He enters into a 12 month lease agreement using a lease form that is based on current municipal, county, state and federal laws, and covers all of his tenant’s (and his) responsibilities. He asks for a security deposit of $800.00.
• He uses a billing service that invoices his tenant on a monthly basis while he receives payments at his PO Box. His plan for responding to nonpayment is to begin a process to evict right away. His tenant tests the system – once.
• The grounds look beautiful! The county assessor increases the value of the property to $138,000.00.
• At the end of the first 10 months, Ken is busy at work, but wants to ensure that he isn’t surprised by a move out in the next three months. So, he begins to communicate with his tenant about options for staying or for leaving. The tenant decides to enter into a new 12 month lease with a minimal ($15.00/month) increase that covers the change in Ken’s insurance premium. At the end of the first 12 month term, Ken can count on this revenue stream for another 12 months.
Assuming that the cost of PO Box rentals, hourly rates for attorneys, and insurance premiums – the value of the investor’s time, gas and missed work are equal; let’s compare where the investments of John and Ken are after two years…
Not only is the bottom line impacted but maybe even more importantly, how and where the investor’s time and quality of life are impacted for two years.
Fast forward 20 years (when Ken and John are both ready to sell and retire), if they each continue down the path they’ve begun, John will have profited approximately $122K while Ken will have profited approximately $352K! And, in terms of the quality of where and how they’ve each spent their time, well…
The moral of this story is just this — identifying the methods for managing real estate investments that are based on the individual investor’s values and principles, then implementing them – whether doing it all, hiring someone else to do it all, or utilizing experts to manage those areas of property management where the investor does not have expertise, interest or time – really does have an enormous impact on that property’s value to the investor from the date of purchase to the date of sale and every day in between.
Kathleen Wilcox, EMBA is a principal at Lamplight Enterprises, LLC. Lamplight Business Services, a division of Lamplight Enterprises, LLC, provides concierge-style business support services to real estate investors who own and manage real property to help them achieve greater profitability month-over-month and long term ROI.
For more information about Lamplight Business Services, please contact 206.779.5231 or [email protected] or visit www.lamplightnw.com.