California E&S Insurance

My experience buying, owning, managing, and selling a single family home rental property A number of years ago I wanted, nay, I needed to do something to accelerate my time to being financially independent. This was basically me trying to turn frustration into something productive. I ended up looking into buying rental property. When I was initially considering buying a rental property, I had an easy time finding a ton of people trying to tell me what to do, but a hard time finding actual examples to think about myself. So I guess I'll post my experience in the hope that it's useful for people thinking about rental property as a source of income! ## Phase 1: Searching for properties I spent over a year watching properties before I finally pulled the trigger and bought one. What I did during that time was spent time researching neighborhoods, attending classes on how to be a landlord provided by a local non-profit that mainly covered federal, state, and local laws, and making sure I understood the local residential rental market sufficiently well to convince myself I wasn't tossing money out the window. As part of my search, I developed [this spreadsheet (note: I just converted this from an Excel spreadsheet, there might be minor formula errors in it)](https://docs.google.com/spreadsheets/d/15D5l6Xkyo8Acs9LLZ99RkvZd2JVosPaduxAMumFewJQ/edit?usp=sharing), which gave me a chance to make sure I understood roughly what I was getting into, and also let me compare potential residential property purchases easier. The basic concept was I was comparing the total cost of ownership (purchase, maintenance, PITI, selling costs, income) against a hypothetical 8% investment return if I just invested the money in the market. If a property on paper could beat that fairly high hurdle, I would consider purchasing it. What was a bit frustrating was the number of variables that went into my spreadsheet, few of which I had control over. In general, my approach was to underestimate expenses and overestimate things like vacancy rates. Other factors I considered included things like distance from home and work, and general neighborhood feel and quality. All in all, I evaluated 36 rental properties before purchasing one. 4 duplexes, 2 quadplexes, and the rest single family homes. ## Phase 2: The purchase and initial updates I ended up purchasing a 3br/1ba single family home on a short sale (the one in the linked spreadsheet above) for $175,000. One interesting note here was that the seller's realtor was doing the work pro-bono, and I used a real estate lawyer to purchase, so the total cost of the transaction was $900. There were many things to remedy, so I had saved up about 2 weeks of vacation and my plan was to take all of my vacation and remedy everything I could reasonably do for $5k. This turned into 2 60-hour weeks of work, and then 2 more weeks of 20 hours each (in addition to my normal work week) to get everything in shape for renters, and that wasn't even including the time my wife spent helping me. Basically every surface was modified, including drywall, carpets, refinishing wood floors, refinishing cabinets, refinishing wood trim, and many other minor repairs. The mortgage I was able to get required 25% down at 4.5%, so a down payment of $43,750. Since I immediately had to put $5,123 into it, this meant my immediate investment totaled $48,873. ## Phase 3: Landlording My process for evaluating potential renters included background checks, calling previous landlords, verifying employment, and meeting the renters in person. I had 2 landlords with decades of experience that I met through some of the earlier mentioned landlording classes that helped me decide on renters. The main lesson I learned here is that no matter how careful you are, you won't be able to avoid all potential problematic renters. I had 3 renters in the ~3.5 years I ended up owning the place, and there were issues on some level with all of them. My rent started at $1630 the first month, and increased slowly over time. I ended up owning the property for just under 4 years total. Here are the numbers from that time: | Year | Rent | Principal | Interest | Tax&Ins | Maint | Improve | Deposit | Cash Flow | Net Income | Hours Spent | |------|--------:|----------:|---------:|--------:|-------:|--------:|--------:|----------:|-----------:|------------:| | 2016 | $9,780 | $1,046 | $2,943 | $2,459 | $0 | $5,123 | $0 | $3,330 | ($745) | 248 | | 2017 | $19,560 | $2,166 | $5,814 | $5,417 | $750 | $0 | $550 | $5,962 | $8,128 | 47 | | 2018 | $20,040 | $2,264 | $5,715 | $5,730 | $1,100 | $0 | $0 | $5,223 | $7,488 | 59 | | 2019 | $18,370 | $2,167 | $5,147 | $4,760 | $750 | $35,111 | $2,400 | $2,934 | ($30,009) | 342 | To be clear: * Cash Flow = (Rent + Deposit) - (Principal + Interest + Tax&Ins) - Maint * Net Income = CashFlow + Principal - Updates Net Income isn't really useful, the improvements column wasn't something I could deduct immediately, improvements are basically treated as new investments that start depreciating on their own schedule, so I could only start depreciating a small fraction of them. Tax&Ins in the above table is just the property taxes. Income taxes were more complicated. Here's another table for it: | Year | Cash Flow | Bracket | Depreciation | Income Taxes | Carryover | |------|----------:|---------:|-------------:|-------------:|---------:| | 2016 | $3,330 | 28% | $3,872 | $0 | ($572) | | 2017 | $5,962 | 28% | $4,079 | $367 | $0 | | 2018 | $5,223 | 24% | $4,079 | $274 | $0 | | 2019 | $2,934 | 24% | $4,435 | $0 | ($1501) | Note that the "Carryover" for 2019 is going to be subtracted out of the 2019 tax bill a bit later. ## Phase 4: Selling I decided to sell late in 2019 and managed to close before the end of the year. There were significant repairs made prior to the sale which I was allowed to deduct, and proceeds from legal action. Hey, how about another table (edit: I borked this table somehow, falling back to lines of text): Sale Price $248,500 Realtor Fees $14,910 Repairs/Imp $35,111 Net Legal $3,600 The adjusted cost basis for the property given the depreciation and repairs/improvements is $198,769. The adjusted sales price minus the realtor fees is $233,590. This means that I have $33,320 in capital gains after subtracting the remaining carryover from 2019. So my total taxes due are the capital gains at the capital gains rate, and depreciation recapture at my top federal rate capped at 25%, or: ($33,320 x 0.15) + ($16,465 x 0.24) = $8,949. There are various other modifiers to that tax bill, for example, I finally had unrented time, and there were other small deductions I could make that I'm not going into here, that bring my bill for 2019 to $8,455. This means that after the entire sale process, I netted $24,865. ## Phase 5: Totals and comparison against total market over the same time period OK, so how did I do in total? I ended up making $45,914 on my initial investment of $48,873. Woot. If you remember from way back at the beginning, my hypothetical threshold was comparing the money I invested ($48,873) at a hypothetical 8% investment return. I'm not including the second round of improvements because they were basically put in place immediately before selling. I could also compare against how the market actually did over that same time period. OK, let's do all of the above. I bought the place in April of 2016, so we're using April 1 as the start date, so the first year was only 3/4 of a year. I sold a few days before the end of 2019, so I'll count 2019 as a full year. * If I invested $48,873 @ 8% APY, I'd have $62,260 * If I invested $48,873 in VTSAX, I'd have $81,618 * If I bought the property I did, I'd have $94,787 So I actually outperformed the crazy market over the past almost 4 years. The thing I haven't added in though is the 696 documented hours of time I spent working on the property and things related to the property. If I were to value my time at $20/hr, I'd underperform VTSAX. Yikes. I haven't actually filed my taxes yet, I got an actual tax professional to help me through this year's taxes, so the tax numbers are estimated but should be pretty close to the final values. TL;DR: Buy VTSAX

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