34 minutes | Aug 14th 2020

82 – Are Rental Homes a Good Investment

Click below to listen to Episode 82 – Are Rental Homes a Good Investment? Are Rental Homes a Good Investment?

Learn about the top 10 risks associated with rental property income.

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What’s the other side of the story to all of those remodeling shows? You see the happy couple working hard to update a property for a vacation rental home in order to make a little bit of extra income. Sure, there are benefits to flipping a house or property for rental, but you never hear about the downsides. Have you ever thought about why there are always hundreds of vacation property resales in the most beautiful vacation spots?

People like the idea of having rental property as investment income because it’s a tangible asset that you can see, feel, and walk around. However, many times, the risks far outweigh the benefits, especially if you are looking at rental property as a form of passive income. Instead of a rental property making money for you, you can actually end up losing money.

There are many risks associated with rental property income, and Bob covers the top 10 risks of vacation rentals and home rentals in this episode:

  1. Maintenance and Repair Risk
  2. Renter Risk
  3. Income Risk
  4. Liquidity Risk
  5. Tax Risk
  6. Location Risk
  7. Time Risk
  8. Market Risk
  9. Weather RiskLongevity Risk

GUEST: Bailey Theaker
HOSTED BY: Bob Barber, CWS®, CKA®

Mentioned In This Episode CIS Wealth Management Group Website Bob Barber, CWS®, CKA® Bailey Theaker

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EPISODE TRANSCRIPT

[INTRODUCTION]

Welcome to “Christian Financial Perspectives”, where you’re invited to gain insight, wisdom and knowledge about how Christians integrate their faith, life and finances with a Biblical Worldview. Here’s your host Christian Investment Advisor, Financial Planner, and Coach, Bob Barber.

Bob:
Welcome to today’s podcast where we’re going to be talking about rental homes, and is that a good investment? And it really depends on a lot of factors. One of the things is, with all the TV programs, I know in my family, we have HGTV showing constantly. My wife loves it, or the DIY Network. And we see all the beach, front properties, and we love watching these and it gives us ideas. But one of the things that you’re always hearing is the good side and the positive side, and I’m a positive person. I like that, but when it comes to actually putting money in real estate, I think both sides need to be explored. And we’re going to explore that today. I have a new person that I’m bringing in on the podcast with me. The Lord sent her to me. Her name is Bailey Theaker. She came over here from Houston to New Braunfels, and I’ll tell you what. It’s really cool how the Lord brought us together. Her husband and her are starting a church in San Marcus up at Texas State University. When Kirsten, who worked here for so many years as our office manager, was going into the ministry and Bailey, you’re not coming out of the ministry cause we’re still in ministry here. So, tell us about that. I want to hear about that. Because our listeners have heard probably maybe 20 of our podcasts, or even 50 of them.

Bailey:
Yeah. Well, I’m so grateful to be here. I worked in a church on a church staff for around five years doing student ministry and worship and things like that, as did my husband. We both worked at the same church, and this past year, God called us to be a part of a church plant in San Marcos. And so, we picked up everything and moved here about two months ago. And we were really praying for a role for me because I knew that I wouldn’t be working full time for the church. This role kind of came out of nowhere, it felt like, and we had a lot of people praying for it. And then I interviewed with you, Bob, and with Kirsten, the old office manager. And you said during that interview, I feel like the Holy Spirit’s telling me to hire you, and I just cried on the phone. I’m grateful to be here.

Bob:
Well, I tell you what, it wasn’t but about five minutes into, and the Holy spirit was just hovering over me and saying, you better hire this girl – lady. I’m the old guy here, remember. You’re about the ages of my daughters. So you’ll end up becoming like a daughter to us. But one of the things was you’ve listened to the podcast and you made a comment to me, I guess, about three weeks ago. And I remember, and it really struck me. You said, Bob, you’re always interviewing others when you’re the expert.

Bailey:
Yeah, that’s true.

Bob:
You said, you need to be interviewed. I was like, well, that’s true. And a long time ago when I did my radio program for eight years, I had Renee Broughton here, and the Lord took her home. She had brain cancer and the Lord took her home, but she used to act like the person that’s listening today. I want you to do that because the person that is listening to our podcasts, they’re listening to gain insight. I want you, when you’re joining in on the conversation with me, I want you to think about, well, what’s that person who is in the car driving or right now they’re taking their walk and they’re listening to our podcast maybe on their smartphone, what would they ask? What would they think? I’m thinking that all of y’all that listen to the podcast, you’re going to like that because maybe, sometimes you’re like, well, how about this? So you just think of that.

Bailey:
Yeah. Well I’m young, I’m 26 and I just feel like I’m a sponge while I’m here. There’s a lot of things I don’t know. There’s a lot of things I want to learn about and want to know. And that was why I asked the question about the podcast earlier was I just thought, Bob, you’ve got a lot of good things to say. I would love to just sit down and ask you some questions. And so I’m going to have a lot of questions.

Bob:
Thank you. Thank you. Well, so we’ll get into today’s subject, which is about rental homes. Are they a good investment? And it really depends. I always like to start off with a scripture. I start every podcast with the scripture and this is the scripture for today that I want all of you to think about is Luke 14:28, “But don’t begin until you count the cost, for who would begin construction of a building without first calculating the cost to see if there is enough money to finish it.” And I’ll tell you, think about that scripture. And today, I think a lot of people, they go out and they buy real estate very quickly. They’ll buy that vacation home on emotion. They’ll buy that rental home because all they’ve heard is the good side of it. And there are a lot of pluses and there’s benefits. We’ll talk about a few of the benefits, but no one ever talks about the risk. I guess that wouldn’t be too popular on a program.

Bailey:
Yeah. I’m with you. I watch those HGTV shows all the time too. And it just looks glamorous and easy and like a walk in the park to just buy a house and rent it out and make all the money you can on it. And so I’m interested to hear what the other side of that might be.

Bob:
What are some of the benefits? What would you think? Because you’re watching these programs all the time, kind of like me. Think about the person who is listening to us today. What would you see as some of the benefits of buying a home? What would you think of immediately?

Bailey:
Sure. I would think of income first and that that would be the best way to make some income.

Bob:
The possible passive income, of course, real estate here in Texas seems to do nothing, but go up, up, up. So there’s appreciation that you would get. Another thing is, is like when people buy stocks or mutual funds or ETFs, they can’t feel it. They can’t touch it. Do you like to go home shopping? Walk into the houses? So that’s another thing, I think, people really like. You get to see it. You can go into a home that needs remodeling and you can picture, well, that needs new cabinets and that needs a new floor. You can see the before and after pictures. By the way, what’s one of your favorite programs that you watch on HGTV.

Bailey:
I like watching “Flippers”, and I will say with the rise of Pinterest and things like that, it makes DIY projects look so easy. Like, Oh, you have some wood laying in your backyard. You can rebuild the whole wall. And so, it just makes everything look so easy. And so that would be appealing to me in buying a rental property. It’s something that you could flip. And that looks really, really simple because you can do everything on your own now. But I wonder if it’s actually as simple as it looks.

Bob:
No. Things are never as simple as they look, believe me. I know from years of experience in that. My favorite is “Love It or List It”. The poor guy that goes and shows all the homes to them, it’s like 90% of the time he loses because they’re always going to love it. And you know why they love it. Have you ever thought about why they love it? I think it’s because of all the staging. They make everything so beautiful. Here he’s going and showing them all these houses while his partner is fixing this house up, and she puts all the white pillows and the white – everything’s white, by the way. Have you noticed that? They have four kids and are making everything white. That’s crazy. You’ve got two teenage boys and two toddlers coming up. Come on. But they do. I think people get caught up in that. And that’s why they always go, well, we didn’t think our house looked this good before, but I think we’re just going to love it. And the poor guy, he goes, I showed you five houses. One of them you love. I saw one the other day where it was like double the square footage. It was a nice, it had everything they needed, but they loved it. They didn’t list it.

Bailey:
Chip and Joanna Gaines, their show is wonderful. But even when you walk into their section at Target, I think I want to buy all of this, but I can’t. And so if our houses look like that, then sure. Yeah, I would rent that.

Bob:
We went up to Waco one day and went to their, I call it, their Disneyland where they have all those silos. It was amazing. I couldn’t believe how many people were there, food trucks, and everything. Have you been to it?

Bailey:
I have, yeah.

Bob:
Did it feel like a little Disneyland?

Bailey:
Oh, it’s magical.

Bob:
Another thing I think when people think of rental properties, they also think of vacation properties, and there is a benefit. We’ve had a couple vacation properties ourselves, knock on wood. I’m going to talk about the risks today. I got caught up in the emotion. I’ve done it. And it is a great place to build those family memories. We really thought we were going to do that. And then we’re always asking the kids to come down and they’re like, Oh, I got something to do this weekend or I’m busy this weekend. And I was finding that we had these beautiful vacation properties. We had one. We sold it, and we bought another one. And the last one we had was in Rockport. We sold five months before the hurricane came down there. So, I’m glad of that. But the kids came down like once or twice. So, we weren’t building those family memories like they always show you on “Beachfront Properties’. So those are definitely the benefits, but there’s also a lot of risk associated with owning a rental home or vacation home, plus all the costs if you finance, and I’m going to show you, this can really result in negative cash flow even with a 95% occupancy rate.

Bailey:
Sure. Yeah. And Bob, you’ve had the experience of being on kind of every side of this. You’ve been the financial advisor for people who are looking at rental properties, but you’ve also owned a rental property. I have assumed that you’ve rented things from people as well. And so you’ve kind of been on every front. So having done that, what would you say are the top risks for somebody looking into investing?

Bob:
Well, the main risk that I see besides just financial, but it does play in the financial is the maintenance and repair risk. That’s number one. And I’m going to be going through 10 of these risks. I do want to mention, today from the podcast, like always, you’ll be able to go to Christianfinancialpodcast.com and get a list of this because after today, that rental home that you’re thinking about buying – or vacation home – you may want to think differently after you hear, but the maintenance and repair risk. If you’re not skilled in carpentry skills, electrical, and plumbing repairs, it can be really costly. It’s costly to remodel, and it can be costly to keep up. The wear and tear on rental properties is constant. Now, if you have the skills to do it, that’s fine. But I tell you, when you call the plumber to come to your house before he even shows up, he says, I want a $100. Skilled labor today is one of the the highest paid professions. I’m starting to notice. I sit there in my church every year and I see all of these graduates come across, and they’re all going to college and then maybe one will come across that says, I’m going to be an electrician. I said, that’s going to be the rich one of the bunch. They’re all going to be hiring him to come. So that’s one of the risks is the maintenance and repair risk. Another one is renter risk. I just don’t think renters are going to take care of a property the way that the owner would. We saw that in our vacation condo that we had in Rockport. We couldn’t believe some of the things that we found. I told you some of those stories and I’m not going to share those stories here. I mean, it was crazy. And the things that went on while we weren’t there, and we had our neighbor telling us, too, “Do you know some of the things that are going on in your condo while y’all are not here and you rent it out?” I said, no. And they started to tell us, we’re like, oh no, we’re sorry. We did not know that. This is supposed to be our vacation home. It meant a lot to us. Now, if it’s a rental home, and it’s not your vacation home. You may feel a little bit different, but still you own it. And they’re not going to take care of it the way that you do.

Bailey:
We haven’t yet purchased a home – me and my husband – since being married. We’ve only lived in rental places. I’ve always said, why would anybody buy a house? Because if my dishwasher breaks, I just call the landlord and say, hey, come fix this. But I could imagine how those things would rack up with all the things that you have to take care of. And not only your own house now, but the house that you’re renting to somebody else.

Bob:
The water heater can go out. You have a hailstorm come through or a big wind storm blow all the shingles off. And now, you’ve got to go out and repair the roof. Now a lot of people are listening. They’re going, well I’ve had a rental home and I haven’t had any of those things happen. Well, I hate to say this, but just wait.

Bailey:
Yeah. And usually they all come at once. I hope you have a good savings account.

Bob:
Have you heard the old saying when it rains, it pours, especially here in Texas.

Bailey:
Well, Bob, I know that we live in kind of a new world with coronavirus right now. And so I’m wondering, are there any risks that are kind of multiplied because of what the new world we live in looks like.

Bob:
So this is the third risk of our 10 risk is the income risk. And right now with these COVID-19 laws, do you realize that you can just say, well, I’m not gonna pay my rent. And the law is going to stand behind you all the way until the latest here, I wrote this down, was til August 31st. So, they can not evict you. So you’ve got people that are renting a home to someone, and if the renter can’t pay the rent, you can’t push them out of there. And you wouldn’t want to, maybe it’s a family. You don’t want to do that to them. But what if you have a mortgage on it. Now, this really applies to those with mortgages like landlords with single family properties, with an FHA insured or Fannie Mae or Freddie Mac back mortgage, that these are the ones that cannot evict the tenants. They’re the ones that need to the most because they have these payments. So, if the tenants are not paying you, what’s happening, and it’s coming out of your savings. So, you better have a lot of cash reserves. You have that income risk, also that risk of income. Renters, they move around a lot. Maybe they’re looking to buy a new home or something like that. So maybe your normal renter’s going to stay in there for two years, three, or maybe just one. But during that time, like I’ve experienced here as an owner of the building that we make our podcast in. During that time, when a renter moves out, now you’ve got to find another renter, and there may be a month or two. You’re getting it cleaned up. You may have to go in and do some repairs where you’re not making anything.

Bailey:
Sure. I would think that that would be similar, too, for vacation properties, that people aren’t going on vacation as much right now, because flying is a scary thing. And or when things, like you said, you sold your home in Rockport before the hurricane, but I can imagine the people who didn’t. I mean, they’re losing that income, too, if anything ever changes.

Bob:
Yes. Well, we’re going to talk about that one. That is another risk on our risk of 10. So far, we’ve gone through maintenance and repair risk, renter risk, and income risk. Then, there’s a liquidity risk. People, they don’t think about that because in a good market, real estate is pretty easy to get rid of, but it’s not considered a liquid asset. In a weak market, it can take a good while to sell a home. And everybody’s thinking, when have we ever had a weak market? We have. We’ve had weak markets before. I remember right here in Central Texas in New Braunfels in the mid 80’s when the market dropped, and home prices didn’t come back for five or six years. The liquidity risks, too, is not just, you have to put it on the market, but it’s all of the fees associated with selling or buying. If you sell and you have to pay a realtor fee, title company and the title policy fees, recording fees, attorney fees, and a good rule of thumb to figuring all this is between 8-10% of the sales price. Well, when you liquidate say a stock or an ETF today, most of the trades are free. It’s not 10%, and that can be a high number. You have a $200,000 home or a $300,000 home that you’re selling. 6% to the realtor and another 3% or 4% in title fees and all the different fees. That adds up. All of a sudden you were selling for 300k and you’re getting 270k. That’s a huge difference. You’re also paying fees when you buy, and they call it the five year rule when you need to at least own five or six years just to break even. So maintenance risk, renter risk, income risk, liquidity risk. That’s four of them. So, the fifth risk is tax risk. And most people, they’re thinking there’s a tax risk. Well, I will explain this to you. So as an example, if you own a vacation property and you use it personally, the days that you use it personally are not tax deductible. Okay, so let’s say you have all your expenses that add up. Let’s say you rent that property for three months out of the year, and then you use it for three months out of the year. And then the other six months maybe it’s vacant if it’s a vacation property, because vacation properties are like that. They go with the peak seasons, but we’ll assume three and three, or even just five and five, or you use it five months and you rent it out five months. If that’s the case, you’re only going to get to deduct 50% of all the costs associated with maintaining that property, the property taxes and things like that, because you’re using it a percentage of the time. So you have to keep up with that. We’re halfway through on just the risk.

Bailey:
That’s crazy. I had never even thought about all the little details that could go into having a rental property. And like you said, I mean, one of the things that people love about it is that it’s a tangible investment, but there are all these kind of invisible things about it that don’t feel tangible, but then they’re there. And so I probably would have never even thought about those things. So it’s a little bit of a scary thought to think that you could be making income from this thing, but all of a sudden it’s actually costing you. And so what would be the next point?

Bob:
So, we’re going to head into our last five, and number six is location risk. I had my condo in Rockport, Texas, right? Remember I was telling you about that. Praise God I sold. I did not know the hurricane was coming, but did you know that that condo today is still not completely finished? We’re coming on three years now. It was three years ago. Had I held onto that condo, I would have not been receiving rent for three years, but I still had to make all the other payments. So there’s location risk, and weather risk comes along with that. That’s one of the risks there’s location risk and weather risk. Also, trends can really change quickly. You can be in a real hot area where everybody wants to buy. And then the next thing you know, it’s hot somewhere else. And the tax rates can change too, which takes you back to the tax risk. Oh, one thing I didn’t mention with the tax risk was the appraisal district is a tax risk. Appraisal districts love to come and reassess your property because they want to get more tax for the county. That can be a risk, too, under tax risk and under location risk because taxes can change and go up on you for that particular location. So the next one, number seven, is time risk. Have they ever talked about that one? Well, you get a salary here. You do. But think about what are you worth per hour? You just take what you’re being paid and divide it by 2000. That’s how many work hours are in a normal year. So someone takes the amount that they’re making. They divided by that number. That’s what we refer to as time risk. What is your time worth? Is your time worth at least $15 an hour or $25 an hour, because rental properties can be very hands on and get in the way of travel plans, family plans, and even leisure time, because it may really require you to be physically involved. But if you’re not and say, well, I’m not gonna worry about that. I’m going to hire it out. So, I’m going to hire it out. I’m going to hire a property manager, and I’m going to hire expensive, skilled labor to take care of it. If you’re not using your time, you’re having to use somebody else’s time. That’s going to result in a lower yield to your overall yield. We just got three more now.

Bailey:
Wow. So, okay, so that was number seven. So we’ve been through a lot of risks so far, we’ve been through maintenance and repair risk, renter risk, income risk, liquidity risk, tax risk, location risk, and time risk. And so now we have kind of the top three left. What would they be?

Bob:
We got three. I don’t know if they’ll be the top three or not, but they’re in there. It’s market risk, weather risk, and longevity risk. Market risk is that real estate markets could collapse. It kind of goes back to location risk where you’re so reliant on just one location, one property, and one unit. That market could go down dramatically. After the hurricane in Rockport, nobody wanted to buy real estate down there. It’s hard to believe that markets can collapse, but they can, and it can take many years for it to come back. Then we had the weather risk that I mentioned – the hurricanes, but there’s also flooding tornadoes. You’ve been hearing about the fires, again, out in California. Those people were losing homes. So you have fires, you have earthquakes. These are examples, and it happens all the time. And when you have that happen, it takes away the potential income. And then longevity risk in that renters are not obligated like an owner. They can move out with just a four to six week notice, and this can really eat into your profits. So, that’s the 10 risks of owning rental property and vacation properties. So now we have another area we’re going to go into for just a little bit.

Bailey:
Yeah, well, I know that you’re a numbers guy and I’m sure a lot of our listeners are too. Can you kind of break down the top 10 risks? It feels like a bird’s eye view of all the things that could go wrong. Can you kind of break down the numbers for us so that we can look at what the actual costs and income might look like?

Bob:
I sure can. And so what I did was a couple of days ago, I went on Zillow, and Zillow is kind of cool because you can find rental properties on Zillow. And of course you can find properties for sale. So I went on Zillow right here in New Braunfels and I pulled up rental homes and I got everything from $1300 a month on up to $4,000 a month. So what I did was I picked a property that was renting at $1500 a month. And then I went and looked at that square footage property. And I said, well, what would that property sell for? Here in New Braunfels, that’s about $200,000 – $230,000, even up as much as $250,000. So, it was kind of a range – 200k to 250k. I picked kind of in the medium, I picked 230k as a whole number. So I have this rental home property return worksheet.

Bailey:
Okay. And is that going to be available for our listeners?

Bob:
That will be available. I’ve been using this worksheet for many, many years, and I’ve had a lot of people that were looking at buying a rental home. But even if you’re not looking to buy, maybe you own one already. And you’re like, I can relate to a lot of the stuff Bob’s been saying, or you on that vacation home. I would invite you to get this because when you look at the yield, you’re going to be surprised at what the yield is. And quite frankly, I’ve never come across one, in all the years of doing this, where the yield was greater than 3-5%. Never. It’s not like what you think, because on the surface you look at it and go, all right. So, I did my research. I can go buy a home for $230,000 here in New Braunfels. I can rent it for $1500 a month. So I got $18,000 coming in. Well, immediately I’m going, well, that’s an 8% or 9% return. You want to bet? Let’s put the numbers to it. Okay. So what I did, I’m just going to go down this real quick because you’ve got to get the worksheet to really understand this. I’m going to tell you the cost I put in here. I put in what the average, annual maintenance cost is. I used about 1%. That’s the rule of thumb – painting, roof, repair, plumbing, electrical, heat and air, flooring, and general overall maintenance on an annual basis, about $2000 a year. Annual liability costs – you really want to have liability. So, if somebody’s slips and falls, you need to have a million dollar coverage so that you’re protected against being sued. That’s not much. That’s just about $250 a year. Then, I went and looked up on the appraisal district what the taxes would be on a $230,000 house in New Braunfels, $4,500 a year. Then property and casualty insurance, a good insurance policy, not one that’s not going to cover you, but one is going to cover you with the right amount of coverage, about $1200 a year. Then I just said, well, what if every one or two years, I’m not getting rent because it’s between somebody moving out and somebody moving in. So I took away one month of rent. That’s $1500. You notice I didn’t fill in anything on the lack of diversification costs, but that’s something you can think about. You have only one renter, one market, one location that must be factored in and natural disasters. But then I thought about, okay, you’ve got to also, if you’ve got to find a new renter once a year or so, you’ve got a little bit of marketing. Put a couple hundred dollars in there. And then what is your time worth? You’re collecting the rent every month and you may have t