Real estate is sexy. And many have a desire to treat our local streets like a Monopoly board and get paid $200 every time you land on Selwyn Avenue.
But, real estate is also complex, expensive, and one of the most illiquid investments you can make.
To help understand the risks involved, I sat down with Aaron Bock, a 33-year-old who owns 19 rental units in Charlotte. Bock is also a husband, dad of two, and the founder and managing director of a technology consulting firm called Opkalla.
Here’s what Bock says aspiring investors should know before purchasing their first property:
(1) Owning a rental is not “passive” income.
Most people are attracted to the idea of doing nothing and receiving a paycheck – a.k.a. passive income. But, what new investors quickly realize is that being a landlord is anything but “passive.”
Bock estimates that he spends a minimum of four to five hours a week dealing with his properties — and that’s with outsourcing many tasks to property managers.
(2) You can’t just compare the mortgage payment to the expected rent to estimate how much money you’ll make, Bock says.
Take a $150,000 house, for example. Using the one-percent rule, you can probably rent for $1,500 with a mortgage payment around $850.
That means you’re pulling in an extra $650 a month, right? Wrong. You can’t ignore other factors like:
- Expensive repairs: A property with $1,500 in rent may need up to $750 a month in repairs.
- Cost of a property manager: Plan to pay 10 percent of the rent payment, so $150 a month in this case.
- Capital expenditures, or “CapEx”: Set aside five to 15 percent of the rent payment for future improvements.
- Vacancy: Your property won’t always be occupied, so assume a five to 10 percent vacancy rate.
These additional factors can turn an extra $650 into a negative cash flow.
(3) You make money at the buy.
The more you finance a property and the less you put down upfront, the more at risk you are of negative cash flow.
Many of Bock’s properties have run at break-even or slightly negative cash flow which means that, as an investor, you’re left hoping for appreciation. If that’s the case, then you’re only making money when you sell.
(4) If something can go wrong, it will.
Owning properties will lead to unexpected expenses. To prepare for this, Bock recommends having a big buffer and more cash on hand than you expect. “If a $10,000 expense pops up tomorrow, would you be able to handle it? If not, don’t invest in real estate,” Bock says.
Then there’s the stress of unexpected situations, too.
One time, Bock was watching the news and saw a story about a murder in Charlotte. “As I looked closer at the crime scene I was like, ‘Holy crap, that’s our house.’”
Another time, Bock was away on vacation when a property’s roof started to leak. “I had to beg my best friend to drive to the house and drape a tarp across the roof during a thunderstorm.”
(5) Owning 12 properties may be easier than one.
Bock has found that buying multi-family properties is often easier than buying single-family homes for three reasons:
- Mortgage qualifications: As opposed to a single-family home, a multi-unit property could qualify for a commercial loan versus a mortgage which may be easier to obtain and will be underwritten based on the cash flow of the property.
- Finding property managers: Because property managers are paid a percentage of the rent, they are much more interested as the number of units increases.
- Diversification: If one tenant decides to leave in a four-unit property, it’s not as big of a deal than if it’s a single-family home.
(6) It’s possible to invest in real estate without becoming a landlord.
There are many options to share in the upside of real estate without dealing with the direct headaches of being a landlord. I would recommend consulting with a financial advisor before jumping in, but here are a few alternatives to consider:
- REITS or basically a stock of a company that invests in real estate
- Limited partnerships through brokers, friends, family, etc.
- Real estate investing platforms like Cadre or Fundrise
(7) Research … a lot.
When I asked Bock how he finds his properties, I expected to hear about Zillow, Redfin, or another new technology platform. But no, his response is simpler.
“I drive around,” he says.
If a property is listed on a major website, you can assume that a lot of people are viewing it at the same time which makes it harder to find a good deal.
“Instead, I closely track recent developments around the city and figure out which areas are likely to grow in popularity,” he says. Areas near light rail extensions, new company headquarters, and the Eastland area since the MLS announcement, for example.
Interested in learning more?
“Some things you can only learn by doing,” Bock says, “but a few of my favorite resources are BiggerPockets.com, The Weekend Millionaire, and the Apartment Building Investing podcast with Michael Blank.”
You can also revisit our Cash Confessional series — a few respondents have mentioned rental properties like this 27-year-old who uses “house-hacking” to make $145k or an airline pilot who plans to start investing in rental properties.
Or if you’re house hunting, check out our weekly open house listings here.