November 16, 2009

Why You Should NOT Invest in Real Estate

For about a month and a half now my wife and I have been pumping money into one of our rentals. The tenants moved out without notice and we're having to fix up a few things and a couple more things and then even more things. The bills seem to just keep adding up. This has been a unenjoyable reminder of how some of the negatives of owning rentals.

There are many good reasons to own rental real estate, but there are also many reasons why its not a fun investment and there are some substantial risks. For a worst case scenario of how bad a tenant can be you could watch the movie Pacific Heights. Of course thats just fictional drama but its not outside the realm of possibility. Unless you're the luckiest person in the world most landlords will run into some problems and you need to be prepared for them before they happen. Below I list some of the negative sides of owning rentals.

Mortgage obligations - If you have a mortgage on your property then you'll have to pay that mortgage. Generally your rent will cover that mortgage, but what if there is no rent? In a worst case scenario you may be in a situation where you have no rental income coming in but you'll still have to pay that mortgage.

Unexpected repairs and maintenance - You might luck out and have very low maintenance and repair bills. But you might have bad luck and your property might start falling apart soon after you buy it. Big bills can add up... What if the furnace breaks down? Thats $500 for repairs. What if termites infest the home? That will be $400 for exterminator. What if a hail storm damages the roof? Your $1000 insurance deductible comes out of your pocket. What if you're really unlucky and all 3 of these things happen in the first year? All the sudden you're paying a $1,900 loss. This isn't even a high bill. Electric problems, plumbing problems or a dead HVAC system could cost you $2000 or more pretty easy.

Difficult tenants - Most tenants are great but some are not. Some tenants can be a giant pain in your rear end. Tenants might break your lease terms and lie to you about it. You might smell cigarette smoke and hear a barking dog coming from their unit which you don't allow pets or smoking in but they'll insist that it isn't them. They might harass or annoy you over trivial things. You could get phone calls at 1am in the morning because they are drunk and locked themselves out of their home.

Tenants who do not pay rent - Most tenants pay rent on time but some don't. Inevitably you will have tenants who are unable to pay their rent for some reason or another. Usually they have a legitimate reason for not having the rent like loss of a job or other personal problems. But sometimes your tenants have no good excuse other than they 'blew' the money elsewhere. They might try and get you to let them owe you for a week and that week might turn into two weeks then a month. If you allow this then before you know it your renter is 2 months behind in their rent.

Having to evict a tenant - Actually having to physically evict a tenant is not very common assuming you do a decent job of selecting tenants in the first place. But for one reason or another you might eventually get one of those tenants who simply won't leave and tries to work the system in their favor. If you do have to evict a tenant then you might take a couple months or more figuring out the system, dealing with the lawyers, courts and eventually the sheriff who will normally physically remove the tenant in the end. The actual legal eviction process can be a giant hassle and expense for a landlord.

Criminals - No matter how well you screen tenants you might end up with a criminal. Criminal activity by tenants could cost you a significant amount. If tenants set up a meth lab in your rental property then having the property cleaned up could run several thousand dollars. (this is one of my dads major fears as a landlord) Or worse yet a renter could be violent and pose a physical safety risk to the other tenants or yourself.

Protracted vacancies - Just cause you have a home to rent doesn't mean anyone will want to rent it. Its not always easy to find good renters so its possible to have a unit sit vacant for a month or two. If an area is hit hard by some economic problems then people might move out of town and rentals might sit vacant for a long time.

Legal liability - One of the worst case scenarios is if a tenant suffers some sort of physical injury and sues you as the landlord for damages. Lawsuits aren't really as common as people seem to think but they do happen. You need to worry about legal liability and make sure you aren't legally negligent in any safety hazards on the property.

Renter damage - When a tenant moves out you'll be lucky if they clean the place and leave it in the condition it was when they moved in. Often tenants won't bother to clean and its common that they'll have left some damage. Sometimes the amount of damage is more than the security deposit. If you don't think tentants could do much damage then think harder. Tenants might drag their car battery into your home and spill battery acid all over the carpet. You could rent to this guy who left a giant pile of trash in the apartment.

Most of the above is not stuff that you're likely to see. Most tenants are not criminals who will skip out on several months worth of rent leaving the apartment trashed. But there is a risk that anything above could happen. You might get unlucky as a landlord.

If you never want to take the risk of any of the above problems happening then you should probably not be a landlord. If you are a landlord or are considering buying a rental then you could avoid most of the problems above by being very careful and picky about who you rent to. Otherwise you can mitigate these risks for planning and budgeting for some problems in advance.

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