Have you ever made pancakes and discovered you just have just enough syrup left?
Sometimes things work out just right.
It happens in rental property investing too – my Memphis property had an exceptional 2015.
The Property-Year
I like to think in terms of property-years. No, this isn’t a real term, it’s something that makes sense to me and might sound crazy to everyone else.
What is a property-year you ask? It is 1 rental property for 1 year.
I think about things in terms of property-years to better understand randomness. Humans struggle to interpret randomness – it’s just the way we are wired.
We see something happen over and over again and expect it to keep going that way forever. Like expecting good weather in the summer, then being shocked that it rains one day.
We notice a result and make up some cause and effect that just isn’t real. Like a lucky pair of underwear the baseball player wears all playoffs.
We need a way to keep things in perspective and remind ourselves that randomness exists.
The Expected Randomness in a Property-Year
There are any number of expenses that you can encounter for a rental property.
Some are predictably periodic: they happen every X years. You can simply count down until the next time you have to take care of it. An example is insurance, every year I’ll have to pay it, so each month I add a portion to my escrow account.
More difficult to understand are the expenses that will probably occur eventually, you just don’t know when, such as having to call someone from somewhere like Make It Drain Plumbing & Rooter to fix a problem with showers, toilets, pipes, etc. The fact that it doesn’t happen one year doesn’t necessarily make it more likely the next year.
Here are a few:
- 1 in 2 property-years: a tenant moves out
- 1 in 10 property-years: replace the water heater
- 1 in 12 property-years: replace a major appliance like fridge or dishwasher
- 1 in 15 property-years: a major plumbing expense like a broken pipe
- 1 in 20 property-years: replace the roof
- 1 in 30 property-years: replace the garage door opener
- 1 in 50 property-years: evict a non-paying tenant
The accuracy of the numbers isn’t too important, just the concept. This isn’t a complete list of course – there are many more expenses that could crop up unexpectedly. For example, I recently heard about an investor who had to do a removal because it grew too large too close to the house. This can be a worrying problem for those buying property as it can damage the foundation and cause more expense. That is why investors may want to look into tree removal in Augusta, GA services, or wherever their property is, to make sure they are not paying out for damages alongside removal. Tree maintenance, stump grinding and other important aspects of home renovation by eminent Tree Service providers could prove essential.
Another example of the same could be water damage! Oh, I’ve heard the woes of it from one of my friends (who lives in Colorado Springs) when a broken pipe led to a flooded basement! She had to probably get in touch with specialists who deal with Property Damage Restoration Colorado Springs to get it fixed. I would not wish that on my worst enemies!
That said, the property-year view gives me perspective. The perfect year with no expenses isn’t going to happen every time. The bad year can be expected every once in a while, but it won’t be the norm.
Looking at a Perfect Property-Year
Let’s look at my Memphis property for 2015. The tenant stayed in the property the whole year, rent was paid on time, and there were no major expenses.
In fact, it went even better than I could have predicted! When the tenant’s 1 year lease at $975/month was complete, he opted to stay month-to-month at $1075/month rather than signing a new lease. So the rent collected was $600 greater than expected!
With $12,300 in rent collected, here is a complete list of all the expenses for the year:
- Principle paid of $1,049
- Interest paid of $3,951
- Property Management of $1,230 (10% of income)
- Taxes of $1,086
- Insurance of $635
- Repairs of $150 (replaced thermostat)
The principle paid is like a savings account in my name. It just becomes equity that I can access later, so while it is listed as a cash expense above, it actually is neutral.
My taxes also show depreciation of $2,796. This isn’t something I actually had to pay for so it’s not listed as an expense above. The depreciation gave a tax benefit of $1,043 for 2015 (based on my 37.3% marginal tax rate).
Doing some quick math, here are the results for 2015:
- Cash in my pocket: $4,199
- Tax savings: $1,043
- Principle paid down: $1,049
Not to mention Zillow believes the property increased in value $5,000. All told, this property-year was worth $11,291!
Let’s Celebrate!
Just kidding. I know all years won’t be this good and I should save some of that money for future expenses.
Note: In fact, the tenant moved out on December 31 which led to some significant lost income in 2016. The new tenant is now moved in and later on we will take a closer look at how the tenant turnover process went.
But man, that was a good year! It was roughly 50% of my initial investment!!!
Overall, what do you think? Is the property-year a good way of thinking about the randomness and not getting overly excited about a great year?
Congrats! Great going.
Can you please let us know details about your property – location, how did you find them, down payment, mortgate interest rate, etc?
Absolutely. Most of the numbers can be found here: https://rentalmindset.com/my-actual-results-an-examination-of-my-rental-portfolio-after-four-and-a-half-years/ (complete numbers are in the spreadsheet you can download there)
I haven’t written about identifying markets or properties yet, but I am a big fan of turnkey as the best way to get started. There are rehab companies that find the properties, fix them up, and sell to investors. I get help finding the best fit for me (and hand holding along the way) by going through a national marketer of turnkey properties: Jason Hartman or Norada.
Pardon my ignorance. But what’s a turnover property? I haven’t heard of this term before.
Turnkey? It’s when you buy from a company that finds the properties, fixes them up, and sell to investors. There is a lot of info online or on podcasts that will give a good overview of how it works.
That’s great Brian. Have you had a good experience with Norada? I’ve talked to them, and other turnkey providers, but haven’t purchased anything yet.
I have not purchased through them yet, just talked on the phone a few times. I purchased my first 2 through Jason Hartman and had a great experience. They were helpful through the whole process and very tolerant of a new investor asking a ton of questions. Right now I’m thinking I’ll do my next one through Norada to see what their process is like.
The expected surprise expenses go with everything in life. However with rental property you do have to consider what other people do. It is nice when you can go through a year with a good renter and everything held up. My in-laws rental home turned into a nightmare when their tenant decided to rebuild his motorcycle in the front room during the last months of his lease. Oil and other petroleum based chemicals absorbed into everything ruining floors and cabinets. Someone with a seemingly good credit score, payment timeliness and job history decided to take his life in a different direction at their cost. Skipped town after not paying the last months rent just before eviction and left an expensive mess behind. Good to have decent insurance to help with the unexpected. One bad apple doesn’t mean you abandon the rental income strategy. There is always something new to learn.
Wow what a disaster! There are plenty of horror stories out there that get passed around. The worst case scenario and fear mindset hold some people back from ever getting started.
Nice! Do you apply any of your extra cash flow toward paying off the principal faster? If not, what do you do with it?
That’s a really good questions I should answer at length in a post. I am in the phase of building up my portfolio, so I’m saving the cash flow and reinvesting in more properties. At some point I will likely switch to paying off some properties, but this is years away.
I’d love to read that post when you have time to get to it. I tend to steer toward accelerated debt payoff, because the compound interest savings are just so darn sweet. But I understand that the payoff could potentially be bigger if it means leveraging your money into getting into a whole new property instead of just paying one off. Plus, in your case with the SFRs in different locations, you might be better off adding more properties/tenants to spread the risk and reduce the sting of a vacancy (or other problem) in one of the units.
Congrats again on your great year! Hope you have many more.
Right, for me it’s getting to the leverage I’m comfortable with. With evaluating this portfolio on a span of 2+ decades, it makes a lot of sense to keep leveraging early.
Hey Brian – great job and wonderful results!
I wanted to get your thoughts on month-to-month leases. It sounds like you preferred that the tenant signed a mtm rather than renewing for a full year. In this case, you have a tenant that pays rent on time and since there were no major expenses, I assume he/she takes care of the property too. The cost of renter turnover may have offset the extra $100/month rent.
Looking back, do you think the mtm lease was the right decision? Do you prefer mtm leases for all tenants (even high quality ones)?
I would have preferred the tenant stay for another year and would have let him at the same price ($975). It was offered to him, but he didn’t take it because he wanted to move elsewhere. The original lease said if after a year he stays month to month, the rent is $1075 a month. So that automatically kicked in.
I was happy that the tenant decided to stay so long on month to month. Paying $100 a month above market rent, 10% more, is a lot. Yes, you are right that the tenant turnover is more expensive than this extra $600 in rent. But it was going to happen anyway with this tenant, I’m just glad he stayed as long as he did month to month.
In 2015, my average tenancy was right at 26 months. I have mostly apartments, so I think they turn faster than a SFH. on the plus side, they are easy to turn. Only 160 vacancy days between all 24 tenants and 11 turns.
It would have been a lot less vacancy, but I had an extensive remodel that took 3 months.
The turnover time is definitely slower with property management. They just don’t have the same urgency that an owner does. I am going to do a post about that soon, but right now I have a small sample size since I currently only have 2 single family homes.
Congrats on a perfect year. I invested in a condo in Vegas ~10 years (bought it before buying my own home) and it’s a nightmare with HOA since the start. I am so afraid of getting another rental. I just don’t have the time and energy to deal with all the issues.
My boyfriend on the other hand is doing great with his SF property in the Atlanta area. He is planning to invest in Memphis next. I am glad I came across your blog. Will definitely share the good news.
I have heard many condo nightmare stories. Even though you are a direct investor, sometimes HOAs can have so many rules, you actually don’t have much control. It really is case by case though.
Your boyfriend’s investments sound really similar to mine – Atlanta and Memphis. Would love to hear his experience!