We’d like to posit the question:

Who told you that rentals are a good idea?

Was it the memory of playing monopoly; the thrill of your opponent landing on your property— and paying you rent— that inspired good feelings about owning rentals?

Maybe it was someone that you looked up to who bragged about collecting rent checks from his tenants like it was his own private ATM.

There is no right or wrong answer the question; often though, the answer focuses on the upside of a perfect scenario; we like to highlight the reality of this particular investment strategy.

In a recent Facebook forum, a poll was taken that asked a simple question, “Why Rentals?”

One person chimed in saying, “Because everyone else is doing it, it must be a good idea.” It was a funny response that made us laugh, but it’s also the reason why many people jump in. Rental properties can be very lucrative investments; they’re also one of the most socially accepted real estate investment strategies out there.

From our experience, any independent investment pursuit in real estate often results in securing a job first, and a property second. Meaning, an investor must stop and realize that when they become a landlord, they’ve bought themself a job.

The Grind

Each new landlord starts his ‘job’ with enthusiasm. The first rent check received confirms their brilliant decision to buy the property. Enter the first bad tenant who takes you to court, or perhaps doesn’t pay you and destroys your house in the process, and the excitement quickly turns to frustration. Additional stress may be brought on by an unexpected $10,000 repair bill after 3 years that consumes all that “positive” cash flow you have been spending.

One Hillstone investor previously had six rental properties valued at two million. The rents averaged $100,000 per year. Tenants would often not pay, properties were in bad need of repairs, and the landlord was constantly stressed. He listened to the sad stories of his tenants and would often go without rent for months at a time. He worked on the properties himself to save money and tried to keep up with all of their maintenance issues. For him, it was a full-time job. He had enough.

This investor was not alone in his painful experience; there are a multitude of misconceptions and myths about owning rentals that we would like to explore.

Myth 1: The tenant pays for the property.

The landlord has the obligation to pay the mortgage, and is personally guaranteed under the terms of their mortgage. The income generated by the tenants contributes to the costs associated with the property, but may not cover all of the costs. The mortgage is one element of the total expenses; while property taxes, neighborhood or association dues, maintenance, repairs, and utilities are other elements. Typically, accounting for all of these costs can be an additional 30-40 percent of the mortgage payment, meaning the rental rate for tenants must be charged 130-140 percent of the initial mortgage costs — just to break even. One hundred percent of all foreclosures happen to people with mortgages.

Myth 2: Vacancy has little effect in my area.

Experienced landlords have learned to add a factor of vacancy to the equation as a long-term cost buffering tool to combat: the competitive tendency of the rental market, as well as the changing nuances of the real estate market. Even a month of vacancy can tip the scales of profitability. A few months can threaten the long term profitability of a rentals cap-rate that could take years to recuperate.

Myth 3: Raising rental rates is a defensive strategy.

In recent years, many cities have been imposing rental caps (rent control) to prevent the disparity between the availability of affordable housing and units of inventory. These restrictions could challenge a landlords inflationary control against rising costs, thus resulting in less profitability. In the event the landlord desires to improve the property to demand higher rental rates, certain restrictions could prevent an adequate return on the invested capital improvements.

Myth 4: Landlord and Tenant Rights

In Washington, State Representatives are proposing House Bill 1446, which, if enacted may substantially alter the relationship between the landlord and tenant, reducing property owners rights in protecting their properties. Some of these changes include requiring installment plans for costs associated with a tenants move-in expenses, also, permitting unauthorized occupants to receive protection under the RLTA after 6 months of living with a registered tenant — meaning, even though they don’t have a lease agreement, the evicting process could be difficult. Also on the table is a condition that permits tenants to reinstate their tenancy by payment of rent only, and provides no statutory remedy for the property owner to recover unpaid utilities and other fees resulting from the tenant’s nonpayment of rent. These are things to consider about rental properties that are often overlooked. Landlord Tenant Laws are complicated and vast.

Myth 5: Mortgage Interest Deductions

Home owners can deduct most or all of the interest they pay on their mortgage each year, as long as it does not exceed the maximum home loan size of $750,000 (prior to 2017, 1M). This also effects the deductibility of interest on home equity loans (HELOC), too; you can only deduct the interest from a HELOC if the loan was used to buy, build, or improve your home, and if it doesn’t raise your total outstanding mortgage debt above the $750,000 limit. If your mortgage(s) was taken out prior to 2017, other limits apply. Interest deductions seem great, but in effect, it’s kind of a wash. Assume you’re paying a bank $10,000 in mortgage interest a year, you are still losing $8,000 by avoiding paying the IRS $2,000 a year. Don’t lose sight of the costs of the mortgage.

Myth 6: Long Term Appreciation

Appreciation is not a myth; it is historically accurate. Given enough time, real estate will gain value. Maybe you’ve heard the tongue in cheek comment, “They’re not building any more land.” When supply is limited, value increases. However, markets ebb and flow, and rise and fall. Favorable increases can take 5-20+ years depending on local geographic and economic factors. Furthermore, according to the US Census and NAR (National Association of Realtors), the overall appreciation by year lands between 3.1 and 4.4% nationally.*

Myth 7: “I got a great deal on the property”

Buying low and selling high is the strategy of choice for development funds, and investors working the short-term game. But it’s not applicable across the board; especially when a mortgage is involved. Take for example a long-term rental strategy utilizing a mortgage with a rate of 4-5 percent. With a fixed mortgage (30 years and 4.5%), the total amount paid is over 174% the purchase price. Not such a good deal anymore.

Dirt Cheap

Before a rental became a rental it was only a piece of dirt; raw land with nothing on it. Of all the homes that have ever been built, the vast majority (over 90%) have been been partitioned, or built by developers. Similar to Hillstone models, the developer creates value and sells for profit within a finite timeframe. After the in-depth feasibility studies and due diligence research, the developer acquires the property, partitions the land into parcels, and builds homes to sell. Within 12-24 months, the developer has received all of their profit. The developer sells the investment for the highest retail value, as dictated by the market.

From an objective standpoint, a landlord is buying a rental property at or near full retail price. The landlord calculates the numbers and believes they can rent the property to cover their mortgage payment and expenses — they are happy. They spend a 5-20 percent downpayment, and believe that 30 years from now, they will have a free and clear asset.

Wait a minute, 30 years?

Thanks to the mortgage amortization schedule, paying off the mortgage means paying hundreds of thousands more than the original purchase price. Of course, the plan is to be cashflow positive during that time.

People tend to minimize the commitment that owning rentals entails and dream about how much they will make at some unknown date in the future. “When the home is paid off in 30 years, I’ll be able to retire and live off the rent checks.” While this is an admirable goal, it doesn’t qualify the rental as the best use of time or investment.

Lightbulb Moment

Remember that Hillstone investor?

After discovering another way of investing, he sold five of his rentals and now enjoys more passive income than with rentals, and with zero work. By moving his real estate investment portfolio to Hillstone Capital, his stress level has lowered tremendously.

Hillstone offers a hands-off approach for investors that choose to rethink their own rental strategy.

Invest with us!

Reserve your equity!

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