To my friends looking to take advantage of low housing prices:

[In response to a “should I get a rental property? question on a forum, reposted so I don’t have to retype it every time a friend asks the same question đŸ˜€ ]
I think getting into a rental property isn’t a terrible idea, but it’s not a great one. It may be over a decade before the rise in equity even starts to approach what you’ll pay over the life of your loan, so flipping isn’t a bright strategy at all, but the uncertainties involved with the economy make rentals not that stable an idea either.

The problem as I see it is fourfold (forgive me if I am lowbrowing you, it sounds like you are casually interested, so I’m going broad strokes. Most of this you are probably aware of anyways, but I figure it’s worth mentioning for perspective, at least):

1. First off, getting into the landlord business is a pain in the butt. To start, you’d need to get the right deal on the right property. This is not just a low cost property, but one with minimal maintenance costs, as little up front costs like upgrading the plumbing, etc, with desirable attributes for the tenants you are trying to attract – good schools, access to amenities like shopping, health care, and entertainment, etc – just getting a property ready for tenants can be a real investment. Not to mention the outlay for maintenance of the property and grounds once you HAVE tenants. All of this feeds your expenditures, and affects your bottom line.

I say all of that to say that this makes your loan of paramount importance. A few tenths of a percentage point can make a difference of thousands of dollars over the life of the loan – enough that the wrong loan terms can mean the difference between weathering 6 month of non-occupancy or not. You’re not just building equity – and the AMOUNT of equity is more volatile a number than it’s ever been in this country. You simply cannot depend on rising prices to create that profit. As someone who just finished a loan in which I paid $52,000 for a $32,000 car (including a $9000 trade in), I can assure you, you need prices to REALLY move even just to cover the cost of the loan.

My family made it’s money on real estate investment (mostly commercial rental properties), and I’ve sat with my Dad as he went over the math, and that was in far better times than this, and the margin for error is far slimmer than the infomercials would have you believe. My bassist owns three rental properties, and can barely get his mortgage out of em, much less profit. He is still sinking his wages from his day job into them, and hoping that prices will rise again at least to the point where he’s not underwater on em. It’s TOUGH.

It’s tempting, with all the banks are doing to get your money – no down payment, adjustable rates, no closing costs, etc etc etc – but they get their money in the end, oh yes they do. Unless you have cash for a big down payment, and sterling credit to borrow as little as possible, you’re looking at paying 25 to 50% of what you’re paying in fees and interest, and betting that your property is going a appreciate that much (or more) over the life of the loan. And again, that doesn’t figure in the maintenance and administrative costs of rental property ownership.

2. The way the economy is right now, there are better places to put your money with a better chance of a higher return. Corporate and investment profits are at or above the already historic levels of 2006ish. The innovation in financial markets has continued unabated, creating a host of still unregulated exotic products for the savvy investor. Advances in information tech and other emerging fields has led to other opportunities as well. There are also a host of safer, well performing funds that take a lot of the guesswork out of investing, and as long as you work with a trusted firm to stay out of a Madoff scheme, you can expect steady returns as the financial market seems to be doing very well.

3. The development boom seems to have continued without too much of a hitch. A lot of these development plans were started long before the meltdown, and developers have little choice but to slog on. With capital behind them, developers can subsidize rents in some places, have access to advertising, and enjoy access to government to pass favorable legislation to give them an even greater advantage over the smaller landlord. Here in Seattle, Mayor McF**head…. I’m sorry, Mayor McGinn is trying to deregulate development and real estate to keep Seattle’s building boom going. This hurts in two ways – not just direct competition for tenants, but it also drives down prices, and creates a glut vs occupancy. Especially in a high turnover area like Vegas, this makes for a very tough rental environment for landlords. Competing with brand new complexes with state of the art amenities that can undercut your costs in a low occupancy area is a recipe for disaster.

4. Everything else is still broken, 50% of respondents to a bankruptcy questionnaire cited a “major medical expenditure” as a major contributing factor to their financial woes. If you need to get out of your investments in the financial market, there are ways to do that. But getting out of a mortgage in such a depressed housing market is going to be a nightmare. Having the cushion needed to tie up that much money for that long (even just assuming a vanilla 30y mortgage) with the rest of the economy in such uncertainty is a gamble with very little guarantee of a payoff.

One thing you have to think of is the financial health of prospective tenants. In this “jobless recovery”, people’s lives are changing very quickly. The loss of a job is a deadly problem now. Having tenants that can’t pay is a real possibility, and every month your property isn’t generating income, the more it unbalances your bottom line, and the success of the investment over the long term – not to mention the possible strain on your own finances, depending on how much you rely on that income to offset the expenditures.

So, in conclusion, I’d say this: put your money somewhere else. Even though the prices are tempting, real estate depends on stability, the one thing we certainly don’t have. If you have a lot of cash to burn (so your debt load is low and not a burden even in future hard times) and can wait out the recession for prices to move – and I mean 15, 20 years if not more – sure, there are some opportunities out there. But IMHO it would take more expertise than most of us have, and a larger investment in time and effort than most of us could spare to make it work, and even then, there’s no guarantee that prices will rebound (at least not sufficiently), that you’ll even get out from under the loan, much less develop actual equity. Infomercials and “conventional wisdom” would tell you differently, but if you really look at the reality, and the math (which I encourage you to do!), I think you’ll see that the risk/reward is just not in your favor.

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