Buying Rental Property: Don’t Fall in Love with an Investment!

by FI Fighter on December 17, 2013

in Real Estate Thoughts

backyard

For many investors, buying a rental property is something that happens later in life. Generally speaking, most people don’t start investing in property until they have already secured their own primary residence. If that is indeed the case, you must be careful to avoid falling into this trap — Never evaluate a rental property using the same metrics you would use for evaluating your own residence!

Avoid the Trap

It’s easy to fall in love with a piece of property. Unlike stocks, most people have the desire to tour the grounds and “see for themselves” before buying. Just looking at a Proforma sheet is typically not enough, no matter how great the cap rate, or cash-on-cash numbers look.

The problem with seeing a property with your own eyes is that you can easily become emotionally attached to it. This is why real estate agents love hosting open houses in the summer — they deliberately do so to create bidding wars! They know that if they stage the setting just right, you’ll lose your senses and eagerly overpay. When you fall in love, you become blind and irrational. And there’s simply no place for that in your investment career. You do not want to be a sucker and overpay for an “investment” that is actually making your poorer!

When Buying YOUR Own Home

If you were to purchase a property for yourself, you would probably be most interested in the home itself. More specifically, you would want to verify the following before signing any papers:

  • Is the house big enough? Is there enough square footage?
  • Is there a nice backyard? Enough room for the kids and dogs to play in?
  • Is the house single-story, or two-story?
  • How old is the home? Is it modern or starting to show its age? What about aesthetics?
  • Any special amenities? Swimming pool, storage unit, gazebo, etc.

Sure, you would also pay close attention to the important details surrounding the house (nice neighborhood, good school district, easy access to freeways/public transportation, etc.), but I’m guessing the house itself would make or break the deal. In other words, if the house wasn’t up to your standards, it wouldn’t matter how great everything else around it was. When buying your own home to live in, a crappy house will not overcompensate for a fabulous neighborhood.

When Buying SOMEONE ELSE’S Home

When you’re buying an investment property, remember that you aren’t buying your own home. Don’t lose sight of the important fact that you won’t be the one living here, so it really does no good to evaluate the property as though you would be. When I look at rental properties, I desire the following attributes, instead:

  • The house shouldn’t be too large. If it is, that means there’s more damage to be done. More walls to paint, more carpet to clean. These costs will come back to bite you when the tenant moves out and you have to make it rent ready for the next tenant. Further, if the house is big, you’ll end up paying more for it. Not only will the downpayment be higher, but so will property taxes and insurance. This all eats into your bottom line.
  • I don’t want a nice backyard. Again, smaller is better. The single family home I bought in Indianapolis doesn’t even have a fence in the backyard… the entire backyard is shared among many neighbors. That sounds lovely to me! No fence means one less repair bill to worry about.
  • I prefer single-story homes. This decreases the total square footage of the home and typically reduces the sales price. Again, property taxes and insurance should also be reduced as a consequence of the smaller size. In addition, I prefer single-story homes because I worry about things like potential lawsuits happening… So, I try and avoid stairs whenever possible. The last thing I need is for a tenant to take a tumble downhill and then come chasing after me to help pay for their medical bills and trauma!
  • Beauty is in the eye of the beholder. Some people love the more modern look (cookie cutter, mass manufactured homes), while others prefer the “character” that older homes provide. I must remember, just because I’m a fan of something, it does not mean that someone else will be as well. For example, an older home might have old, rundown hardwood floors, vintage crown molding, and even an old-school chandelier in place. It would be naive of me to think I could simply rip up the old stuff, install something more modern (laminate flooring, recessed lighting, etc.), and proceed to charge more for rent. If it isn’t broken, it might be a better to just leave it in place. When it comes to aesthetics, you just never know what someone else might like.
  • For rental properties, I don’t want any special amenities. More special features mean more repair costs to pay when they inevitably breakdown. Further, I make it standard to not furnish certain appliances like washer and dryer. None of my rental units come with these appliances. In Indianapolis, it’s even customary to not provide a refrigerator or stove. Unfortunately, it’s difficult to get away with this in California…

As you can see, the mentality of an investor buying a home is completely different from that of a prospective homebuyer purchasing for themselves. You can never forget about the cash flow, because ultimately that’s what will make or break your investment.

Focus on The Surrounding Area

There’s a popular saying in real estate investing — It’s better to own an ugly house in a great neighborhood than to own a beautiful house in a warzone.

So, instead of focusing on the finer details of the house itself (however, do focus on the expensive items: stable foundation, good electrical, plumbing, roof, etc.), I would encourage you to perform your due diligence and make sure to verify that the surrounding area is up to stuff. It is important to ascertain the following critical pieces of information before purchasing a rental property:

  • Is the property located in a good neighborhood?
  • Are the properties primarily owner occupied or rented out by investors? (Buying into owner occupied neighborhoods can be a great strategy to reduce competition for renters. Property values should hold up better as well.)
  • What type of people live here? (Working class, affluent, college students, Section 8, etc.)
  • What’s the local economy like? (Jobs, wages, stability, etc.)
  • Ratings of nearby schools? (Applicable to SFH’s, since many renters will have small children.)
  • Is the property located near public transportation? How far away from the main city/jobs?

The bottom line is that your investment home needs to be located in an attractive enough area where people will want to live. It will be of absolute no use to you, as an investor, to hold a gorgeous home in your portfolio that nobody wants to rent because it’s located next door to a meth lab.

Go Where the Jobs and People Are

When buying investment properties, I also make an emphasis to buy in large metropolitan areas where the people are living. For instance, in my own situation, Bay Area rentals are no longer affordable, so I would have to drive inland to find anything that remotely cash flowed.

But then I asked myself this important question — Do I really want to be buying up a ton of properties in Stockton, Modesto, or Lodi? (no offense). Are there lots of jobs out there? Is this a growth area where the people are moving into? I couldn’t answer that question with a convincing “YES“, so I opted to invest out-of-state, instead.

The importance of location cannot be overstated when deciding where to purchase an investment property.

Summary

The primary objective of an investor is to make money. This seems pretty obvious, but can be overlooked and completely forgotten about when you are first starting out. It’s understandable too, because houses will ALWAYS appeal to our senses and emotions.

As an investor, though, you must not lose sight of your goals and objective. Most importantly, don’t invest in “too much” property. You don’t want to be the person with the portfolio containing the prettiest homes, but worst cash flow! So, invest in rental properties, but do so while looking through the lens of an investor, not homebuyer.

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{ 16 comments… read them below or add one }

Charles@gettingarichlifeNo Gravatar December 17, 2013 at 2:12 am

Definitely agree with your assessment. My mom loves real estate and I took her once to look at an investment property. She couldn’t hide how much she liked it, so the owner didn’t budge. Safe to say I Never took her again until after I bought. Always take emotions out of the equation. It’s not if you would live there, it’s if you can get a good renter to cash flow.

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FI FighterNo Gravatar December 17, 2013 at 8:15 pm

Charles,

Yeah, it’s so easy to fall in love with a house… and when you do, sometimes you just can’t hide it. I’ve seen this happen to many people, so as an investor, you just have to remember what the main objective is — to make money!

Sounds like you made a good decision. Just take her there after closing and then she can enjoy it all she likes! ;)

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Fast WeeklyNo Gravatar December 17, 2013 at 3:13 am

You made a couple very good distinctions FI. Most importantly, not to evaluate the house as YOUR primary residence. Also, the less you put into a rental….the more you can take out….month after month. So basically, you get what you DON’T pay for :o)
-Bryan

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FI FighterNo Gravatar December 17, 2013 at 8:17 pm

Bryan,

That’s a great way of putting it… I like that and will probably start using it from now on.

Exactly right. You get what you DON’T pay for!

Cheers!

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writing2realityNo Gravatar December 17, 2013 at 7:46 am

Couldn’t agree more on most of these, especially the concept of stripping emotions out of the picture. A couple of years ago my dad and I were looking at some properties and this was the exact same process we went through. Cut the emotion, find what makes sense financially, and don’t change the parameters of acceptability.

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FI FighterNo Gravatar December 17, 2013 at 8:19 pm

writing2reality,

You got it! These days, I even invest without ever seeing the property with my own eyes. That may be too bold for some people, but I try and be as detached as possible… I focus a lot more on the area than the house itself…

The property I bought in Indy sits alongside these massive two-story behemoths. My thought was, “looks like a fabulous owner-occupied area. I’ll take the cheapest one you got!”

Cheers!

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Done by FortyNo Gravatar December 17, 2013 at 8:00 am

Great advice, and timely too, as we are considering rental properties. There is something about property that makes us illogical. Our emotions are typically the root cause of a lot of our bad decisions. As McRaney tells us, we are not so smart.

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FI FighterNo Gravatar December 17, 2013 at 8:23 pm

Done by Forty,

So very true. Houses and emotion go hand in hand. This is very dangerous for an investor, especially if you are trying to make money.

On the flipside (probably suitable for a separate post) of losing money by overpaying, it can also be lucrative making money off of other people’s emotions. Distressed sellers immediately come to mind. In many cases, not very ethical, but there are investors out there who prey on the weak/desperate.

Take care!

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moneyconeNo Gravatar December 17, 2013 at 10:12 am

It is all about the location! This has to be emphasized when you purchase property as an investment – pay attention to ‘rentability’!

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FI FighterNo Gravatar December 17, 2013 at 8:24 pm

moneycone,

When it comes to real estate… location, location, location.

That and deep discounts don’t hurt either ;)

Cheers!

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JC @ Passive-Income-PursuitNo Gravatar December 17, 2013 at 3:39 pm

Just what I was after. Focus on location first. I’ve been busy looking at more houses, online only seeing as how I’m at work, and running some numbers. And size really does matter here in Texas because our property taxes are quite high. On almost every property I’ve looked at property taxes are almost as much as the mortgage. Sheesh! I need to do some more analysis on location, luckily one of my friends recently got her RE license, so I might be hitting her up for some research/info in exchange for business coming her way. Win-win!

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FI FighterNo Gravatar December 17, 2013 at 8:25 pm

JC,

Yeah, for sure property taxes in Texas have to be taken into careful consideration before buying. It is crazy how the taxes can basically equal your mortgage payments!

Happy hunting! Let us know how the property search goes!

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The First Million is the HardestNo Gravatar December 17, 2013 at 6:39 pm

Good points, I think I’d have trouble separating what I like vs what would be the best for a rental. Also, providing a refrigerator & stove isn’t standard in Indianapolis!? Wow! I couldn’t have imagined having to own/move those things back in my renting days!

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FI FighterNo Gravatar December 17, 2013 at 8:27 pm

Jay,

Yeah, that came as a big surprise to me as well! Another way to look at it might be, if the tenant has to bring in more appliances, they might have an incentive to stay longer. After all, who wants to deal with moving heavy appliances?

There have been some good articles written about the benefits of investing in SFH’s. One good reason is if the tenants accumulate a lot of stuff, the property basically becomes a storage unit… and no one likes moving!

Cheers!

Reply

LeighNo Gravatar December 18, 2013 at 8:28 pm

I actually think it’s important to not fall in love with a place you plan on living in before buying it either. You don’t know if the deal will fall through, if the inspection will turn up terrible things, or what. It also helps you be more thorough in your price comparisons and find a good deal. After all, this is a place that you’re going to live in for several years! So you do have to like it, but I would recommend waiting to fall in love with it. It took me a long time to fall in love with my place, but I slowly have and I can’t really imagine moving somewhere else!

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TomNo Gravatar February 27, 2014 at 11:33 am

Hey FI – Within a year or so I am hoping to invest in my first property, but I’m a bit torn as to whether my first purchase should be a home for myself, or an investment I can rent out. What is your general opinion on this? Should I first own my own place before buying an investment property? Thanks

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