Last Updated on November 27, 2018 by Dave Farquhar
Is landlording profitable? The answer is yes. Where people disagree, I think, is on the timing, and perhaps to a lesser degree, on the strategy.
My wife read an article yesterday on real estate investing that made her mad. I’d link to it, but I can’t find it today–maybe it was pulled. But the premise was that you shouldn’t invest in real estate, because being a landlord isn’t a quick way to get rich.
I agree with the second part. But the first part doesn’t logically follow. In fact, I don’t care who you are, probably the best thing you can do for yourself is forget about trying to get rich quickly. I speak from experience.
My grandparents were rich. I don’t know exactly how rich, and the only people who could answer the question definitively are dead now. But that fortune is gone. The trustee of my grandparents’ estate lost it all, trying to get rich quick, which is absurd considering he already was rich.
I have a few trinkets left over. My dad–who wasn’t the trustee of the estate–purchased a few things from his own parents’ estate auction. I keep them where I can see them every day. It reminds me of where I came from, and what mistakes I don’t need to be making.
That’s all I have to say about getting rich quick. So let’s talk real estate.
One thing this article said was that you don’t really make a lot of money renting out houses. I actually sat down and did the math this past week, because my wife and I have a house we rent out, and we were trying to figure out if it made sense to buy another one. And at the end of the month, after we’ve collected our rent and made the house payment and paid taxes and insurance, we have about $300 profit left over. We’ll round down, because unexpected expenses can and do pop up from time to time.
You can look at it like a part-time job that pays $300 a month, or $3,600 a year. And there is some work involved. You have to make some repairs, or track down someone to make some repairs, then pay for them.
If your goal is to become a millionaire, $3,600 doesn’t put a very big dent in that goal.
But it gets better. After a time–it could be 5, 15 or 30 years–you own the property outright, so the interest and principle payments go away. Insurance and taxes don’t go away, so the rental doesn’t become pure profit, but, conservatively speaking, the profits will at least double to $7,200 per year. (Today’s dollars.)
There’s also another way to look at it: like an investment.
When you buy a house, you make a downpayment of 20%. If you buy a $100,000 house and rent it out for $1,000 per month–don’t buy a house if you can’t rent it out for 1% of what you pay for it–that means you made an initial investment of $20,000. For that $20,000, you get a $3,600 return on investment each year. That’s 18 percent. Things can and do go wrong, but 18% is much higher than the average rate of return in stocks and most other traditional investments.
And while all of this is going on, hopefully the value of the property is increasing, so when the time comes to sell, there’s profit involved there as well.
The classic book on real estate investing is William Nickerson’s How I Turned $1,000 into $5 Million in Real Estate, first published in the 1950s and last revised in 1984. His formula was to buy slightly dumpy properties that he and his wife wouldn’t really want to live in, make any necessary repairs, then do whatever cosmetic fixes that would make it a property he and his wife wouldn’t have to make any apologies about if they lived in them. Then they’d rent the property out for at least 1% of what they paid, or hopefully a bit more, and they’d make some improvement every year to justify raising the rent. Then, as they could afford to buy more property, they bought more property.
You can’t get started in real estate today with $1,000. He got started in the 1940s, when $1,000 was a lot more money than it is today. A more honest title would be How I Turned a 20% Downpayment into $5 Million in Real Estate. But the idea worked, and Nickerson’s secret sauce was that habit of inexpensive improvements that increased his profit margins slightly every year, and over time increased the resale value of his properties. But all the while he had a desk job at a telephone company so he and his wife didn’t have to live off their real estate income. Anyone with the means to make a 20% downpayment, get a loan, and make the payments until they can get the property rented out can repeat the formula today.
Nickerson’s book was a bestseller until people came along with gimmicks, promising ways to get rich faster, with less money up front, or both. It always involved more risk, taking advantage of situations that were specific to one given time or place, or both.
Real estate is more work than sending money every month to a broker–especially if you use the Nickerson method rather than just passively collecting whatever rent the market will bear as the property slowly slides into decline. You have to decide if the higher rate of return is worth it.
Those are the numbers, and that’s how it works.
Let’s talk about my grandfather again for a minute. As far as I can tell, he was in position to buy blue-chip stocks at Depression-deflated prices and hold them for a long period of time. That’s why I was buying S&P 500 index funds during this most recent recession.
But now stocks have recovered to roughly their pre-recession levels. They aren’t a bargain anymore. Real estate still is.
Here’s a slightly different take I wrote a couple of years after this one. The data is a little different but the conclusion is essentially the same.