Many owners don't have the degree of success they hope for. When looking at a prospective property on paper there often appears to be a lot more cash flow than there is in reality.

Why? Most novice buyers underestimate true operating cost and the amount of time needed to properly run rental properties. Some are misled by sellers and some by their own desire to own the property

One day a new owner came to my office. He had purchased a property near 17th and Burnham and was in a bit of a pickle. The upper had been vacant since he bought the place June 1st despite a lot of expensive ads. The lower hadn't paid rent since July. Boy, did he need help.

First question I asked was 'What are your rents?' Well he was expecting $600 per unit, about $125 to 175 more than the market in the area. 'Well...., your rents may be a bit too high. Perhaps if you lower the rents to what other owners in the area are charging you could find paying tenants for both units.' That is when I found out how upside down he was. He bought the property for 80k and took a seller second for most of the down payment. He neglected to figure in the high cost of sewer and water in Milwaukee. He estimated his insurance cost on what he was paying on his suburban home. This property's insurance cost were much higher even though the coverage was much less.

No, he was certain he couldn't lower his rent by more than a couple of buck otherwise he couldn't cover the cost of ownership. I looked at the property. It is by no means a gem in the neighborhood. Five years ago it would have been worth 20k to 25k and not much more. Today people have gone real estate crazy and are paying far more than the income stream will support.

His vacant upper is not prepped and he is hoping to rent it "as is." His stretched budget doesn't figure in for maintenance. Well you should at least evict the nonpaying tenant i tell him. Can't afford to and it would leave the entire building vacant he responds.

Moral of the story: Make sure the rents you are quoted by a broker or seller accurately reflect the market in THAT specific neighborhood. Leave enough in the operating budget to actually be able to operate. Figure water cost for a three bedroom unit at $50/unit/month. Rush out and look for leaks if your bills come in that high, but don't budget too little. Maintenance in older buildings in lower income neighborhoods is going to cost you $100/month/unit. Sure you may skate through for months without incurring any expenses and then whamo! you need new electric service, you get a lead order, you have paint the outside of the house, a sewer lateral collapses...

The poor guy in this story probably won't right himself. Two vacant units and two mortgages have strained his finances to the point his meager savings are gone and he hadn't been able to make last month's payments when we spoke. He is unwilling to lower his rent so instead of actually getting $900 a month he will hold on to the hope of $1,200. His story will end when one of us buy the property from the bank after a foreclosure for 20k-25k and then rent it out for $400-500 per unit.In lower income neighborhoods figure $100 to $125 per unit per month in real maintenance cost. In middle-income housing figure $35-50. Oh, you will sail along for months without any cost and then one day a sewer will collapse and you have to shell out 5 grand or your formerly ideal tenant will vacate without notice leaving a thousand dollars worth of damage and $800 in rent due.

You will try to tell me that your maintenance cost won't be so high. After all you do all the work yourself. Does this mean you are willing to unstop someone else's toilet for free? But even if you are willing to work for free, doing it yourself is not without cost. You decide to fix the trashed unit because there is little money left after paying the bills with that empty unit. 'Can't go tomorrow 'cause little Jessica has her dance recital, but I hit it hard over the weekend.' Weekend comes after a long week. Even if you do go, you are not productive. Soon that one-week to prep the trashed unit turns into a two and a half month ordeal. The rent you lost would have more than paid for having someone else do the prep, let alone all the time you spent.

Perhaps it isn't the maintenance per se but the toilet that was running for 3 months and you only realized it when the bill for a thousand dollars showed up in the mailbox.

Over the 25 years plus I have been in this business the single thing I would have changed in the early years would have been to hire employees sooner and contract out more work than I did. The return on the time I spent doing things that I could reasonably hire out and the lost opportunities because it just don't work out. And I was working for a remodeling contractor at the time so I had more of these mechanical skills than most.
The rental housing business is often intense and certainly not a spectator sport. It is not for everyone. But if you buy right, stay at it when all others would quit and hire out more work than you think you should you can make it succeed.

Paul Adds

I couldn’t agree more. In my experience, $487 a year positive return is absolutely going to be a considerable LOSS when maintaining a 4 family property. Even at a 2% CD your return would be $778 with a lot less headaches.

I'm finding that with rents equaling 2x my mortgage, by the time I maintain my properties in good condition, pay my water bills and City Fees, and meet the needs of my tenants, I'm making minimal positive cash flow. The landlord business is a combination of smart buying, smart selling, and smart maintenance. If any of these gets out of balance, you will quickly realize considerable losses.

On the other hand, if you manage these three carefully, you can realize considerable gain in the long run. Unless you are extremely real estate savvy, and put in lots of hours shopping, making offers, watching court house sales, etc., it's not been get rich quick scheme in my experience.

Also see the Housing Bubble which discusses the chance for a substaintial drop in market value of rental housing

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