Submitted by: G. Brian Davis
We’ll start with the assumption that you would love to retire, with reliable income flooding your account with little work on your part. For our purposes here, we’ll also assume that you’re a real estate investor or landlord.
Many real estate investors started with the goal of acquiring as much real estate as possible, gathering up rental properties with the hope of earning a few hundred dollars monthly off of each rental. Here’s a brief summary of the old real estate landlord model:
An aspiring real estate investor saves some money, and buys a fixer-upper to renovate. Once the property is finished, the investor refinances for a permanent loan, pulling back out the cash they put into the investment property, and keep the property as a rental property. With their original cash back in hand and a rental under their belt, the new landlord repeats the process, thus building an inventory of rental units.
It sounds like a sensible strategy, and in many ways it is, but the problem is that with each property, you take on all of the liability of a rental (both legal and financial), and the liability of a maximally leveraged asset. Let’s assume, for a moment, that your incoming rent is $850, your mortgage is $600, and your taxes and insurance are $100. If you use a property manager, they’ll probably charge $60-85 as well. Now you’re looking at roughly $75/month cash flow per property, according to this model.
Then one of your tenants stops paying their rent, because they lost their job. So you have to cover all those monthly expenses, plus pay the court and eviction costs, plus carry the property for several months while you or the property management company looks for a new tenant.
Then a furnace stops working in one of the properties, and must be replaced. Then a roof starts leaking, and needs to be replaced. Then one of your properties is broken into catch the point? In the immortal words of the ‘Seventies, $hit happens.
Then one of your tenants sues you for lead paint poisoning. Then the neighbors of one of your properties sues, saying that your contractor who put on that new roof did damage to their roof (you’re liable, not the contractor).
Do you see what I mean now when I say that each rental property is a liability?
So what’s the answer? Don’t buy rental properties? Don’t invest in real estate? Sell all of your rental units?
None of the above. The answer is to minimize your liability, while maximizing your profit. This means that having 30 rental units, all leveraged to the hilt, may not be the right approach, but having 5 rental properties that are all owned free and clear is great position to hold. If you didn’t have the $600 mortgage on each property, then your monthly cash flow suddenly jumped from $75 to $675 PER PROPERTY.
So exercise some fiscal restraint, and pay off your mortgages. If that means selling three quarters of your rental inventory to pay off the rest, then so be it; you’ll have drastically reduced your legal and financial liability (not to mention headaches), and improved your passive monthly income.
About the Author: Brian Davis is a real estate investor and landlord based out of Baltimore, MD. He is also a film critic and real estate writer, and contributor to a database of real estate investor articles and a landlord blog. For state-specific
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articles, take a look at EZ Landlord Forms, who also offers listings of local real estate investing clubs & attorneys.