The terrifying math behind why rental properties could make you go poor if you buy at the peak. When price were rising real estate was an option because of the equity rise. Today we don't have prices rising, in fact in many markets prices are starting to fall especially in the cities and are quite possibly going to fall for quite a while. Without that equity increase traditional rentals are just not that amazing of an investment as is easily proven. I'll use round numbers to demonstrate . Let's say you buy a single family very basic house outside the city for $100,000 all in including closing costs, repairs etc.
How much can you rent that house for? A $100k house outside the city say $800 a month. It is advisable to keep your price lower and more appealing than the competition so you have a list of prospective tenants to choose from rather than charging more money and being vacant or less selective. But we'll start with $800 as gross rent. Next lets look at expenses. The first is taxes. Taxes can be higher for commercial properties but let's use the National average of 1.19% that's $1190 a year or about $100 a month. If you are in New jersey your rates are 2.19%. So check your state tax rates to be sure. Next - Insurance - often 20% higher to insure a rental than your own house, the average owner occupied premium is about $850 so say $1,000 a year for insurance or $83 a month. Next up - Maintenance - there are many estimation myths like the 1% rule where you spend 1% of the house value annually, the 50% rule the 50% rule where your operating costs are half you rental income, or the $1 per square foot rule, none are accurate but I'm going to use 1% which is way too low but let's stay conservative so 1% of the property value each year and we'll tack on another $1000 a year or $83 a month. Pro tip - it's never that low and if you have ever replaced a roof or windows you realize how expensive it can be. But even using a conservative 1% we are already down to $534 from our original $800.
Next up are the utility costs. If you included those in the rent which a lot of tenants prefer in order to to control their expenses - you have an$100 additional cost of very conservatively $150 a month. Depending on gas or electric costs in your region and how long your tenants leave the windows wide open in December your costs will vary but let's use a conservative $150 a month for heat, water and hydro - you are now left with $384. Now if you do make the tenants pay the utilities, and you buy a house that is poorly insulated, and their costs are steep - like $400 a month - you will be vacant often. When possible always check previous utility costs to see what you or the tenants can expect.
Now you might say you know people who did well investing in real estate - so do I. But today is not yesterday and most people did well because of the equity rise. We can now watch and see how people do when equity goes the other way. But math does not lie - those expenses were pretty conservative and we didnt even get into advertising costs if you lose your tenants, lost revenue for vacancies, legal costs for evictions and more. Now admittedly there are some tax benefits to owning a rental but there are tax benefits for any business without investing that much money. And most people think of a house investment as cash but it is actually quite illiquid especially when the market is down - it can be very difficult to free up your cash quickly if you need to sell.
Now are there ways to still make money in real estate? Of course if you think outside the box.
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