I've heard of terrible landlord stories, However, this is the worst landlord horror story you will ever hear.
I've a landlord since 2005. In general, it's been a worthwhile experience because rents and real estate prices have appreciated significantly since.
Real estate is my favorite asset class to build wealth. You get to buy a property with other people's money at a dirt cheap interest rate. Your costs are largely fixed while rents keep on going up thanks to inflation. You get plenty of tax deductions. And you get to earn a $250,000/$500,000 tax free profit upon sale in America, depending on if you are single or married.
But I haven't done a good enough job over the past eight years telling you about the negatives of owning real estate. The main reason why is because I've been bullish on the asset class – both heartland real estate and now coastal city real estate. What a shame it would be to have convinced you out of buying years ago.
For more balance, I'd like to share a reader's horror story about being a landlord in the last down cycle. I've shared my own horror story, which sounds like a first class trip to Paris in comparison.
The Worst Landlord Horror Story: Taking A Vegas Gamble
$250K janitors. $9K/month direct deposit easy rental income. It all sounds so wonderful, but it applies to a tiny part of the US, metro areas with concentrations of educated professionals with very high incomes sipping lattes and driving their Priuses to the wine country on the weekends to stay in a nice B&B.
I moved from the Bay Area to Las Vegas in 2004. I thought I was so smart to sell my Bay Area townhouse for $425K, enabling me to buy a single story LV house here for $220K. Then I bought two rental townhomes, new construction for $200,000 each. Cash.
I didn’t see the point of borrowing money and paying interest if I could afford cash. I was going to be a happy landlord, collecting rents and capital gains on my investments. One day, I would trade my one abode in the Bay for a nicer abode here. Plus, I'd have two rental streams. In my mind, I had retired, early.
Bankruptcy
By 2007, the builder of the townhome complex had filed bankruptcy with 157 of 300 units empty, and all the other units which peaked at about $250K were being abandoned by people walking from their mortgages.
The banks would often leave them in limbo, vacant, and vagrant squatters would break in and live in some units (new construction, remember). As foreclosures were slowly processed, the going price to buy a unit similar to mine on the courthouse steps for cash was $50K.
All the units that had been purchased with financing were abandoned, there was no point to continue paying a mortgage for even $150K on a unit worth only $50K. The new purchasers at the foreclosure auctions were mostly absentee landlords, out of state, many from CA, but many Canadian, Australian etc. They simply wired money over and instructed realtors to buy some and get them rented.
Finding Poor Quality Tenants
The median income in this town was under $50K per household, and these people mostly bought a house. The tenant pool was much poorer. And vacancies were off the scale, so lots of property with hungry landlords needed income. Therefore, very poor quality tenants got great deals.
Realtors then told their out of state landlords that the best way to get a tenant who could pay and not have to be evicted would be to Section 8. Get a poor person with a government voucher to move in, and the government pays you 80% of the rent.
You collect the remaining 20% from the tenant, except they usually do not pay. A landlord can evict, and lose his income stream, but most often landlords simply take the 80% payment from the government and write off the rest.
A New Owner In Town
When the builder filed for bankruptcy, the court ordered sale of the remaining 157 units were bought in bulk by an investor for $9M. That works out to about $60K per. They rent for approximately $1K per month, creating an astounding 20% gross rental yield.
That investor experienced high vacancy rates as well so they took in Section 8, and this new construction complex in a new and up and coming area quickly started looking like an inner city housing project.
Crime, drugs, idle people milling around all day, sitting in their garages smoking pot, tons of kids everywhere. Domestic disputes. Continuous police presence, you name it. Have you seen The Wire?
The HOA fees started at $42/mo but over a couple years, and three managers later, they were raised to $145/mo.
Common areas were destroyed by tenants. A swimming pool bathroom was lit on fire. Pool furniture was thrown into pool. An unsupervised toddler drowned in a pool while mom was passed out in a unit from drugs.
Gangs of unsupervised thug kids terrorized residents for fun. The pool has been chained closed for five years due to lack of funds to open it plus the scepter of repeated vandalism. Water to external landscaping was turned off years ago to let the landscaping die, due to lack of money to pay for water.
Landlords experienced continuous turnover and breaking of leases. No one would live there, except people who had no other choice. Lowest credit quality applicants, Section 8’s whose past history caused other landlords to turn them down but desperate landlords would take them here. Gang symbols were spray painted on buildings and fixtures.
Here's What Happened To My Rentals
I have owned these rentals since 2005. Today my $200K purchases have returned to about $130K in current value from a low of $100K. I have evicted twice, and repeated repairs and turnovers.
The latest blow is that it turns out the HOA was managed for many years by a local community manager who didn't have a license. The reserve study shows it should have $1.6M in reserves, but has about $200K instead.
A $900K construction defect lawsuit was won against the builder’s insurance co, which should have provided some relief, but all that money was ‘spent.’ Legally spent, by overcharging by managers, contractors and other helpers.
The State Dept of RE has ordered audits, fined the HOA, and has a case pending against the board president who it turns out started a pest control company then and made sure to get a $6K contract for his little company from the HOA. All the absentee out of state landlords pay their dues and really have no idea what is going on.
I suspect soon I will get a letter saying a new manager or receiver has been appointed. He'll turn around and tell us the HOA is woefully underfunded and special assessments of an extra $1K a month are now required to keep the HOA afloat.
Related: Sell Investment Properties Or Hold As A Landlord?
Profiles Of My Tenants
My tenant applicants have been: DJ, prostitutes (legal), exotic dancer, cab driver, etc. Here are the financials for one example: he earns $1700/mo and has $700/mo car payment. No thank you.
Another application was for roommates, three young people each with incomes of $1000/mo (McDonald’s) who wanted to pool their resources to rent for $1000/mo. Big question is how do you afford this if one of you moves out? Uh. No idea. When I pointed out that move in cost would be one month rent plus one month as deposit, and each of the three would need $660 cash they realized they couldn't afford to move in.
These are not isolated examples, this is reality. This is the tenant pool in this market. They simply do not have the income.
Running In Place
My own home that I bought in 2004 for $220K is again worth roughly $220K today. At the bottom it was worth $100K and many around were foreclosed. At that time I bought two more, at $100K, and so clearly I have a gain there, which offsets my losses on the townhome disasters.
My point is this happy landlord dream with continuous work, toilet repairs and many other repairs (yes I do it all myself) has earned me perhaps a break even on capital, and perhaps a rental yield of 5%. And the break even required gains on the townhomes I bought in 2012 to offset the ones I bought in 2004/5.
It all sounds so wonderful in blog land. So happy, effortless. I gather that many of the people who have discovered the joys of this investing have never seen a crash or downturn. Or a destroyed unit. Evictions. Tenants threatening your life by calling in the middle of the night firing guns to scare you, because you filed to start eviction and they have no money to pay.
Maybe it will never happen in La La Land. But maybe it will, and you'll question why on Earth you tied up so much of your capital and your life to an extremely illiquid asset.
If you want real estate exposure, consider buying a REIT or diversifying into real estate crowdfunding instead. Earning income passively is 100% better. Your sanity will thank you in the future.
Buyer Always Beware
I hope this reader's story gives you a clear idea of what could go wrong when the real estate cycle turns south. Here's a property owner who paid cash for three properties in 2004. He also had to buy two more properties in 2012. 13 years later, he just broke even. Hopefully things are much better now in 2021.
What's worse is the amount of stress and heartache he had to go through to manage the properties. If he had to stretch to buy all those properties with a mortgage, I'm pretty sure his entire retirement nest egg would have been wiped out.
If you're close to retirement or in retirement, the last thing you want to do is spend your free time worrying about your assets. I'd much rather go on an around the world cruise and earn income 100% passively.
Sure it sounds like the reader could have hired a property manager. However, if you're already bleeding cash, you aren't as amenable to bleeding even more cash. This truly is the worst landlord horror story I've ever heard.
The longer you are an investor, the higher the chance you will experience bad times. It's easy to feel good about your investments after such a prolonged bull run.
Just know that when the storm hits, the floor drops out as the herd gets scared. At that time, you'll wish you had a tremendous amount of liquidity. Much like the investor who bought 157 units for a mere $9M with a 20% yield.
Recommendations
Explore real estate crowdfunding. If you are frightened by the this landlord horror story, then you can take a more hands off approach to real estate investing. Take a look at Fundrise, one of the largest real estate crowdfunding platforms today.
Fundrise are the pioneers of diversified eREIT funds. Thanks to technology, it's now much easier to take advantage of lower valuation, higher net rental yield properties across America.
If you're looking to invest in individual real estate deals, take a look at CrowdStreet. CrowdStreet focuses on real estate in 18-hour cities where growth rates are usually faster and prices are much cheaper. With the work from home trend booming, partially due to the pandemic, CrowdStreet is sourcing some really interesting deals.
Personally, I've invested $954,000 in real estate crowdfunding after selling my SF rental property in 2017. So far, it's been wonderful not to have to deal with tenants and maintenance issues. I'm an investor in Fundrise funds, and both Fundrise and Crowdstreet are long-term supports.
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“If you want real estate exposure, consider buying a REIT” That is the same conclusion I came to in 2010 after 5 years of horror and losing near 600K had I invested in an index fund instead. I don’t know how some of these landlords keep their sanity.
A friend of mine just recently got interested in purchasing a rental property and I totally trampled on his dreams. Spent the last 3 days going through all my records during that time and documenting it for him to see firsthand.
My father ended up giving away one of his rentals to a university after one of his tenants shot the other dead in it.
Sometimes we even get burned on a primary residence. We bought a luxury home then moved a year later to take a better job. Oil prices tanked and we are now renting the house x 4 years. The lesson I leaned – ALL real estate is risky, not only rental.
Oof! That sounds awful. While predicting a downturn is really difficult, there are signs to look out for before investing in an area. If I had to be a landlord, I would want to have a SFH in a middle class area. And for my tenants to not realize I was the owner, because my property manager should handle everything.
I appreciate the look at the dark side of RE investing. You often hear things about real-estate like “there are more millionaires in real-estate investing than any other business”, which paints a very rosy image. But people don’t brag about their failures, and so we’re only left reading about the people who were good enough (or lucky enough) to get it right.
I started looking into real estate investing myself after reading about a bunch of success stories. I bought books and read everything I could find. I found out that real-estate investing is a lot harder than it looks. However, as investment sites like fundrise grow, I may take a different angle getting into the real-estate game.
Great article. Thanks for bringing us potential real-estate investors out of the clouds and back to Earth.
I see many blaming others for the plenty of woes. But it is because you refuse to risk more by upgrading homes. It’s unlikely another 2008 will repeat itself for the next decade, maybe in 20 years. It’s not the idle people’s fault you bought a couple homes into section 8 neighborhoods. At $1000/month over a yr you’ll have $12000. Minus 5% for repairs. After half a decade you’ll have collection $240000.
Now spend the money collected in rent to buy a better home in better neighborhoods. Upgrade to restaurant managers, waiters and waitresses, bartenders.
You get the tenants you pay for. Buy in section 8 neighborhoods get section 8 renters. Double the amount you spend on a home to a hipster neighborhood and get hipsters renting. And when you collect enough rent after 5 to 10 yrs upgrade again and get professionals renting. These are the easiest and the best. They pay on time always. It’s on you, not them, for not upgrading to safer, better neighborhoods. You won’t get professionals in section 8 housing, and vice versa.
Steve, tell us about what you’ve done in real estate land. Have you had a perfect run so far?
I’ve surveyed and talked to real experience for years so I knew exactly what I would experience in the coming couple years ahead. I started in hipster neighborhoods. All my properties are walkable distance. I don’t do direct deposit since there is usually something minor, a small problem regularly. I can’t make the luxury rentals work because it is out of my walking way from my hipster rentals. I’m not gonna drive 1hr round for a single rent payment. Who would?
Section 8 I questioned from being yelled at from porches merely walking around, and already mentioned above. I questioned it. But landlords know all sorts of landlords. And did the section 8 landlords sell it like it was gold. Business talks about it became contentious every time. I really had my doubts still. It’s so cheap you get steady rent everyone told me. No worries. I took one cheap section 8 property with the expectation it wouldn’t work out. So I bought on the edge of hipster meets section 8. I sold very very quickly at no profit and no loss.
If you read the article carefully, this was not a section 8 neighborhood originally.
Also, I would wait until you have gone through at least two boom-and-bust cycles before you cast the first stone. Watch how fast the hipsters scurry if there is another stock market crash, many are living off of their parents, who can tolerate it because their retirement portfolios are up 2-3x over the past decade.
OTOH, I would never buy property in LV, the town is basically a drug & prostitute paradise. That part I believe everyone knows prior to buying there. Miami is similar that way, lots of booms-and-busts, with partying being the main industry. Choosing the right city and neighborhood is critical!
When I read the Lala blogs about how real estate investing is awesome, I think they are being overly optimistic. But when I read a story like this and see people commenting that real estate is horrible and that you should stick to REITS and crowdfunding only…I think it is being overly pessimistic. There is a middle ground here. I am very new to real estate investing as I only bought one property so far. It is in the Midwest and I live in NYC (where I couldn’t afford to invest). However, I made sure to choose a location which is stable and the quality of the tenants are nothing like the ones in this story. Obviously, you never know who you’ll get but you can mitigate your risks if you choose the location properly. Not familiar with Vegas but it seemed like there was so much development at the time and the neighborhood was not an established one which leads to more risk.
You mentioned that you were bullish on real estate in coastal cities. And in a previous post, you are now bullish in the heartland. Do you think directly investing in real estate in the Midwest is a good idea (after doing your due diligence of course)?
All you’ve got to do is give it time, and bad things will happen as a real estate investor. The key to financial freedom is to forecast your misery, and take steps to get out or get ahead of the game before the misery becomes overwhelming.
With my new BURL philosophy, I do like the Midwest and Southern real estate. The key is to have a large enough return to make the investment worthwhile.
We own two 70s era condos in the (Roseville/Citrus Heights) Sacramento area. They’re affordable rent-wise vs. the surrounding neighborhoods but not dirt cheap. As such, they tend to attract low-income families who are unwilling to live in the true ghetto (in South Sacramento, mostly) but can’t afford anything better in the nicer area. We paid cash for both of them. Prices have risen about 130% since then. So far so good.
It’s definitely not a passive investment. Screening tenants is an exercise in picking the best of the worst, credit and income wise. We tried property management but that ate into margins. Repairs can be costly and tenants conflicts are stressful. And the HOA is totally out to lunch. There’s just a certain level of stress that comes with maintaining rental properties, especially on the low-end.
On balance, we would do it all over again. After HOA, property tax, etc, cash flow is not amazing but it’s still a solid monthly amount that doesn’t take a huge chunk of time and energy when averaged out over the year. But yeah, choose wisely. Do a ton of online and in-person research.
This is crazy. More examples of experiences that landlords face every day, but are unimaginable by most! There’s a new book on Amazon along these same lines, titled “A Day in the Life of a Landlord”. Stories about situations that landlords experience, written by a landlord. I checked it out on Kindle Unlimited. Some crazy stories!
Wow! What a story, I’m sure he can’t help but think what is SF town house would be worth had he stayed put!
Reinforced my idea that new builds are risky and real estate is a lot more difficult below the surface.
Best way to get into Real Estate? Buy a home to live in and rent a room out, tax efficient and low risk.
Sam
P.S. Would love to read about commercial real estate as this I hear is another beast.
Landlording is difficult. I’ve had 2 evictions in 2 years and so many stories to tell. However, getting lucky with appreciating properties and positive cash flow makes all of the issues laughable. I always thought I was just a laid back landlord, but it may just be that I was lucky with my timing. I feel for this guy. Buy and hold would have worked well here. One day I thought of selling my 4 properties in nice areas and buying 10 properties in a shitty area, and I’m always glad I didn’t.
No risk, no gain. I have yet to live through a big downturn and I believe we are seeing more optimism right now than reality. “Be fearful when others are greedy and be greedy when others are fearful”.
One of the ‘rules’ I was taught by a mentor early on and has served me well is to only buy quality properties that you would be comfortable living in (with your family) if it ever came to that. While your returns (both cash on cash) and appreciation rate may be lower, and there’s of course no way to completely protect yourself from downside risk (and headaches), you’ll likely avoid the real disaster stories like the one shared here. Thanks to the author for sharing and best wishes going forward.
Very wise advice indeed! Buying inexpensively in an unattractive area is going to decrease your pool of high quality long term tenants. I also highly recommend purchasing close to mass transit and other amenities. Every rental property I own is less than a 10 minute walk from a train station.
What I commonly find when talking to other landlords is that they tend to underestimate operating costs (taxes, repairs, insurance etc) and fail to realize that vacancy (even for a month) can be a killer.
Luckily in the Bay Area there are so many qualified tenants with high paying jobs and if you hold a property for 10 plus years in most cases you are going to experience a really nice bump in appreciation.
Good honest view. I’ve had similar experiences over the past 25 years. I’ve been schooled in House court, held hostage by section 8. Learned the in and outs of buying bank owned property and dealing with the Lazy think they know it all real estate brokers. “Which don’t own rental property themselved”. With all the get Rich real estate books, late night tv ads. It is very possible to gain wealth through real estate long term but it’s not as easy as it sounds. A lot of hard work! You need to learn to fix most everything or pay crazy money to someone else. I handle myself in housing court but You must have a good Attorney. THEY WILL protect you when deals go bad and they will somewhere along the line. MONEY WELL SPENT.
IF your young and want to try this real estate get Rich scheme. Buy your 1st 2-4 family owner occupied.Put down 5-10% in an area your familiar with. Learn the ins and outs of your new house. Gain experiance dealing with tenants. Understand housing Tenant laws for your state. Don’t be cheap Use Tenant screening service. 35 dollars or so well spent.
AFTER a year or 2 but another 2-4 family if you like.
Keep it simple.. Buy low, sell High..
Wow. That is an eye opening experience. We’ve probably all heard stories like these but for you to stick through it the entire time is really impressive.
Time to start browsing the listings on crowdfunding real estate sites instead. haha.
And we just bought our first rental property…
Although you never know what changes can do to an area, like your story points out, investing in knowledge (and a network) is key before hitting it with a rental property.
We bought a rental in an area with a high employment rate, a scarcity in good rentals (like the one we bought) and a high demand of living in this area.
Additionally, we actively connected with lots of people in the RE market to learn the ropes and work together with a solid property manager with a lot of knowledge on the market there.
Q: what would have happened if he stayed in the Bay Area, and invested there instead in 2004?
A: he’d be a multi millionaire by now!
Moral of story: invest in prime locations
This is exactly why I wrote a blog post a week ago about why you shouldn’t invest in real estate until you know what you’re getting yourself into. I’ve been fortunate with my properties, but they’re decent homes in nice neighborhoods. They would never come close to the 1% rule even if bought during foreclosures. I’m just content to have others pay off my mortgages and enjoy the tax advantages of being a landlord. Thanks for sharing.
Sorry to hear that. Sequence of returns really screwed you over.
I’ve been relatively lucky. The only property that isn’t doing well is our primary residence, a condo. We purchased in 2007 and the price just got back to what we paid this year. I averaged down during the intervening years so our real estate investments are doing pretty well. Definitely need to sell some off soon, though.
Real estate is not easy and it is definitely not passive! I have had bad tenants, a stolen HVAC unit, and even a case of a boxing speed bag installed too close to the wall!
If you are lucky, get the right tenants, and have the right team, it can work. I use a property management company, and I’m glad I do. I repeat, real estate is not passive!
A stolen HVAC??!? What…they’re huge! That’s crazy!
I don’t know… doesn’t sound so bad.
Still think my pitbulls + dead tenants + police + greedy lawyer rental story was worse.
I’m 36 years old and have built a portfolio of 40 units in a non coastal Midwest city. Unemployment in the area is low, tenants are stable and maintenance labor is cheap. The rentals provide a great source of (mostly) passive cash flow and a good balance between capital preservation and appreciation. I am conservative with debt and have a <50% LTV currently, but with a large blanket LOC on top for opportunistic investments.
I started buying in 2008 and had a few horror stories but none like this. It is surprising to read that this development in Vegas hasn't recovered to pre-2007 levels like most other areas of the country.
I lucked out in the ’80s. We bought the four-plex I was living in. Thus I knew the neighborhood and other tenants. Then I bought the duplex a block away. Only real nightmare was a single-family house a half-hour north of town. Tenant’s son took over when the dad bought a house further north. The kid was problematic and had to evict then remodel the house afterwards. Even that wasn’t particularly bad, so I guess I’ve been blessed.
Bottom line is that landlording requires on-the-ground, local knowledge of rental market conditions to mitigate risk.
Wow that’s rough. That’s why I invest in REITs instead. :)
Curious which ones you favor?
I am 100% in VNQ since it’s tracks the whole sector, but interested in other ideas.
I have a decent size position in OHI. It focuses on the aging of America and has a 7.5% yield.
I’m waiting for it to get back to around $30 a share or under to accumulate more, but not sure it will get there.
We have a few of Canadian REITs. For US we own OHI like Sam and a few other health care REITs.
Great thanks. Adding to watch list.
REITs are pretty volatile so might be worth putting in a good till cancelled limit order.
Two comments: A) Vegas is tough, lots of transients….B) Bad real estate can ruin 10 years of your life/finances…
Good post!