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I’ve been intrigued by real estate for years. I first saw it as a way to accelerate my path to early retirement. More recently, I’ve considered the benefits of diversifying out of paper assets due to high stock valuations and low interest rates.

But I’ve never been able to pull the trigger. I’ve been stuck on the sidelines for two reasons.

First and foremost, I hate having debt. You can invest in real estate without debt, but it requires tying up capital with little diversification.

Second, real estate investing seemed labor intensive. I was fearful real estate would become another full-time job.

Last summer, my wife and I found a home with the amenities, location, and price we were seeking for early retirement. The problem was the house was in Utah and we lived in Pennsylvania.

I had commitments to fulfill to finish my job, we needed to sell our home, and we wanted to allow our daughter to finish preschool. So we were a year away from being ready to move across the country.

We decided to buy the house anyway. We rented it out for a year, giving us a chance to dip our toes in the water as landlords. In the process, we learned five valuable lessons that will shape our future decisions related to real estate investing that will help others sitting on the sidelines pondering whether investing in real estate makes sense for them.

Full Disclosure

Before discussing our experience and sharing lessons learned as landlords, I want to acknowledge that we rented out one house for eleven months. This does not make me a real estate expert. We made some decisions that worked out great for us, but are generally not advisable.

We were looking to buy a house in Ogden, UT, one of the hottest real estate markets in the country. According to Kiplinger, the median home price in Ogden increased by 15.3% in 2017. Zillow reports prices increased 18% over the past year.

Conversely, our home town in western Pennsylvania has a stagnant real estate market. Prices are flat or even decreasing slightly. Waiting to buy when we were ready to move in a year was likely to cost us tens of thousands of dollars.

It’s unwise to speculate on appreciation. We took a calculated chance that worked out well.

We purchased our house with a home equity line of credit (HELOC). This allowed us to finance the home with no closing costs, no origination fee, no appraisal fee, and a 1% interest rate for the first six months. After six months, the loan had a variable interest rate.

This made perfect sense for our situation and worked out great. However, buying a home using a loan with a variable interest rate is rarely smart.

Our home would not be considered a solid rental by real estate investors. It failed the 1% rule miserably. Our primary concern was getting a good tenant in the house quickly, allowing us to avoid paying a mortgage, utilities, and maintenance on a vacant house for a year.

Despite our unique situation, we gained valuable insights as landlords.

There Are Ways to Make Money With Real Estate, Even While Losing Money

Chad Carson describes the different ways you can make money with real estate with the acronym I.D.E.A.L. It stands for income, depreciation, equity, appreciation, and leverage.

This acronym made sense conceptually, but I never grasped how tax efficiently you can build wealth with real estate until I became a landlord and analyzed our numbers. Here’s a breakdown, showing how it worked for us.

We rented the house for $1,250/month for eleven months, giving us $13,750 gross income. Our expenses included taxes ($1,762), insurance ($1,168), repairs ($870), and management fees ($1,375). After these expenses, our income was $8,575 prior to making our loan payments, about $780/month.

For the first 6 months, we paid only 1% interest before our HELOC had a variable rate. During this time we were slightly cash flow positive, making about $50/month.

Over the second half of the year, our interest rate was variable. During this time our interest payments jumped substantially. We were cash flow negative for the second half of the year, meaning we lost $250-400/month.

Applying the I.D.E.A.L. Acronym To Our Numbers

• Income: After paying the expenses associated with our home and making our monthly loan payment, we had no net income. We actually lost about $1,600 over the eleven months we rented our property.
• Depreciation: Depreciation is a required paper expense where a rental property (minus the value of the land) is depreciated over 27.5 years. I’m not clear on how exactly you determine the value of the land versus the property. We provided our accountant our records, and they calculated this “expense” at $3,172 on our 2017 Schedule E for the months we rented the property. At a 25% marginal tax bracket, this saved us $793 in income tax. Because we rented for half the year in 2018 as well, we will have similar depreciation. However, we’ll be in the 12% marginal tax bracket because I’ve left my job and the Tax Cuts and Jobs Act lowered tax rates, so this benefit will be less valuable.
• Equity: In our experience, this was the biggest benefit of investing in real estate. Over the past year, we’ve benefitted by using someone else’s money to pay off our loan. Thus, we increased our net worth by approximately $700/month, or $7,700 for the year.
• Appreciation: We purchased this house in large part due to speculation. This is generally not advisable. Real estate typically appreciates at about the general rate of inflation. That said, if we assume we bought our home at fair market price at $240,000 and got average appreciation for the area of 15%, we made $36,000 in increased home value in only one year.

Our net worth increased by over $40,000 between equity and appreciation in our home’s value. At the same time, we lost several thousand dollars between negative cash flow and depreciation, giving us a significant tax write-off.

Our financial win was in large part due to how we purchased the property, which brings me to our next lesson…

There Is Such A Thing As Good Debt

The “L” in the I.D.E.A.L. acronym is leverage. We utilized the maximal amount the bank would loan us on the HELOC, which was approximately $170,000. Thus we put $70,000 of our own money towards the property.

Initially, this made my wife and I uneasy. Fear of debt is the biggest factor that stopped us from investing in real estate previously.

My opinion on using debt to invest in real estate has changed dramatically after my year as a landlord. I now see leverage as one of the biggest attractions to investing in real estate.

There are benefits to buying properties with cash. They include improved cash flow, ability to close quickly on good deals, and decreased risk because you don’t ever need to make a mortgage payment.

However, buying properties with cash is very tax inefficient. It requires spending after tax dollars to purchase property and creates unnecessary taxable income for those who don’t need immediate cash flow. Buying with cash also adds risk by having to tie up a large sum of capital in only one property, rather than spreading money out across a diversified portfolio. 

Utilizing debt allowed us to avoid tax consequences we would have incurred if selling off investments to produce cash to buy the house. We kept our money invested to grow and collect dividends and interest over the past year. Leveraged real estate also allowed us to use our tenant’s rent money to build equity.

The next lessons relate to my other hang up that prevented me from investing in real estate…

Investing In Real Estate Is Not Passive

My core investment strategy focuses on investing in index funds. Index investing is about as passive as it gets. Conversely, real estate investing is not passive.

Prior to going to Utah last summer, my wife and I looked at about 100 properties online over several months to narrow down locations and get a feel for the market. Once there, we looked at about 15 properties in person. We then went back a second time to look at two properties before making an offer on one.

Once we made an offer, negotiated, and got the house under contract, we spent hours on the phone and computer over the ensuing month. We had to schedule inspections, line up financing, and interview property managers. After the inspection, we had to schedule contractors to make repairs.

Managing the property from the other side of the country made using a property manager a necessity. Even finding a manager we were completely satisfied with did not make the process passive.

We had to agree upon what to charge for rent, establish tenant screening criteria, and make decisions to do upgrades. This included painting a few rooms to make the property more attractive and installing railings for safety reasons. This meant more phone calls to ensure everything was being taken care of and more bills to pay.

On top of this, there was stress and anxiety knowing that until we found a renter we had a mortgage to pay. Even once we found a renter, we couldn’t be sure they would be a good tenant until after they moved into our house.

From the time the tenants moved in until a year later when it was time for them to leave, we learned our fourth lesson…

Investing In Real Estate Can Be Very Passive

It was a lot of work to find a good property, get favorable financing, get the property in shape to rent, and screen potential tenants. However, once the house was rented, we did nothing but sit back and collect rent checks for the next ten months.

Aside from one minor issue with the house, the only time we heard from the property manager was when they did periodic checks of the exterior of the property.

We received monthly statements from the managers showing the rent collected, their management fees, and the other rare expense. Our money was received by direct deposit to our bank account.

We passed the statements along to our accountant, making the whole process extremely simple, efficient, and passive.

The process remained passive and low stress until the month before we were ready to move. We had to coordinate, through the property manager, when our tenants would move out and we could move in. The house needed a thorough cleaning before we moved in. We also had to make some minor repairs including replacing a set of broken vertical blinds and doing some painting.

This brings me to our final lesson…

If You’re Going to be a Landlord, Be a Good Landlord

John Schaub dedicates a full chapter of his book “Building Wealth One House at a Time” to “Attracting and Training Long-Term, Low Maintenance Tenants”. He points out that you can decrease hassle and increase profitability by providing quality housing at a fair price to attract quality tenants. This limits turnover which is costly, stressful, and labor intensive.

Schaub asked landlords what they are looking for from tenants. They responded:

1. A tenant who pays on time
2. A tenant who takes care of the property
3. A tenant who stays forever
4. A tenant who never calls.

After identifying these ideal tenants, Schaub asked them to tell him what they are looking for from a landlord. Their answers were:

1. A house in a safe neighborhood
2. A house big enough to hold all our stuff
3. A house that is clean and in good repair
4. A landlord who will maintain the property
5. Fair rent
6. Fair rent raises
7. Privacy
8. A house that is not for sale.

In other words, to increase the odds that your experience as a landlord will be passive and profitable, be a good landlord!

Despite not being able to offer a house where our tenants could stay for a long time, we offered everything else on Schaub’s list. This increased the odds of having a positive experience as landlords, despite only being able to offer the house for less than a year.

We may have just been lucky to have a good experience with our tenants. However, if we buy more rental properties going forward, we will continue to follow this model of buying middle to upper end housing, pricing it fairly, and maintaining the properties.

It makes sense that this increases our odds of attracting the types of tenants we’re looking for, while decreasing the hassle and expenses that come with frequent turnover.

The Final Verdict

So after spending a year as landlords, will we be buying more rental properties going forward? Maybe.

After renting our house for a year, I no longer have the fears and doubts that stopped me from investing in real estate sooner. I’m now confident we could quickly become successful real estate investors without requiring a lot of time or excessive risk.

I still think it’s wise to diversify out of paper investments in this time of high stock valuations and low interest rates. Real estate is one way to provide that diversification.

So why not jump into buying more properties immediately? That leads to one bonus lesson we learned that is only tangentially related to our experience as landlords…

Having Enough

I need to take a deep breath, then decide where I want to focus my attention going forward. A wise person once explained why you’ll become busier after retirement.

I didn’t heed that advice and attempted to tackle too many projects I’d been putting off for years while working. In addition to this real estate experiment, I started contributing to this blog, wrote a book, sold a house, and made a cross country move in the eight months since leaving my career.

I’ve come to realize we’re at a place in life where we can search for activities with the greatest personal return on investment (ROI), rather than needing to seek optimal financial ROI. I’ve also learned that we don’t need to pursue every opportunity just because it is viable. We can say no to good opportunities to pursue great ones.

We’ve spent most of our adult lives building wealth in the pursuit of financial independence and early retirement. Frankly, we’ve been pretty good at it. Though we’ve achieved most of our financial goals, we’ve found it harder than anticipated to shift gears and focus away from accumulating more and toward enjoying the life our saving, investing, and planning has enabled.

My wife continues to enjoy her work and is not looking to get any busier with real estate investing. Despite the expense of moving across the country and setting up our new home, her income alone means we’re on pace to have a positive savings rate in my first year of retirement. This provides the slack we desire in our finances.

I’m enjoying my writing ventures. I’m also starting to see that my writing can provide another consistent, if modest, stream of passion income. I prefer writing over being a real estate investor, even if it is less lucrative and far more work.

Investing in real estate could generate even more money, but we have no urgency to pursue more. We’re focusing on figuring out how to appreciate having enough.

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