It’s official. I’m back in the real estate business!
Before you get too excited, let me explain. Waaaay back in the day I was a third owner of a real estate partnership with my dad and brother. We bought investment properties of all kinds. We specialized in single-family homes, but owned plenty of multi-unit buildings, storage and rooming houses.
My partners were more along the lines of the silent kind. I, of course, could bounce ideas off them, but the workload fell on me. I hired maintenance staff and crews and was always interviewing potential property managers. Before we closed shop we had taken an interest in 179 buildings (not all at once). At the peak we had somewhere north of 80 units scattered all over NE Wisconsin.
We sold properties frequently once our inventory grew. We held some properties longer — our first property was one of the last to be sold.
After we were in the business a few years we gained a reputation for renovating run-down properties. I used these as a way to generate cash for long-term real estate investments.
Eventually a few local cities had us on speed-dial when they condemned properties. We picked up these rat-traps for pocket change ($5,000 or less). Spent $40,000 or so renovating and sold for $70,000 or so; rinse and repeat.
Buying and selling (and managing) so many properties eventually caused me to burn-out. It was a good (if not sometimes a dirty) business. I washed my hands of investment properties and sold en masse.
For years we were buying and selling multiple properties per month. Now I was just selling.
Investing with a Purpose
The last rental property in the partnership was sold in the year 2000. I never thought it was more than a passing phase of my life. I did the real estate thing and was content.
Except I wasn’t really out of real estate.
When $40 million of real estate transactions cross your desk in 12 years you learn a few things:
- Real estate agents are full of schmoo. They are in the business of selling real estate and will say whatever necessary to earn a commission. (I have changed my opinion on this and think agents are vital in the buying, selling and managing of RE.)
- Real estate investments are “passive” only in the Tax Code! Buying the right property takes work. Maintaining properties — even with a property manager — also takes work. Index funds are truly passive.
- Real estate isn’t a free ride to wealth.
- Tenants are people and people are not always fun to work with, especially when they owe you money and while they live in your property.
- Good tenants are awesome and should be considered for inclusion in the next family reunion.
- Bad tenants cause normal accountant’s to reconsider bringing back debtor’s prisons.
- People are destructive, especially when they don’t own it.
- No money down deals are not the best deal going unless you’re selling a real estate investment course on late night TV (back in the day) or on Facebook (today’s version of late night TV).
- Work doesn’t get itself done so stop crying.
- All this said, RE can be a powerful income source with plenty of wealth building qualities. And that is why I am back.
The Best Tenant
As I alluded to earlier, I never really got out of the RE business. In 1995 I bought the current office building I rent to my tax accounting practice. This building generates $36,000 of annual rental income and the tenant is the best I ever had! For some reason the tenant and I always agree. Go figure!
So, the best tenant you will ever have is you. But if you don’t have a business (treated as an S corp, I might add) this opportunity is unavailable.
There is a runner up option nearly as good, however.
To understand this second option I need to explain my mindset. When researching an investment (or tax deduction, or investment or. . . ) I prefer more than one out.
What do I mean? More than “one out”.
As an example I recently commented that I prefer more than just a deduction for my retirement contributions. This means the tax break isn’t enough on its own. When planned correctly, a retirement plan contribution can open up additional tax breaks. This is the doubling and tripling of benefits I call more than “one out”.
In real estate it is the self-rental concept that provides multiple values: a dream tenant, fills a business need, rental profits and tax benefits all go to my best friend (me) and no bad tenants. Under the Tax Cuts and Jobs Act of 2017 it also opens the opportunity for more of a Qualified Business Income deduction.
Another Awesome Tenant
This Sunday my oldest daughter, Heather, graduates from college. She had a lot of false starts as she found her way and daddy refused to provide a free ride. (The first test of college is getting there. Loans and daddy are not a part of “getting there”. Scholarships, a job or business and hard work are.)
Heather won several awards along the way and served as an officer in PTK this last year. She has matured a lot.
She also fleshed out a business. She is returning to China this summer after finishing a tour in South Korea teaching English as a second language.
Her business involves tutoring and she has several product ideas and services coming online. And, smart girl she is, tested everything and never quit just because an idea failed. She learned and grew with each step. And now it is time to move out and tackle the world for real.
And this is where my renewed RE adventure begins.
Heather tried living near the campus while in college, but got an eyeful of the idiocy of the average young adult. She also experienced bad landlords and roommates.
So Heather took control and decided she would pick her roommates this time versus the school or landlord. She wants to keep costs low, sharing the expenses of renting with a roommate, while being closer to her clients (she’s been invited to several local schools and universities to teach).
She found the right roommate after screening out several. Then she started researching accommodations and running numbers.
Then she told daddy. Daddy almost lost it!
Rent has changed in the last 20 years! (God, I’m getting old.) Rents were from $850-$1,200 per month on average and they were nothing fancy either. (Yes, we live in a pretty reasonable market yet.)
This caused my accountant mind to start shaking out the rust and think about this situation a bit. It became clear, after a cursory review of available local duplexes and 4-plexes, that it would be better if I bought a property and rented to Heather and her friend.
And that is where we are at. I’ll purchase a property this summer before Heather returns from her South Korea/China trip and her friend starts her next semester of classes. Both have jobs and adequate income.
Doing it Right This Time
All this assumes you have a responsible child. There are plenty of horror stories of parents buying a home for their child and getting killed financially.
I would not have considered this even a year ago. (She could have remained living at home with mom and dad if necessary.) But Heather has finally reached the tipping point. Her business has reached critical mass and she has a waiting list looking for her services.
Heather was ultra picky when vetting potential roommates. She wanted two roommates, but could only find one worth keeping. For now.
You might be tempted in a situation such as this to have your child manage the other units. It’s an insane thought so drop it fast! Heather is a teacher and business owner with no skills in — or desires for — property management.
Heather and her friend will pay rent to me with a regular rental contract like any other landlord/tenant relationship. We do it by the book.
The remaining unit/s (I have my eye on a 4-plex, but will settle for a duplex) will be managed by a professional property manager.
I have no interest in managing RE ever again so a manager is a must. The only advantage of having my daughter live there is the updates on the needs of the property (something needs fixing or updating). Unless she says anything, the other tenants will not know her relationship to the landlord. Squeak, squeak.
This wasn’t a numbers post on how to buy the right property at the right price; I did that previously.
This post should help you start thinking about the additional benefits of RE ownership beyond the mere rental income (the doubling and tripling of benefits).
Renting to your own business is a no-brainer in most real estate markets. The high-priced coastal cities of the U.S might be an exception, along with Denver. Of course that could change over time.
Rent has an element of profit (or at least it should). Slumlords take shortcuts to keep their rents lower, but you don’t want to live there. Good properties, good apartments, cost money. And good landlords are as hard to come by as good tenants. There are plenty of them out there but they are already renting their apartment from a good landlord and have no intentions of leaving anytime soon.
The next best option is renting to a responsible family member. This isn’t an easy road. My youngest daughter isn’t close to being there. Heather made the leap recently which gave me the idea and hence this post.
Doing it right means buying the right property that cash flows out of the gate and having a property manager handle the rest.
Heather may find additional tenants for me from her work, but it still will all go through the property manager. I’d rather pay a fee than spend time managing the property
It’s the right thing — and profitable — thing to do.
And, of course, this assumes you buy a quality piece of real estate and maintain it.
More Wealth Building Resources
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A cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.
Worthy Financial offers a flat 5% on their investment. You can read my review here.
Monday 4th of November 2019
My wife and I moved out of our condo and left our son in it. He got a roommate and paid us rent. Albeit a little below market. Allowed him to save, get married, have a child and buy his own 3 bedroom home. We have since rented it out for the past 5 years. My wife and I are selling our current home and downsizing and moving back into the same condo in February. This accomplishes a few things. We need to downsize, it's closer to both our works, it will greatly reduce our capital gains tax by converting it back to our home....though we will still have some, and no more mowing and outdoor chores.
Mr. Hobo Millionaire
Sunday 19th of May 2019
Keith, would you mind explaining the benefit of you renting to your business vs your business buying the building and paying a note over time. Is there a tax issue with the depreciation? You can depreciate/offset your taxes and the business can't? A specific post on this setup, showing actual numbers, would be great.
Sunday 19th of May 2019
That is a great idea, MHM! I'll put it in the queue. A short answer would not do it justice.
Saturday 18th of May 2019
When I was a student, studying was more than a full-time job. In my final years, I normally studied until midnight. I cannot understand how a person can study for a regular degree and have the equivalent of a full-time job at the same time.
Friday 17th of May 2019
Love the idea! How about another “out”? What if you bought that 4 plex when she was born or before age 3 with a 15 year fixed mortgage. The property would be paid off, the cash flow should be all, or a sizeable chunk of the tuition on top of all the other benefits. The obvious question is “what if my kid doesn’t want to go to school near where I purchased the house?” Sweet, just 1031 the house you bought at birth and trade up to a property near the school of their choice. Hopefully the property paid for itself over the 15 years. Your original down payment will hypothetically provide you with a college education for your kid, student housing, and a paid off cash flowing asset that can be used for the next kid or retirement income. Wish this was my own idea, but credit goes to Brandon Turner from Bigger Pockets.
Friday 17th of May 2019
Renting to a family member or friend? Good luck with that.