The Challenges of Active Real Estate Investing: Tenants, Toilets and Trash

The main focus of Actively Passive is to teach you how real estate investing can be done in the most passive way possible – through syndications. But how do you know what’s good for you if you do not see and appreciate how much hard work actively investing can be? I started investing actively in single-family homes back in the 1990s, and to this day, I remember getting back home each night exhausted. I had a lot of fun, but boy-howdy there were some tough days. For the more adventurous out there who want to actively acquire and manage rental properties, as well as those who don’t, here is a summary of what it is like.

Real Estate Investing – Finding It

When you are flipping and renting single-family houses, you should aim to make money when you buy. What I mean by this is that once escrow has closed, that on a good project, you will have instant equity in your new property. This is because when you bought your property, you hopefully will have purchased it at a discount. And there might not have been anything wrong with it. In fact, quite the opposite. You might have purchased from a distressed seller, someone going through a divorce, or some other life-changing event, and they were in a hurry to sell. This can be a win-win for both the seller and you, the buyer, because you are helping solve their problem and you are getting a property at a 20%-60% discount off its true market value.

Finding properties like this is a lot of hard work. You have to scour the multiple listing services with realtors, or check public records for any clues that might lead you to a prospective seller. The follow through, tracking and contacting people takes up quite a bit of time.

Scaling up to a multifamily property, such as a 30-unit or more apartment complex has its challenges as well. With these properties, chances are that you will not be working with a realtor. Instead, you would work with a commercial real estate broker, and in order to really have them take you seriously, some ask for proof of funds before even helping you in any way. Again… work.

When I was focused on single-family homes to add to my portfolio, I was pretty lucky in that I had a couple of realtors who exercised large quantities of patience with me. I had certain requirements for each purchase, so it was a numbers game. I would evaluate hundreds of properties, and then inspect dozens in person, before settling down with one. I would estimate that for every property I purchased, the real estate agents I worked with would spend 40-80 hours of their time helping me, so they really earned their commissions.

Real Estate Investing – Financing It

When you apply for a mortgage with a bank, it is easiest when you have a good income that can easily cover the costs of your investment property. Particularly on smaller properties, the bank looks to your income and credit when making an approval for financing. Contrast that with a larger multifamily property, such as a 155-unit apartment complex, where the bank looks at the project’s pro forma income (not the buyer’s credit) when approving a loan.

Getting financing can be extremely unpleasant and stressful. Just when you think you are in the home stretch, after supplying bank statements, tax returns, pay stubs, and any other financial documentation you had to provide at the beginning of the loan process, the bank’s underwriting department seems to always find some kind of additional documentation they need, causing you to scramble and get it to them. I think this is what caused my hair to go gray.

Stress and work… see a theme?

Real Estate Investing – Closing on It

I don’t think I had a single deal where there wasn’t some sort of surprise at the closing table. For this reason, I found it necessary to read every document thoroughly and contest anything that wasn’t agreed on beforehand. Once papers are signed and recorded at the county recorder’s office, these are the new single source of truth should anything have been missed. I have had to delay closing because someone at a bank or title company made a clerical error. You cannot take anything for granted and must keep a watchful eye on everything.

Score: Now we are up to proofing others’ work, doing your own work, and stressing out throughout the whole process.

Real Estate Investing – Renovating It

For me, this is the most fun part of the process. You get to create something where there wasn’t anything to appreciate at the start. You get to produce a beautiful new home for someone. I’m a creative person and have found renovations to be an excellent outlet for that creativity. But the downside of this, especially in a DIY setting, is that you sometimes have to put in the back-breaking labor to bring something to fruition. Sure, you could hire contractors to do the work, but this is how costs can get out of control, and can cause you to actually lose money on your investment. You have to constantly negotiate.

Smaller projects like a single-family home and even a duplex or triplex can have slim profit margins. You don’t get to take advantage of economies of scale like you would on the larger properties, meaning that on a per-unit basis, you tend to spend more on labor and materials. Contractors and construction materials providers usually give you a break on costs because of the volume of work on big apartment complexes.

Add aching back to the scorecard.

Real Estate Investing – Renting It Out

Finding a good tenant can be a challenge. Finding any ol’ tenant just is not enough. You need to find great tenants. On top of this, landlord-tenant laws vary state by state. You need to know these rules inside and out.

A great tenant will respect and take care of your property, pay the rent every month and on time, and will not create any unnecessary challenges for you or the neighbors. It is very challenging to screen a potential renter, and to determine a good fit during the interview process, but this is absolutely necessary. Some of the major things to look at when screening prospective tenants:

Income check and verification – The minimum monthly household income should be 4 times the rent.

Employment – Ensure your new tenant has a job.

Smoking – You do not want to have to clean the walls and ceilings when you have a smoker. I added a section of my lease agreement addressing this, saying that smoking must be done outside.

Credit score – You need to set a minimum credit score. Between 600 and 620 is usually sufficient. There are many companies that can help with this reporting, usually at a cost of less than $50. These reports can also include past evictions and/or civil or criminal charges.

Past rental history – You need to ask for a list of past landlords, contact info, and reasons for leaving. You will need to contact each to verify truth.

References – These can be members of the church, professors, friends – anyone who can vouch for your new tenant and assure you that they will be responsible.

A good best practice is to do a physical walk-through of your rental every 6 months. Not only do you need to be able to spot things that will need to be fixed, but you are actually assessing how clean and tidy your property is. This also helps keep a line of communication open and discourages tenant-caused damage.

Score: +More time.

Real Estate Investing – Managing It

No matter what type of single-family or multifamily property you purchase, as an active investor, you ultimately have to manage your property. You could hire a third-party property management company to do most of this for you, but you still have to manage the manager. You are ultimately responsible for everything that goes on at your property which can cause some sleepless nights.

Repairs on a rental are inevitable. It’s not a matter of if – it’s a matter of when. Not only do you need to keep a list of contractors like plumbers and A/C repair technicians on hand, you have to budget for these eventualities. It is a good practice to maintain a reserve fund for repairs, and add to it monthly.

Score: +More money.

Real Estate Investing – Renovating It Again

Every time you turn a unit, landlord-speak for getting the home ready for the next resident, you have to do some cleaning and refreshing. A good landlord provides a clean and inviting space to tenants. Sometimes this includes painting the whole interior, upgrading appliances, fixing water leaks, and making other repairs. Flooring is also addressed at this time, whether steam cleaning or replacing it.

If you messed up on your tenant screening, this is one area that might bite you in the bottom. I once had a tenant who used the living room on one of my single-family home properties as a motorcycle repair area, doing oil changes on the new carpet. The day I found out about it was the day that I started learning everything I could about screening tenants. I found that I had missed some key screening techniques and vowed never again to make that mistake.

Score: Add learning moment.

Real Estate Investing – Selling It

Eventually, you will want out of your property, either because you can’t handle it any more, or it is a good point in the market cycle when you can take some profits due to appreciation. You can sell it yourself or use a real estate agent. Remember that when using an agent, you have to pay up to 6% in commissions, but selling it yourself involves seemingly endless phone calls from looky-loos.

I have found that staging a house makes it sell faster and closer to the asking price. This involves putting in just enough furniture to suggest a certain positive lifestyle, and show some of the best aspects of your property. Good looking furnishings evoke a positive feeling and can subliminally cause prospects, who are on the fence about buying your property, to turn into buyers.

Add additional time and call center experience to the scorecard.

Learning from It

On one of my projects, I had an investor alongside me responsible for bringing the cash needed to make it happen. As a passive investor, she provided the down payment and funds needed for renovations, and I provided the sweat equity. We ended up sharing the profit 50/50. I would love to have been in her shoes because she got to participate in this great deal without the backbreaking work I ended up doing.

When I compare the experience of actively investing in real estate with making syndication investments passively, I truly appreciate the passive side. I get to avoid the headaches and backaches of being a landlord, but still get the cash flow and tax benefits of owning real estate. And now that I know where to look, I have the ability to pick and choose the opportunities that I want to participate in. Additionally, when something goes wrong, I don’t have to lift a finger, since that is the job of the syndicator.