smoothy proposal: So you want to be a landlord. | Military Retirement & Financial ...

Another content-heavy, link-filled post to get you through the weekend!

I recently read a Reddit question that also describes how servicemembers turn into landlords:

I?m in the military, eligible for a housing allowance based on my rank and typical rent levels for this ZIP code. I see the following three options for housing:

1) Live on base. Pay no rent or utilities but forfeit the additional income of the allowance. From a financial independence standpoint this would be awesome because it would put me a little closer to work and the gyms, but the houses are often of low quality and the waiting list is long. This seems like the easiest, relatively no-hassle way to have a house with my spouse.

2) Live off base and rent an apartment. This is what I currently do, and since I picked a small apartment close to base with cheap rent, I pocket several hundred dollars a month after rent and utilities are paid. Definitely FI living, but there are a lot of things we value that apartment living cannot offer.

3) Live off base but buy a house. I would receive the housing allowance but instead of using it to pay a landlord I could build some equity and perhaps generate additional income.

The easy pros:

A house for my wife and (future) family.

Creative control over our living space.

A backyard, which means a garden and probably chickens.

A garage, for building and maintaining ALL our things.

The easy cons:

I can handle most of the maintenance? if I?m not deployed.

We?ll only be living there 3-4 years before moving. But this is common around bases ? the market is always fairly strong because military families are always coming and going. We have even entertained the idea of keeping the property and renting it.

So what do you think? Anything I?m missing? Any ideas?

You can see where this servicemember?s logic is going. We buy a home for the best of reasons: lifestyle, family, control over our own turf, perhaps a little extra money each month, and maybe growing some equity.

But then we get transfer orders and face the decision: Sell it or rent it?

First, figure out the right factors for your decision. If you?re on your first or second tour, then you?re probably still building up your savings and your retirement funds. You might not have the assets to risk pouring thousands of dollars into landlording. If you bought this property in your younger years, then statistically it?s highly unlikely that you will care to return to it in your later years. You may love the area, and it may be close to family, but that particular home is probably not in the right school district or big enough for your family or suited to your latest needs. Worst of all, avoid falling in love with the house because of memories and sentiment. If you?re going to be a landlord, then that house is a depreciating pile of deteriorating building materials? and you may not even be in the same time zone, let alone able to take care of it.

Second, consider your short-term plans and long-term goals. Do you feel obligated to be a landlord because you don?t have enough money to sell the house? Do you still think that you?ll return to the home in a later tour, or after you leave the military? Do you think that you?ll be gaining equity from all those rent checks? Is this an investment that will support your financial independence?

Frankly, I?m trying to discourage you from being a landlord. I?ve been one for over 20 years, in two different properties, and it?s generally a chore. Many homeowners lack the temperament to be landlords and property managers. It can be a huge obligation with no easily determined exit. Like any other job, at some point it?s going to be a lot of work? probably at the worst possible time. It will occasionally cost thousands of dollars to keep the home in good shape for good tenants. The investor psychology aspect of loss aversion means that landlording?s profits are less enjoyable than the pain of the expenses.

Some of you readers were born to be landlords. No matter how discouraging I may be, you?ll ignore me and start buying properties? and that?s fine. You probably have the ability (and the perseverance) to succeed because you?re hard-wired for it or you grew up with it. For the rest of you, let?s make sure that any blissful ignorance is tempered with knowledge and thoughtful advice.

Before you buy a home for sentimental or family reasons, take a cold-hearted look at your finances. Are you sure you want to tie up your assets in home equity? Are you paying off student loans or other debt? Are you maxing your TSP and your IRAs? Real estate will diversify your investment portfolio but it?s highly illiquid and its value grows (long-term) at about the rate of inflation. Do not expect to buy a house for a few years and then sell it for a profit? the transaction costs alone could be over 6%.

Before you start house shopping (even if it?s for the best of reasons), avoid setting yourself up for trouble. Pay off your debts (especially credit cards and vehicle loans). Save up enough money for the closing costs. Save up more money for a down payment of at least 20%. Yes, the Veteran?s Administration will guarantee a mortgage of up to 100% of the home?s value, but your down payment is the safety margin that will hopefully allow you to sell the house quickly when you transfer. Forecast your home?s maintenance & repair costs (plus property taxes and other monthly fees) and make sure your budget can handle the additional expense. When you sell the home in a few years, will it need expensive repairs like a new roof or a paint job? It?s even wise to start saving for the expenses of selling the home: title company fees, transfer fees & taxes, primping for open houses, and up to 6% of the sales price for realtor?s commissions.

If you?ve bought a home because you wanted a better lifestyle, and not with the sole purpose of becoming a landlord, then don?t keep it any longer than you have to. Aggressively pay down the mortgage while you?re living there so that you?ll have more ?safety margin? on your equity when your tour is over. Put it on the market as soon as you get transfer orders and sell it as quickly as you can. Either rent back from the buyer for a few months or find temporary quarters. It would be great to sell the place at a profit, even after realtor?s fees and closing costs, but that?s not the point. Your goal is to avoid being saddled with an expensive obligation. You may lose a few thousand dollars in the process, but that?s better than losing thousands of dollars a year? for years. Remember all that money you?ve saved from your housing allowance while you were living in your own space? Payback time.

Once you?re in the house, take the time to school yourself on selling it and on being a landlord. Treat this as the training & practice that you?d like to have before a crisis, because once you have transfer orders it?s going to be awfully difficult to find the time. The two best books I?ve read on landlording are (1) Investing in Real Estate and (2) Landlording (older editions of both are at your local library). In addition to these basic manuals, give yourself a dose of hard-core rental financial analysis with Frank Gallinelli?s 10 commandments. Read his other posts on rental expenses and cash flow. You don?t need to buy any of his products, but your reading will give you a good grasp of the fundamentals of managing rental property.

I?m not going to discuss the process and costs of selling a home? this post is about landlords. However the Great Recession taught many homeowners (most of us for the first time) that home prices don?t always go up, and the cost of selling a home can exceed 6% of its sales price. If you simply can?t afford the money to sell the house and pay off the mortgage (let alone pay the sales costs) then maybe renting it out is the only alternative. It?s a hard choice, and you shouldn?t live with it for any longer than you absolutely have to. Consider renting with the following tactics:

Offer ?rent to own? (a portion of the rent goes to the tenant?s down payment).
Let your property manager know the minimum price you?d like to get for the place.
Keep in touch with a realtor who caters to house-flipping investors.
Boost your savings fund for emergency rental property repairs.

If you?re transferred several time zones away from your new rental property, you are absolutely at the mercy of your property manager. That?s not so tough when you have good military tenants, but I?ve seen people deal with this for 20 years of active duty from up to 12 time zones away. Do your due diligence on your property-manager candidates, contact at least three other landlords for references, and be ready to spend more money for a highly regarded professional firm. If you go cheap on a property manager then both you and your tenants will regret it. You don?t want to be bickering with the property manager while you?re in the desert? or even worse, undersea on a submarine and unreachable.

Try to manage your other risks. Your emergency rental-property fund should be able to spend at least $250/month of unbudgeted maintenance surprises for 6+ months, and a $1000 emergency repair. Ideally you?ll also have at least three months of mortgage payments in savings. This will handle the deadbeat tenant that you have to evict through the courts, or the broken washing machine hose that floods two rooms. These casualties will happen? your only input to the problem is how well you?ve prepared to pay for it. It will also handle the costs of vacancies between tenants and the marketing expenses to find a new tenant.

While you?re a landlord, keep learning. Read all you can about managing the property and about controlling your expenses. Network with other landlords on Internet forums. Track the market rents in your neighborhood. Document your expenses for your tax returns, and ensure you?re properly depreciating the property. Maintain a spreadsheet of your expenses (and taxes on depreciation recapture) for the day that you can sell the property. If you?re in the area, drive by the property (unannounced) before checking in with your property manager. Have a plan for the day when your property manager tells you that you should invest $25K to ?update? the house for quality tenants and higher rent.

Finally, have an exit strategy. Some servicemembers still think that they?ll move back to their rental property someday, yet the vast majority of us don?t even return to that area of the country. When you finally do leave the military and choose your place, you might want to sell that far-off rental property to buy another home. When the market recovers and your home rises in value, what?s the minimum price you?ll take for a sale? It?s still worth selling the home at a $10K loss if you?re already losing hundreds of dollars a month in landlord expenses.

Owning a home has many non-financial values. But as long as you?re on active duty, just be sure that you?re ready to handle the hidden financial risks.

If you?re a landlord, what?s your advice? What do you wish you had known before you started, and what would you do differently?

Related articles:
Real estate: rent or buy?
Paycheck Chronicles: Five ways to be a great landlord
PTMoney: Find a Tenant: Credit Check and Screening

Does this post help?

Sign up for more free tips on financial independence and military retirement by e-mail, Facebook, or Twitter!