If you’ve read Money & Markets for a while, you might remember I became an “accidental slumlord” earlier this year.
It took months longer than it should have, but I made my old house a rental property in January. The first rent check hit my account in February.
Now that I’m six months into the experience, I thought I’d revisit it and share a few pointers.
My Rental Property Update
Overall, it’s going well. My tenants have been on time with the rent every month with no major issues.
But there’s always something.
In the past six months, there have been two plumbing issues in my rental property. Neither was major. But each one cost me about $150.
The house is in a wooded area of Dallas, not far from a creek system. So there are critters: squirrels, opossums and good old-fashioned field mice.
They’re everywhere and seem to love nesting in my attic. Having pest control de-critter the house and seal all the entry points wasn’t cheap.
I make money on the property, as the rent clears the mortgage payment with nearly $1,000 per month to spare. But every unexpected expense like this chips away at my profit.
And then there are the bigger expenses…
I power-washed and stained the wood fence surrounding the yard before I rented out the house. But I know the thing is one good Texas thunderstorm away from falling. It wasn’t new when I bought the house 11 years ago.
Replacing the fence up to the neighborhood’s standards will cost a good $20,000.
The air conditioning system is working just fine, but I’m already planning for its demise that’s likely to occur within the next seven years or so. A/C replacements aren’t cheap!
My Top Rental Property Tip: Establish Your Margin of Safety
I say none of this to discourage you from trying your own adventure as a landlord.
I believe real estate is a fantastic long-term investment and a great diversifier to a portfolio.
Given how the market has performed this year, I’m glad that a chunk of my net worth is in the rental house and not in the S&P 500.
That’s why it’s critical to establish a margin of safety.
I wouldn’t have as sunny of an attitude toward my property if the rent barely covered the mortgage and I needed to pay every random, unexpected expense out of pocket.
We might get a correction in the housing market if the Federal Reserve’s tightening pushes us into recession. Rising mortgage rates could also make payments based on current home values unsustainable.
Only time will tell.
If prices fall and you get the itch to try your luck in rental real estate, the one rule to remember above all others is: Watch your margin of safety.
Everything else is secondary to that.
As long as your tenant’s rent can cover your reasonable financing costs with a fat margin left over to cover all the excess expenses, you can figure out the rest as you go.
But if you cut it too close, you’ll have to find cash elsewhere to cover shortfalls.
If you’ve run the numbers and don’t see the margin of safety, walk away from the deal.
It’s that simple.
Bottom line: A margin of safety is a form of risk management.
You should never invest in anything, be it a house, a share of stock or (if you’re my son) a Pokémon card, unless you have risk management in place.
While I’m talking about establishing risk management with rental properties, Adam O’Dell and I apply the same principles when we are managing the Green Zone Fortunes model stock portfolio.
We never add a new position without first establishing our plan for the stock. And that means setting rules that should allow us to exit without realizing massive losses.
If you want to see how we achieve this, click here to learn how you can join Green Zone Fortunes today. We’ve just added a new renewable energy stock to the portfolio, and Adam’s presentation will show you why he holds the renewable energy mega trend in such high regard.
To safe profits,
Charles Sizemore, Co-Editor, Green Zone Fortunes
Charles Sizemore is the co-editor of Green Zone Fortunes and specializes in income and retirement topics. He is also a frequent guest on CNBC, Bloomberg and Fox Business.