It's been a busy month for the FI180 household! My wife had a birthday, I wrote a guest post over on the FireyMillenials blog, a mustachian friend from Warner Robins made a visit, and we got to record an episode of the ChooseFI podcast, scheduled to air later this month.
But perhaps most exciting for the wife and I, April marked the end of our decade long adventure in real estate! As you may recall from our previous post on how NOT to buy a house, we blindly purchased our first home in 2007, right before the big real estate crash. Less than a year after our purchase, our home was valued at only 40% of its mortgage balance, with a $1,614.96 monthly payment that contained exactly $0 of principal.
When we started our Financial 180, we knew we needed to cut our losses and figure out an exit strategy. Unwilling to walk away from our financial obligations, we decided to buckle down and pay off that mortgage as fast as possible, while simultaneously renting the property out and living with family to increase our pay down even further. Two years later, we were able to pay the mortgage off, but we still had a poor performing rental property on our hands.
Last week, we finally closed the book on this house from hell and sold the property. It was a wild ride, and we’ll be taking a nice break from real estate for a while.
First, Some Numbers
OK, here's the damage report:
So… yeah. We didn’t do so well in our decade in the real estate market. We ended up selling the property for $40k less than we purchased it for, and we were only able to recoup about 14% of our expenses in collected rents. The property was simply a poor performing rental. While mortgaged, it was nowhere near cash flow positive. Even when fully paid off, the expenses were still more than half the revenue. With high HOA fees, low rental income, and an expensive sticker price, this property was a good lesson of what NOT to look for when choosing a rental property.
Perhaps it isn’t quite as bad as it looks on paper, however. We did live in the property the first few years, so some of those expenses would have gone to rent if we lived somewhere else. Also, it’s important to keep in mind, when we purchased this property we never considered how it would perform as a rental. Like most of our clueless friends, we assumed we would sell it a few years after buying and pocket a few thousand bucks of appreciation. And you know what they say about assumptions…
So, why did we sell at a loss? Why didn’t we continue collecting rent and wait for the property value to continue increasing? So many reasons… let’s start with our rental experience.
Lessons in Landlording
NOTE: Names have been changed to protect the innocent. And the guilty.
When we first embarked on renting out our property, we decided to go with a property manager. Our first property manager, Kate, was wonderful. She was sharp, professional, and kept great communication between my wife and I and our tenants. She helped us find our first tenant, Dave.
Dave, a middle-aged engineer with a wife and one kid, was the definition of the perfect tenant. He took good care of our property, paid on time each month, and rented for multiple years with no issue. He was easy to get a hold of by phone, and never had an issue with the occasional inspection. On the rare occasion where I’d need to enter the property, I’d give him a day's notice and everything was fine.
Ironically, Dave looked bad on paper. He had a very low credit score, because he walked away from a large mortgage after the crash. He also had pets, which worries most property owners. But in actuality, Dave was as good as it gets. After a few years of bliss, Dave had to move on though, and we got a new tenant, Steve. Unlike Dave, Steve had great paperwork. Awesome credit score, no pets or kids living with him. He even claimed to be a self-described ‘neat freak.’ We were sold.
As you might have guessed, Steve turned out to be a horrible tenant. He was perpetually ten to twenty days late with paying his rent, nearly every single month. While this worried us a bit, he always paid the late fees, so we allowed it to continue. A few months later, things got worse, and twenty days late turned into over thirty days.
A Perfect Storm
It was around this time that a perfect storm started to brew. Our favorite property manager Kate left for another broker, and our property was handed over to a different manager, Shelly. Shelly already had dozens of other properties she was managing, so she was swamped. She didn’t know our situation. No personal touch. In fact, she often got details about our property wrong and didn’t communicate well. She took our late rent problem and made it worse.
This past November, the very first time Steve was late more than 30 days, Shelly encouraged us to wait another month and see if he would pay. Possibly due to his track record of late payments, but also probably because she didn’t want the hassle of starting the formal eviction process. When December rolled around and he was two months late, Shelly told us not to evict someone right before Christmas. She played into our emotions, and so we waited.
When January came, I contacted Steve directly and made him an offer. If he left by the end of the month, I wouldn’t file a formal eviction on him; he just needed to get out so I could re-purpose the property. In the county I live in, a formal eviction means you can’t rent again in the county for five long years, so I considered this a very considerate offer.
He assured me that there was no need to worry, however. The money was coming. He even sent me a screenshot of his PayPal balance showing funds that were ‘on hold’ from eBay sales. Shelly persuaded us to give him a few more weeks (this is an example of a bad property manager). Contractually, I had to continue paying money to Shelly each month for that bad advice, regardless if rent was collected or not (this is an example of a bad management contract).
Enough Is Enough
When February came around, my patience was gone. At this point Steve was over 90 days late and over $3000 behind on rent, not even counting late fees. I tried to get in touch with him, but he had changed his phone number. I told Shelly we needed to file for the eviction. “Sorry Joel, I can’t file for the eviction until you mail me a check for $250 for the associated fees.” This was puzzling. “Can't you take it from Steve’s security deposit?” I asked, frustrated by the situation. “No, we can’t touch that money yet.”
So I mailed the check and waited. Weeks went by with no news. I finally realized that the best way to get this management company to move their ass was to incentivize them. “As soon as we get this property vacated” I said, “I want to put it on the market for sale. No new tenants.”
Suddenly, things started moving. When the judge took too long to sign required paperwork, the management company visited the property to find that Steve had already abandoned it. The power was off, the water was off, and there was a fridge filled with rotting food and garbage all over the house. The smell was apparently so offensive that instead of asking me if I wanted to clean the property, Shelly decided to hire professionals to do it, at a cost of $700, without confirming with me first.
Perhaps the strangest experience for me in this adventure was the damage to the property. It was beyond bizarre. Steve stole our smoke detectors, our air vent registers in the ceiling, our fire extinguisher, and an interior bathroom door. He also removed many other doors from their hinges, and ripped up the tracking system for the closet doors. Not the biggest expenses to fix, but still, so very bizarre!
In the engineering world, after a project fails, we have a meeting with all stakeholders involved to understand what went wrong, and what we would do differently in the future. We call this lessons learned meeting a postmortem. For those of you in the real estate game, here's our lessons learned.
I should have seen the warning signs. Unlike our good tenant Dave, Steve never wanted us to enter the property. It would usually take 5 minutes of loud knocking and repeated phone calls just to get him to answer the door, and when he answered, he would only open it a crack so I couldn’t see inside. When I came over to put up hurricane shutters before the big storm we had last year, he wouldn’t let me inside, and raced to the back of the house to close the blinds before allowing me access to the back patio. When I told him we’d be back the next week to take the shutters down, he assured us he could handle the task himself. Five months later, when he abandoned the property, the shutters were still up.
Sure, this was partly our own fault. The signs were all there. Why weren’t we inspecting the property more frequently? Well for one thing, the house is a forty minute drive south of where we currently live, so trekking out there every weekend to spy on our tenant was not high on our to-do list. Also, we hired a property manager to take care of this for us, so we could relax a little bit on the weekends after spending fifty hours working jobs we don’t enjoy. The management company held quarterly inspections (or at least, they said they did), and never notified us of anything unusual.
Additionally, things went so smoothly with our previous property manager Kate that we didn’t even realize all the things she did on our behalf. Kate didn’t take crap from anyone. She solved small problems all the time, most of which we didn’t find out about until after they were already resolved. She felt like a team member who was looking out for our property for us. This is how a good property manager should feel. Otherwise, why else would you give up 10% of your revenue?
Our new property manager Shelly didn’t do much of anything, other than call us to tell us that while we wouldn’t be getting a rent check each month, we still owed the management company money. She made no attempt to familiarize herself with our property or our situation. For example, I told her numerous times that Steve had only been renting from us for a few months, and yet she’d often say “give him a few more weeks on the rent… he’s been a good tenant with you guys for years, hasn't he?”
Real estate has been an adventure for us. I haven’t even told you about the crazy time we had selling the property. The insane buyer who wanted us to hire a licensed contractor to change some light bulbs, and show her an invoice. The drama with the property appraisal coming in thousands of dollars less than our contract price, and the buyer wanting to walk. The crazy closing costs that consumed over 11% of our sales price, which itself was only 80% of our purchase price over a decade ago. While a lot of people made good money in real estate over the past decade, my wife and I were not among them.
Enough complaining though. These are sunk costs. The past is behind us, and we’re finally done with that property. No more late night phone calls. No more giant HOA payments. No more pleading with tenants for rent payments. Much of our misfortune was due to bad timing, impatience, and lack of due diligence on our part. I still think we learned a lot during the process, and the lessons are probably worth the money we paid in on our real estate ‘investment.’ Besides, with a savings rate of over 80%, we're able to afford a six digit mistake like this and still make it through ok.
So the big question… why did we sell at a loss? If we had waited and rented for a few more years, couldn’t we have recouped our losses? Well, possibly. But we already waited over a decade. There are no guarantees the property would go back up to its bubble heights, either. There’s an equal chance the values will drop again in the next few years. Plus, we were tired of late rent payments. We were tired of being under contract with our crappy property management company. We were tired of all the work that went into fixing up and cleaning the property between tenants.
In the years since finding the FI community, we’ve embraced the passive “Simple Path” to wealth that Jim Collins describes in his stock series and book. These are genuinely passive ways to build wealth. While real estate is an equally valid (and potentially even faster) way to build wealth, it is not truly passive. Even when we had our excellent property manager Kate, it was still work. And we don’t want more work at this point in our lives. We already sit in cubicles 50+ hours a week at jobs we don’t enjoy. Time is the thing we are short on; not money, and certainly not work. So for right now, I am happy to report that we are taking a nice long break from real estate.
In FI, we'll likely have plenty of time for DIY projects, and will likely jump back into the real estate game. The wife enjoys it more than I do, spending hours browsing Zillow and scheming about various housing projects. With time and planning, I could see us buying four or five small rentals in FI, and diversifying our income stream. With all of our lessons learned, I could see us successfully skipping the property manager and doing everything ourselves. But for now, we want to keep things truly passive, and unlike Steve, Vanguard has never been late on a dividend payment.
There’s one more thing we haven’t discussed though. One other big reason we wanted to cash out now, even at a loss. The truth is, we have plans for those home sale proceeds… On the next Financial 180!