Should I invest in a condo?

As I briefly mentioned in my last column, I'm not a fan of investing in condos. I dislike the troubles behind owning them, and I dislike them as an investment. Although there are a few exceptions to the rule, I will probably never own a condo as an investment.

The first set of concerns weigh on all who buy a condo, not just investors. These are the costs of owning a condominium. For starters there is the condo association fee. Most home purchases are part of an association, which tends to all of the common areas My parents pay less than $100 a year for their single family home. Biff and I pay, on average, about $70 a month for each of our town homes. The condo owners I know pay between $200 and $400 a month in condo association fees.

Why so high? For one thing condos have a great deal more common area than single family homes. There are lobbies, offices, exercise rooms and pools, not to mention the common roof. All of these things must be maintained, and the maintenance will climb every year. Unlike the 30-year fixed mortgage that charges you the same amount every year (and therefore decreases every year when adjusted for inflation), condo association fees will rise over time.

But sometimes that association fee isn't enough. If too many repairs hit in too short a time, the condo association can extract that payment from the owners, which can sometimes cost in the tens of thousands of dollars for each owner. This comes in liu of having to pay for repairs to a single family home, by yourself. But with a house you can control the care and the abuse it encounters (to some extent).

Condos are a pain for everyone who owns, but they have even more added pains for investors. Condos (outside of any bubble) tend to appreciate extremely slowly in most areas of the country. There's a very good reason for this. Consider, if you will, this "real estate expert" and his view on why condos are an extremely good investment (as always, emphasis mine, bad grammar theirs):

Sylvia:

Could you explain to me that condo and townhouse and what the benefits are of buying a condo our town house because I am not sure which one to buy for an investment?

Jerry:

One of the advantages of condominiums is that in the future, the growing trend will be as the baby boomers get older, they will be seeking to downsize from what they are currently living in and going into low maintenance structures.

Condominiums are popular and will remain so and grow in popularity in the future. You’ll have to take my word for that. All you have to do is look around and see the growth of condominium developments that are spreading out everywhere. That’s because statistics show that the baby boomer generation as we get older is going to want smaller, easier, affordable, maintenance-free housing.

He's right about one thing. Look around you at the new condominiums springing up all around you. That's your future competition for sale, rent and every other business transaction. Then look around at all the empty space, the old houses that are falling apart and will probably be bought by a developer in the next 10 years. That's your competition for sale and rent 10 years from now. Of course, at that point your competition has brand new condos and you just have an old one.

Take another look at that plot of land. How many houses do you think could be built there? 10? 25? Against how many condos? 100? 500?

Unlike houses, which are all relatively unique (due largely to the plots of land they are on), condos are all the same. The only thing that is unique to a condo is the view it offers, and that's out of your control. Aside from the view, why would anyone choose your condo over the one two floors higher that's also for sale? What? You didn't realize that no matter when you sell, you'll likely be competing with other people in your same building? During a normal time (not the current crash certain areas are in) you probably won't be selling against 30 owners, but almost always certain to be selling against one or two. And what advantage can you use against them except lower price?(Photo taken from the Bubble Meter, also the source of my previous bubble pic here. All were taken in Northern Virginia)

With a house you can make improvements, maybe finally get around to building that deck. Then when you sell, you can try (or your realtor can try) to convince potential buyers that your house is worth maybe a little more than the one that just sold down the street last month, because yours has "features". Try doing that with a condo. If John Doe down the hall has an emergency and sells in a hurry for $50,000 lower than expected, your buyers are going to look at the comparable and ask "His unit is just down the hall, with the same floorplan. "Why is your place worth $50,000 more?"

But at least you can rent the condo out, right? The answer is a firm maybe. Your fellow condo owners are not fans of investors, those who buy and then rent out. Doing so lowers their property values. From a realtor website (with several other good questions to ask):

What percentage of units is owner-occupied? What percentage is tenant-occupied? Generally, the higher the percentage of owner-occupied units, the more marketable the units will be at resale.

The New York Times reports that condo buildings that have too many rented units could have trouble qualifying for mortgages! Try selling a condo when your buyer can't find a bank willing to back the mortgage.

Mortgage brokers and loan officers interviewed stressed that to lend money to the co-op corporation, for the underlying mortgage, or to individuals purchasing co-ops or condominiums when owner-occupancy is below 50 or 60 percent, certain conditions must be met. They explained that without these conditions, the risk of an investor who owns a lot of apartments going bankrupt -- and leaving the co-op in the lurch -- was just too high.

As a result, owners in condos are pushing their associations (and rightly so) to limit the number of units avaiable for rent. It is within the rights of the condo association to restrict you, the owner, from renting out your condo. (If you read the link, the answer that the columnist gave the owner is that since his association's By-Laws allow renting, they'd have to amend the By-Laws to pass any rules restricting investors).

So are condos all bad? Of course not, and in some areas of the country they make great investments. Where are those magical areas, you ask? Where there is no land available to build more.

I believe strongly that if you are interested in investing in condos, that you look to urban settings. Chicago, New York, San Fransisco, these are places that don't have any room for more condos. Alternatively, certain amentities, such as oceanfront properties, simply can't be replicated 2 miles inland. In both of these situations, basic economics tells us that if the demand grows, and no one can increase the supply, the price will go up. Buying condos in areas (such as the suburbs around any major city) where developers can add supply by the hundreds simply doesn't make sense.

The problem is that condos in areas like these can go for more than single family homes in most other areas. If you can't afford to buy a condo in those super-hot markets, look elsewhere. Town homes sell well as starter homes (unless in dowtown areas, then they are expensive homes), have no restrictions on renting and many families who can't afford to buy love the space and the yard afforded by a town home. Instead of buying a condo, why not buy an apartment complex? If you look to invest in a college town, look at buying one of those 6-8 unit complexes. No fees (since you control the entire building), no restrictions, and few competitors when buying. And they can often be purchased for less then the price of a condo in one of the major US cities.

Keep all of this in mind the next time you're looking at making that investment. The people who make the most from condos are the developers. And even they lose money sometimes.

What makes a bad investment?

So when looking for investment properties you need to do the math (don't worry, it's easy) to figure out if you are on the right track. I'll walk you through the process I take when evaluating a house, but since there are 2,000 bad deals for every good one, I'll be lazy, take the easy way out, and walk through my thoughts on a horrible investment property.

Let's start with the property (through a listing on craigslist.org):

$325000 INVESTMENT PROPERTY FOR SALE steps from Metro

6 MONTHS OLD LUXURY ONE BEDROOM CONDO RENTED OUT FOR $1450 PERMONTH TILL OCT 2007. STEPS FROM DUNLORING METRO. STAINLESS STEEL APPLIANCES, GRANITE COUNTER TOPS, SEPARATE LAUNDERY ROOM inside the unit, RENTED OUT TO VERY NICE COUPLE.

ALL THE AMENETIES YOU CAN THINK OFF POOL, GYM, MEDIA ROOM BASKETBALL COURT ETC CLOSE TO 495, 66, 29

CAN EMAIL PICS ON REQUEST. FOR FURTHER INFORMATION PLEASE CALL KAY AT 202-689-4256 I am a realtor working for FAIRFAX REALTY looking for buyer for this condo.

Ignore the poor English and terrible grammar for a second...

A 6 month old condo that has tenants? Either this is a strange flip, or an investment gone bad. Right now I'm going to guess the latter, that the original investors eventually realized what a bad investment the unit made and is now trying to bail. But we'll go ahead and continue our evaluation.

One of the first things I like to do when evaluating a new place is look at it on Google Maps. If you have an understanding of the area, this can be extremely enlightening. For example our property claims to be at the intersection of Prosperity Ave and Gallows Rd. By pulling it up in Google we can see that the area in question looks like this (the green arrow indicates the intersection):

This tells us a couple of things, it tells us that when the realtor mentioned proximity to the metro (the DC subway), she wasn't lying. The metro station parking lot is directly to the northwest of the green arrow. It also tells us that the condo in question almost certainly isn't in a high-rise, but instead one of the smaller complexes. So far the condo looks pretty nice. The proximity to a metro stop is a definite plus as that will continue to add value as the area gets more and more over-crowded.

So the buyer seems to be asking for $325,000. Let's make a quick assumption that you, as an investor, are going to put 10% down. That leaves you with a mortgage of $292,500. At a decent investment mortgage rate of about 6.5% (investment mortgages are typically about 0.5% higher than mortgages for a personal residence), we have a monthly payment of.... Uh-oh. $1848.

That's more than $400 a month more than the rent the unit is currently generating.

Let's continue our investigation. I'm going to assume for a moment that we can get insurance to the tune of about $50 a month. It may be a little on the cheap side, but if you do your homework and wrap that insurance up with your personal home insurance and your auto insurance, I'm sure you can get a comparable rate. That brings our monthly costs up to $1898.

In Fairfax County property taxes are set at 0.0089%. Assuming the unit in question is appraised near the sell value, that puts our annual property taxes at $28292.50, adding another $241 to our monthly bill, bring our total up to about $2139 a month to own this thing.

Since this is a condo, the association will charge a monthly fee to maintain the complex. These fees can vary wildly from building to building and aren't publicly advertised. The best place to get them is to look up the condo on google and try to find some resident complaining about the fees via a forum. Since I don't know the name of the complex, I can simply google "Gallows Rd Prosperity Ave condo".... and it looks like I hit the motherlode. The second link leads to a blog that I'm somewhat familiar with, referring to a condo at Dunn Loring called the Halstead. The link shows a wonderful picture depicting the number of units for sale in that particular project:

Even if our condo isn't a part of the Halstead, it's right across the road from them (on the Google Map the Halstead is built in the woods directly south of the metro. Consistent with our "6-month old" description). So this photo gives us a lot more information about the market in this particular area. We've now found strong evidence that this is a strong buyers market which will give us a lot of strength in negotiating, if we decide to buy the place.

But we still don't know about the condo fees. Unfortunately further searching is fruitless. No specific information can be found. But after a little bit of googling I can estimate that the average condo fee for a 1-bedroom in Fairfax is between $200-$250 a month. Since this condo is extremely close to DC, I'm going to assume that the condo fee is on the high side of that, giving a new monthly total of $2389, but since most numbers in this article are approximations, we'll round it to $2400.

So if our numbers are somewhat in the ballpark, at the rate the current tenants are paying (until October 2007), we'd be losing $1000 a month to pay for this property.

Is the rent too low? Maybe the condo is in relatively poor shape and we can fix it up, or perhaps the condo is just being under rented. There are a variety of methods you can use to determine fair rent, such as craigslist, your local papers, etc. According to Rentometer.com, the median rent in our area for a 1 bedroom is only $1300. Proximity to the metro can easily explain why this property is earning more than the median, and when the tenant moved out, I wouldn't be surprised if we could easily get another $75-100 a month out of the place.

Adjusting rental prices to account for amenities is more of an art than a science. Amenities that could inflate rentals in one investment type, could do nothing to another. For example, when dealing with a one bedroom apartment, it's probably a waste of time to even look at school district information. Biff and I's townhomes, however, are located in the best school district of their county, which is a significant advantage for them. On the other hand, proximity to a college campus is more likely to raise the rents of apartment/condos than single family homes.

So what have we learned?

• At the current price, we'd have to expect about a $1,000 a month loss to maintain the property.
  
• The rent is already relatively fair and while we could probably milk a little more out of it, it's unlikely that we could get too much more.
  
• Given that the condo has a tenant and is only 6 months old, the seller is motivated. They either need the cash right now, or their "investment" is sucking the life out of them.
• Most likely, as learned through Google, condos in the area aren't selling very well and there is a very large number of them on the market.

So the deal, as stands, probably isn't a good one. If you estimate that the unit could take in about $1500 a month, once you subtract the condo fees and the insurance, you're only left with about $1200. If you take out property taxes of about $200 a month, you're left with only $1000 to pay the mortgage with. This condo will likely only be profitable if your loans are only equal to about $150,000. (By the way, note that the largest single expense on this property is the condo fee. It's only an estimate, but I would be surprised if the condo fees were lower than that, and not very surprised if they were higher. This is one of the reasons I'm not a big fan of condos, the fees are so high that they just eat up your income.)

So the final verdict? I actually like the area the condo is in. Being located across the street from the metro station is a tremendous asset that will help the unit's appreciation significantly over time. However right now the asking price is far too high. Given what we know about the condo, I think that there's no chance we could make a positive investment out of this unit.

Obviously I'm not surprised with the result. For one thing, there's no real way in which we can add value to the unit, short of dumping a tremendous amount of cash into the down payment. Not to mention that if you are looking for good investment properties, craigslist probably isn't where you want to start, especially with listings that scream GOOD INVESTMENT in their title. Those are usually anything but.

But just for recap, let's run over the important steps we took on this little path of discovery:

1. Look up location on the internet, figure out distances to major highways and landmarks. Maps are invaluable. Even if you go there in person, unless you look on a map you might not realize that I-95 is just a minute away.
2. Google the name of the complex. You never know what might turn up (like our photo above).
3. Estimate your mortgage costs.
4. Estimate your insurance costs.
5. Research the local property taxes.
6. Are there any condo or home owners association fees? Either research or estimate them.
7. What rent can you get? Figure out local averages and then adjust for specific amenities.
8. Compare the costs to the rental income

While the actual methods and formulas that investors use to make their investment decisions vary widely from one investor to another, almost every method requires that you determine the above information. Without this data you are just helplessly speculating.

Try a college town

A short while back I wrote an article about how money is made in real estate. No the answer wasn't to "buy and hold" or even to "buy and flip". The answer is to provide value to one of your three client types, either the seller, the tenant or the buyer. While maximizing value to the sellers and buyers are often discussed, maximizing the value of your property to a renter rarely is. I mentioned in my article that working with people who were not motivated to buy could raise your rental value. CNN.com just released an article that said roughly the same thing.

Why are college students such a good market? Simply the fact that they're not going to be around very long. As I mentioned before, transient populations, groups of people who move around a lot) make a wonderful rental opportunity. Your average renter, if faced with the option of renting for $1000 a month or buying for $1050 a month would always choose to buy. But your average college kid still wouldn't buy. Even if they had money it wouldn't make any sense because once you factor in closing costs and realtor's fees, they would rarely break even after 3-4 years.

The secret here is to find tenants who have money but don't want to buy. Biff and I have currently identified two demographics that fit that description. College students (who parents can pay nice rents) and military families. Military was the demographic we settled on due to Biff's proximity to a heavy military population. When we bought our first property we only put 10% down, yet were able to find someone who was willing to pay a high enough rent that we immeadiately had a $25 monthly positive cashflow. Even though our tenant wasn't military (he was ex-military), the large number of military familes looking to rent in our area has pushed up the average rental prices to a point where we were profitable on day one.

So what other demographics can you think of that fall into the "have money but are unlikely to buy" category?

Breaking down a lease

Own some land and going to rent it out? Before you hand over the keys, make sure your tenants sign a lease. No matter how good a tenant looks, things can always go wrong.

"But how do I make a lease?", you ask. "This is why real estate is so much more complicated than stocks and why I'll never get into it. I'm not a lawyer you know!"

Not so fast my friend. While legal forms, such as a lease, can be intimidating, in the end they're just a list of things you agree to do and a list of things your tenant agrees to do. Usually that's wrapped up in a bunch of legal-ese, but it doesn't have to be. You can very easily make your own lease, or even get one from the web (google the phrase "residential lease" and you'll get tons of templates to use).

Now even if you pull a template off of the web, you need to review it carefully to make sure it covers everything that's important to you. Let's look at the anatomy of a lease and specifically cover the areas that are absolutely necessary to have included in your lease.

A lease consists of 4 basic parts. The first part dictates the specifics of the lease, the rent and dates and so on. The second part explains your rules for living in your house. The third part deals with how you and the tenant will interact, and the last part just deals with the document itself. Sometimes these parts are a bit jumbled up, but they are usually grouped together.

So the first part of the lease deals with the specifics. This is the part of the lease that you have to change every time you get a new tenant. In this part you have to explain:

• The length of the lease (also referred to as the Term)
• When the lease begins, when does it end?
• The rent owed. Most leases will give a total of the amount owed over the life of the lease, and then specify how it's to be paid (i.e. $X on the first of each month)
• Any money that is due up front, i.e. a security deposit or first and last month's rent. You should clearly state how and when they can get their deposit back (such as "after all deductions for damage have been taken out, the balance will be returned to the Tenant within 45 days of the end of the lease").
  

I want to take a quick second here to talk about security deposits. Virginia actually has an entire section of law just about how security deposits are to be handled. Every state is different, but I believe most states have similar laws in place, though the specifics may vary. In Virginia, for example, the maximum amount you can ask for a security deposit is equal to two months rent. And if a landlord holds a security deposit for more than 13 months, they have to pay interest on it when they return it. Please take a look through your state laws, or just try to find a FAQ that can answer those types of questions in your state.

Now that we've dealt with the specifics of when the lease takes place and how much the other person owes, it's time to talk about the most important part, protecting your assets. The next section of the lease should dictate the rules that you want to set down for your property, and while those rules can vary from investor to investor, a few rules should be in every lease.

• How many people can live in the house? This should be filled out before the lease is signed. How do you differentiate between a tenant and a guest? Trust me, you don't want the Cletus's moving in and then having their extended family move in with them.
• Subletting rules. Subletting is when a tenant decides to rent their lease to someone else. This can often happen in college towns when students will sublet their apartments over the summer. Do you allow it? Do you require approval before it's allowed?
• Can the tenants alter the house? Put up some new paint? Replace ceiling fans? Unless you chose a tenant because you want them to improve the property, it's probably best to prohibit alterations to the house.
• How are utilities to be treated? Will you cover them and wrap them into the rent? OR is the tenant supposed to take care of them (including setting them up)?
• What about pets? Allowed? Not allowed? Are hamsters ok, but a fish tank forbidden?
  

In addition to this you need to think through all the other rules as well. If there is a yard, who's responsibility is it to keep it clean? If there's a Home Owners Association, they need to be made aware of the rules. Any rules you can think of for how you want your property treated should be covered here.

In the next section we talk about the relationship between you and your tenant, and what happens if things go wrong. Hopefully nothing bad will happen (the worst Biff and I have put up with is our first tenant hanging animal heads on the walls), but if something goes south you will be extremely glad you wrote this part of the lease. Things to cover in here include:

• The property is in good condition before the tenants move in. This is important to state and have the tenant sign, in case they wreck the place they can't tell the judge "it was like that when I got here". This, by the way, should be accompanied by an inspection form that you fill out when you let the tenant into the property for the first time.
  
• Your access rights. As the owner of the property you have the right to inspect your investment. The tenant should do anything to bar you from areas of the property (such as changing locks).
• What if someone gets hurt on your property? You need to have a clause in there saying you are not liable (called "indemnification"). Of course if someone is injured due to your negligence (you never got around to fixing those old stairs until the collapsed) the judge will throw this clause out, but if someone trips and falls down the stairs by their own stupidity, this will assist your defense.
• If the rent is late, what next? Do you impose a late charge?
• What if either you or the tenant want to break the lease (maybe you have a buyer who is very interested)? How is that situation to be handled?
• Let's say the lease ends and the tenants moves out, what happens to thing the tenant leaves behind? Include a clause that explains that you have the right to treat such things as "abandoned" and can dispose of them as you wish (even in auction).
• When the lease is over, then what? Does it continue on in a month-to-month fashion? You definitely need a clause that states you expect the property to be in as good of shape as when the lease began (excluding wear and tear, of course).
  

A few more things to note in this section. I also have a clause in my lease that says the tenants must leave notice to us if they will be away from more than 7 days, so Biff can keep an eye on the property. As for early termination, if you believe the military will make a reasonable portion of your tenants you should be aware of a federal law that allows soldiers to break a lease penalty-free if they are being shipped out or reassigned. They have to provide you with a copy of the written orders to do so.

Finally the last section of the lease is simply the rules about how the lease itself should be treated. Weird, huh? Yet every lease should mention:

• The fact that this is a binding document. You might get away without having it, but it certainly can't hurt and helps diffuse any possible "ignorance" defenses.
• That the lease cannot be modified by either party without all parties signing the new amendment.
• Severability. This is a fancy legal word that means if some part of this lease is invalid for some reason (like a judge throwing out you no-liability clause) the rest of the document is still considered valid, instead of the entire document just getting thrown out.

Congratulations. You've just written a lease. Now at the bottom make sure you have room for both you and the tenants to sign and date the document. With this document in hand, you are ready to protect both your property and yourself.

What's attractive about real estate?

Why would an individual choose to invest in real estate instead of something else like stocks or bonds, or start some other sort of company like a gas station? Here's a quick list of some of the things that characterize long-term real estate investing (flipping is a different beast all together). If some of these appeal to you then maybe real estate is right up your alley.

Real estate investing is:

• Entrepreneurial - With stocks and bonds you just choose, buy and then watch things happen beyond your control. With real estate you are essentially creating a company that you can impact the success of. You have to deal with things like revenues, expenses, interviews (for tenants), contractors, accounting and the like. Being a land lord is being a businessman, which can appeal to a lot of people.
• Income Generating - Land lording produces an income stream in the form of rental payments in addition to the appreciation of the house. This can be very attractive to people who are investing with goal of using some gains each year to cover running costs (like putting kids through college). With stocks or bonds you have to constantly be selling to meet those costs.
• Off Hours - Unlike trying to open a retail store, most of the business transacted in real estate occurs outside of regular work hours. Since tenants, for the most part, tend to work the same hours you do, showing properties or dealing with problems tends to occur more often after five than during the day. If you work a regular job, this makes real estate investing a feasible business.
• Not Correlated to Stocks and Bonds - Obviously, in the end all things are related (especially to the interest rates). But for the most part real estate is pretty separate from the stock market. Houses can go up in price when the market is booming and they can go up in price when the market is flat (and they can go down during both periods as well). So real estate is an attractive diversification strategy for many. Though I have yet to meet a successful land lord who didn't have a nice stock portfolio.
• Long Term - In general real estate is a solid long term investment. When you get into real estate you typically stay in it for a while. For some people that's a major negative, but for others that's a very attractive characteristic. The money I have in real estate right now will be in real estate for some time, out of my reach. Even if I wanted it desperately it'd be weeks or months before I could get anything into my checking account. It's safe from any emotional decisions I could make (like letting my fiance talk me into spending some of it on our wedding).
  

Most (if not all) of those points should speak very strongly to you if you are considering real estate as an investment. For me personally, I tend to feel the strongest about the facts that real estate is entrepreneurial (I've learned an amazing amount about taxes and accounting since this began) and long-term.

Buy now? Or is it too late?

Lots of people ask "Is this a good time to be getting into real estate?". As always, it depends...

The housing market right now is wildly overpriced -- in some areas. Therefore the first question is simply "Where do you want to buy?" While an extremely important question, it's not the only one worth asking. The second question you need to ask is "Why are you investing?" which is a subject I'd like to pontificate on today.

While some late-night-TV scam artists will try to convince you that you need only to buy a parcel of land and money shall rain upon you like the allegorical felines and canines, there is a little bit of work and research to be done. Money in real estate can be made in some combination of two streams:

• Rental Income
• Appreciation

(While it's true that you can also save some money in tax write offs, no one buys real estate just for the deductions. It'd be a slow and painful route to riches.)

So while you examine your local market, look at multiple things. How much have the houses gone up in your area over the last few years? If it's been in the double digits, then odds are you missed the appreciation train and can't expect tremendous returns through appreciation alone. You can also read up on experts analysis of your area.

According to the sources I linked to, the area Biff and I invest in went up by 27% last year and are currently over valued by 16%. So the outlook of big gains through appreciation over the next year or two look slim, but still possible. Personally I forecast growth of about 6-8% this year, since we lagged behind the rest of the nation in appreciation.

The next important thing to research is rent in your area. Start by simply looking on rent.com or rentclicks.com or some other similar website and compare rental rates in your area. The type of housing you are interested in (condo, townhouse, etc) and size tends to pull down what sort of rent? Have rents been moving up or down? If you are in a market that has rapidly overpriced recently, it's very likely that rents will quickly rise to match. So if you were looking at buying an apartment building this might be the right time to buy, while rents are still relatively low.

Don't be afraid of the numbers. Learn to love them. What sort of mortgage would you have to take out to get a house? 80%, 90%? How much of your mortgage could be covered by rental income at the current level of rent in your area? If houses have gone up, rents will probably follow, would that put you in the black? Could you survive comfortably until then?

The run-up in housings costs have done two things to the investment property market. It's made it more expensive to get into, and it probably guarantees that a run like this one won't happen again for another 5-15 years. But that doesn't mean there aren't good, money-making deals out there. In some market it might make sense to hold off from buying (for the same reason I'm renting), but in many other the opportunities are there. Just bear in mind that the crazy run-ups of the last 5 years are mostly gone. Real estate investing has gone from wild speculation and insane profits back to a simple, effective way to generate a solid cash flow.

Effects of buying houses in different price ranges

In my last post I talked about learning to set a fair rent value for a property. Both Biff's research and the bankrate.com article indicated that the lower the price of the home, the better the return you get on it.

Therefore it seems like a no-brainer to buy cheap homes and rent them out right? Well... maybe. Biff asked me to do a quick rent comparison for investing $400,000 in various house combinations to compare what sort of rental conditions we're looking at. Here's what I sent back to him:

Monthly rent income on a combination of houses with a combined total worth of 400K (approximate).
$2,250 = 1 400k
$2,450 = 1 300k, 1 100k
$2,500 = 2 200k
$2,505 = 3 133k
$2,550 = 1 200k, 2 100k
$2,600 = 4 100k
$2,500 = 4 75k, 1 100k

As it turns out, buying lots of smaller houses does seem to offer you more in the way of rental income. However, there are more factors to consider than just rental yields. In the same e-mail to him I looked at a few other factors, some of which argued against the more/cheaper homes model:

• Cheaper houses, and thus cheaper rent, can lead to less desirable tenants. In other words, the more expensive the rent, the more likely that the person who can afford it is somewhat responsible.
• More houses takes more time, from both a landlording point of view and an accounting point of view.
• Each house will incur closing costs. On the above model it'd take the best 2 house model almost 2 years to turn a great profit than the 1 house model, assuming a $5,000 closing cost per house.
  

And some which supported buying multiple cheaper homes:

• More houses increases your chances of vacancy, but lowers the cost of it. If you own one $400,000 house and can't find a tenant, that's one hell of a mortgage you'll have to cover.
  
• You can buy as you go. You might not have enough to buy that $500,000 apartment building yet, but instead of plopping that money into savings it might be better to start investing with something smaller.

So which is best? It depends on your business model. Biff and I decided that our goal was to cater to young military families. So we're looking for townhomes with plenty of space in the $200,000 range. Upscale and expensive that we don't get much attention from young bachelor that might treat our property with less care.

The Landlord's Toolkit

Getting into real estate, you'll need a lot more than just cash. There's a lot of other tools you'll need before you begin (or at the very least, shortly after). Check out this great article from CNN.

For reference, as the accountant and general financial manager of our company, I started using an Excel spreadsheet to manage out finances. I'm extremely comfortable with numbers and don't feel a strong need to have some program manage that for me. I've only started moving away from Excel about one month ago when I discovered Google Spreadsheets. It's not quite as robust as Excel, but the ability to login from anywhere and update my finances is utterly invaluable.

Maybe tomorrow or the next day I'll go over how I build my spreadsheet to easily keep track of expenses. However I've read in many places that several landlords can't live with out either Money or Quicken, so if you want to go that route you are probably in good hands.

And, for the love of God, buy a digital camera. Both Biff and I each have one and it's been used more times than I can count. We have endless pictures of our properties. Imagine getting a call that your tenants have no hot water. You call the plumber and, as he asks you questions about the house, you pull up your picture of the hot water heater and can answer all of his questions immediately.

Buy a camera. Use it.

I think that later tonight, or maybe tomorrow, I'll talk about some of the paperwork you'll either need or need to become familiar with...

Where to call home (or: finding a market to support our ambitious plans)

So once you've decided to buy an investment property, the next question is where?

I strongly recommend buying somewhere easily accessible to you since I DON'T recommend using a property management company (that can be saved for another post). It's almost certainly best for you to manage your properties yourself.

But if you are in a central area (say Washington DC), or there is more than one person partaking in this venture (dealing with more than one person in a real estate venture is also going to consume an entire post at a later date), then you have options. Here's a short list of things to consider when looking for the first property:

- How expensive are the houses? Can you afford to buy in that area? Even more importantly, can you afford to pay the mortgage if your property is vacant?

- What is rent like? Study this for at least 2-3 months. Are rents rising or falling? Look at places comparable to what you want to buy, how close are the rents to what you'd estimate to be your mortgage payments? It unlikely that you'll be able to rent that place out for more than your mortgage payments (although Biff and I got lucky and did just that), unless you made a huge down payment. Can you cover the gap each month?

- What sort of people are living in the area? The type that are looking to settle down? Or is it a more transient population, people who are just here for a few years before moving on? Obviously both populations can co-exist in the same area, but many areas tend to lean heavily in one way or another.

- As an extension of the above question, what was the demographic you would be targeting? Families? Young singles? College students?

- How much money do you have? This is a crucial question. I don't believe for a second that you can buy houses for No Money Down and make a profit on them. I intend to write yet another post simply on saving up for a down payment, but in the mean time I simply believe that to be successful in real estate you need a decent amount of cash saved up. Remember that, even if you buy for No Money Down, you still need a cash reserve for any emergencies (like a leaky roof).

These were the questions that Biff and I asked ourselves when we were starting out. My initial bright idea was to buy in our college town. On the plus side the homes there were relatively cheap (especially compared to Washington DC), we understood the area (I spent 4 years there, Biff was there for over 8), and the constant flow of students in and out each year would always give us a huge pool of potential tenants.

The bad side of the equation was simple. Neither of us lived closer than 3 hours away from said town, and college students can range from simple and quiet to wild and destructive. Such a property would probably require more maintenance than your average place.

I still thinking that owning in a college town can be a great idea, and there's no shortage of non-urban campuses to consider (non-urban implies far more affordable properties). And someday we may further pursue that idea. But at the time Biff trumped my idea with a far greater one.

We decided to buy near Williamsburg, where he lived. Houses were just about as inexpensive as the college town. There were 3 major military bases within commuting distance and several more smaller ones. The military became our target demographic, they move every few years so they are less likely to be interested in buying, the ones who choose to live off-base tend to be very respectful and quiet, and they have salaries.

So before you buy a property, consider the above questions and try to come up with new ones. At this point we're just interested in finding a general location so don't bother asking questions like "Should I buy a townhouse, condo or single family?" unless it directly pertains to your market.