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Becoming a small-time landlord is not some sort of financial genius move. It is an ordinary job and a rather poorly paid one.

Posted by John Reed on

It is common among very young novice real estate investors to seek as an end point the ability to stop work and just live off the cash flow from their empire of duplexes and other residential rental properties. This is get-rich-quick guru nonsense.
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1. Owning rental properties is a job. I calculate it takes 3.6 hours per unit per month to manage them. At about the 40 units level, that is a full-time job.
2. The cash flow, if you have it, comes from your equity being about 50% of more of the value of the property, not from accumulating more units.
3. Your cash flow is maximized when you own the property free and clear. That also reveals what lousy investments rental properties are until you factor in price of the building appreciating.
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Let me illustrate with a Redfin example. The median home price in the US is about $375K. That is also about the median MA home price. So let me pick a Redfin house there and see what the rent is. I found one for sale at $370,000 at 17 Commodore Road, Worcester, MA.
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Redfin says the rental value of this house is $1,800. Generally, operating expenses for a rental house average about 38% of gross rent. 38% x $1,800 = $684 a month leaving positive cash flow of $1,800 - $684 = $1,116 positive cash flow x 12 = $13,392 a year. So the return on equity of the house would be $13,392 ÷ $370,000 = 3.6% return.
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Today, you can get 3.6% return in a US corporate bond fund. I suggest that you also can live without working if you own the home free and clear, live in it, and also have $684 x 12 = $8,208 ÷ 3.6% = $228,000 bonds which will throw off the interest to pay the house operating expenses.
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That would eliminate the need to spend many hours per month doing unpaid work to manage your rental units.
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The Vanguard High Dividend Yield Index Admiral Shares (VHYAX) is a fund with a SEC dividend yield of 2.75%. The stocks in that fund can also go up in value. Again, you do not have to do anything to receive this money. You manage no buildings. You get sued by no one.
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Subjecting yourself to all the hassles of being a landlord only gets you a fraction of percent more than owning GNMA bonds or dividend stock mutual funds.
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Owning rental real estate free and clear ties up a whole lot of equity and produces a mediocre level of cash flow return on equity plus takes up much of your time and exposes you to tenant lawsuits. You can produce similar returns on equity from ordinary, run-of-the-mill mutual funds and bond funds.
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But somehow, a million novice investors have got it in their heads that if they own enough rental property to live off they are getting over on life. They like to call owning rental property that they live is a “house hack,” suggesting they have broken some secret code of money making.
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Nope. Being a landlord is a daily grind of chores and tenant disputes and probably attracts more lawsuits than any other occupation. If the pot of “gold” at the end of the rainbow is a mediocre 3.6% return on equity, how does this equate to some sort of financial genius way to spend your adult life? How is this being a small-time landlord somehow much smarter than getting an education, working as a professional, saving, and investing in your own home and index funds?
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