In the 1850s gold prospectors from Kansas and New Mexico came to Colorado seeking their claim in the Pikes Peak Gold Rush settling along the banks of the South Platte River, Cherry Creek and Clear Creek. The cities of Denver, Boulder and Golden each have their roots in this speculative era when Colorado was part of the Kansas territory.
125 years later, The Denver Gold, were one of the original teams in the upstart spring professional football league.
Old habits die hard it seems and I always welcome conversations on speculating in real estate. With Denver being one of the hottest markets since the 2008 - ’09 recession, these winds are stirring here again. Adding fuel to that fire are historically low mortgage rates that make real estate investors froth at the mouth for the opportunity to strike it rich using borrowed money.
All that glitters is not gold and real estate speculation warrants a careful examination. The first question to ask, “Do you want to be a landlord?” Take a moment to imagine a few scenarios.
Scenario 1: It’s been a long Monday at work. You get home to find what appears to be a busy restaurant in a dinner rush operating in your kitchen. Just as you’re starting to get the situation under control, the phone rings. It’s your renters. They tell you that they got home to find water pouring out of their dishwasher and they need you to come over as it has flooded the entire first floor and water is running down the walls into the basement.
Scenario 2: You’re vacationing in Mexico. As you are relaxing on the beach you decide to open Facebook to do some brainless mental recreation. The first post from your former neighbors reads, “Watching water pour out of our next-door neighbors 2nd story exterior walls is somewhat relaxing”! What? They live next door to your former home…the one you turned into rental property. You don’t “like” what you see and you end your vacation immediately.
Scenario 3: The renters have not answered your friendly reminder that rent was due 3 weeks ago, so you decide to pay them a visit. When you arrive, you find the house is dark. Assuming that the porchlight must be out you attempt to ring the doorbell. It doesn’t ring. Becoming concerned, you peer into the window on the front porch. To your surprise, the house appears empty. When you go inside, you find the house has been abandoned and where there were once light switches there are now gaping holes punched through the dry wall. It appears that the renters took everything, literally. They have ripped electrical wiring from the walls and the place is absolutely destroyed.
Now let’s get back to the main topic. How much financial “cents” does investing in real estate make? Well, it depends on the approach. Are you investing for passive income? Leveraged growth? Or, just wanting to diversify your retirement dollars into a “real/tangible asset”? Maybe you’ve thought, “I’ll let someone else pay for it while I own it” or “they are not making any more real estate”. All of these are good thoughts and some decent arguments but again I ask is it really the pot of gold at the end of the rainbow?
Aside from these nightmare scenarios, when looking at rental properties you have to take a realistic look at what is required. First, establishing an LLC (limited liability corporation) can protect you from potential claims made against you as the landlord. Be prepared to make a sizeable down payment. Depending on the bank’s financing terms and the local rental market, you may need to put down considerably more than 20% of the purchase price. Also, make certain to have an attorney draft your lease agreement to make sure that it is comprehensive, detailing the expectations of all involved. You will need to setup an operating account for the property to receive rental payments as well as to make mortgage payments, homeowner’s association dues, property tax, hazard insurance payments and a separate reserve fund to save for periodic maintenance such as new paint and carpeting every seven years, hot water heater every ten years, air conditioning unit, roof, landscaping, etc… You should also ensure you always have enough to cover an insurance deductible in case of the unexpected. Don’t forget to background check your potential renters. They may seem like the Flanders when they answer your ad but I promise you, some will move-in with a sixteen year-old Bart Simpson. Did I mention that you may need to hire an attorney (and a cleaning service) should you have to evict?
One of the most often cited experts on the topic of real estate is Nobel Laureate, Yale University Professor- Robert Shiller. He does not believe real estate is a great investment unless you are going to make a full time job out of owning and renting multiple properties. The S & P Shiller-Case Housing Price Index Nationally from 1988 – 2011 measured the real appreciation on residential housing at a dismal 3.20% per year.
While we all probably know someone who sings the praises of their real estate investments, most people who have done it for any period of time will be glad to share with you a horror story or two. At the end of the day, there is a lot more to real estate investing than meets the eye so take your time and do your research to ensure that what you’re looking at isn’t fool’s gold.