A Rental Property is More Than an Investment

This article was first published on my substack at https://successfulrental.substack.com/.

You often hear a rental property called an investment property. 

According to Merriam-Webster, an investment is defined as "the outlay of money usually for income or profit: capital outlay."

So, yes, definitely - a rental property is an investment property that should provide short-term cash flow and build long-term wealth that a properly purchased and managed rental property can create (ground shattering insight there!). I will tackle that "should" word in a future article.

I want to focus on that word "investment" as it relates to thinking about rental properties.

Let's Outlay Some Capital!!!

Commonly, when you hear the word investment, you think about stocks, bonds, brokerage accounts, retirement plans or possibly real estate or maybe one of the other myriad investments you can make these days (looking at you Bitcoin and crypto-world). 

With your average investment, you only make four decisions - how much money to invest, where to invest (ex: TD Ameritrade or Fidelity), when to invest (ex: now, attempt to time the market, dollar-cost averaging) and when to divest (ex: specific time/life event, profit target, investment ends). That is it.  

Sure, each investment type has its nuisances, but most of them boil down to those four questions - that is it. Nothing more. Depending on the investment, some of those questions will be answered for you. 

Most of your potential investments are passive. You can buy some Apple stock, but you do not tell Apple how to run their company. You can buy an expensive painting, but you do not tell the painter what to paint. You can buy some Bitcoin, but you do not decide how the blockchain operates.

Usually, after you outlay the capital, you sit back and wait. Maybe you obsess and track the investment or perhaps you are a set it and forget it type. Either way, you do not take another action until you decide to liquidate the investment. A two-step process; you researched the investment at the beginning and took action at the end to divest with a whole lot of nothing in the middle. 

Yep, those are passive investments, and if your investment is sending you money (say in the form of dividends), that is passive income. YES!!! Your money is working for you and producing more money - ka-ching!!!

Show Me The Passive Income Money!!!

Capital is capital and investments are investments: return on investment, cash on cash return, leverage - just calculations and math. Numbers are numbers, right? An investment in the stock market has gotta be the same as an investment in a rental property???

Dividends just show up, so stocks are a form of passive income. Rent payments just show up, so rental properties must be a form of passive income as well. 

Yes, rent payments are passive as long as your tenant pays on time. But, does that translate to rental properties are a source of passive income?

The tenant pays rent each month. You log into your online bank account to check if the payment cleared. Boom!! Done!! Margarita time until the rent payment lands in the ol' bank account next month.  

Just like your stock dividends, your rental property is Passive with a capital "P"... uh oh....

Hold on... while you are mixing that second margarita or pouring that new local craft beer you are excited about, the tenant called - the toilet is leaking. 

I can assure you there is nothing passive about replacing a toilet wax ring. It takes a lot of work to lift and move a toilet, and then lift and reset it. 

Easy peasy lemon squeezy, you called the plumber - back to passive income and pouring that second drink. 

Oh wait, the plumber is busy and cannot get there for a few days? Oh $@#!, the toilet water supply line is what is leaking and the supply line shutoff valve is old and will not turn. The water will not stop running and is starting to drip through the first-floor ceiling. 

Which plumber do you call now? You need someone there ASAP before water damage starts to occur.

Do you keep calling plumbers until someone can get there? Do you drive there yourself to make the repair or at least turn off the water main until a plumber can get there? Do you call your cousin twice removed on your mom's side because you heard he is handy?

While those rent payments are passive, as you can see, they are only one facet of owning a successful rental property.

Not All Investments Are Equal in Effort or Management

For clarity, let's hit the point home with a few comparisons of owning a stock and owning a rental property:

1 - when the refrigerator in one of Apple's corporate breakrooms breaks, you, the investor/shareholder, never hear about, think about or contribute a penny to replace it.

2 - when your rental property refrigerator breaks, you, the investor/owner, spend money to replace it. 

1 - when you invest 200k in Apple stock, Apple will not come around asking you for more money based on the shares you already own.

2 - when you invest 200k in a rental property, that rental property will come around holding its hand out asking for more money.

1 - when you invest money in Apple stock, Apple plans for income, expenses, customers, cash flow, changing market conditions, asset management, etc. 

2 - when you invest money in and own a rental property, you plan for income, expenses, customers, cash flow, changing market conditions, asset management, etc. 

Maybe you have heard owning a rental property is like running a small business.

Like running a business? Almost but not quite there... Owning a rental property is a business. 

Does that mean owning a rental property is better or worse than other investments?

No - it means they are different and cannot be treated the same; they have different types of risk and liability; they require different levels of your time, management and involvement.

More Than An Investment

Yes, rental properties are investments, and you need to understand your property is an investment and make investment decisions. But, your thinking must go beyond the numbers.  

You have a widget (rental property) to sell (rent) to a customer (the tenant) for a period of time, and when the customer gives the widget back, you do it again. Yes, very much a business, and at times, there will be a lot of work.

For this process, you need a combination of cash flow and reserves to pay for repairs (some planned (new roof) and some unexpected (broken fridge)), and you need to advertise the property for rent, screen applicants, prepare the property for the new tenant, make repairs, select vendors, know federal, state and local landlord-tenant laws, have legal documents and a good bit more - you wear a lot of hats when you own a rental property. 

Do you see how thinking about a rental property as an investment is only the beginning?

Let's nudge this concept a bit further. 

If the tenant clogs or breaks the garbage disposal, you send out a repairman to resolve the problem. In South Carolina, I have the option to pass that expense along to the tenant to reimburse me for it due to the tenant's actions caused the damage. 

If I am only looking at the numbers, I certainly will pass that expense onto the tenant. But, as a student of my craft, I know the top two reasons tenants move are 1 - they do not like the landlord/property manager and 2 - they do not like how maintenance is handled. Usually, how maintenance is handled leads to not liking the landlord/property manager, so the top two reasons tenants move are maintenance-related. 

Would a tenant move for me billing them the $175 garbage disposal replacement? I do not know. 

What I do know is the average tenant turn costs roughly 1/2 to a full month's rent or more (sometimes, much more).  I would rather eat the $175 cost as a goodwill gesture towards my customer/tenant to keep them as a customer/tenant. The age-old business advice is it is less expensive to keep/sell to an existing customer than to find a new one.

Or maybe the tenant has been challenging to work with and I do not plan on extending the lease, then I might bill the tenant for the repair.

Or maybe I recently paid to unclog a toilet and I do not want to eat another tenant caused expense, then I might bill the tenant for the repair.

Are those examples of what you should do in a similar situation? No, of course not. That is the thought process you should go through as a rental property owner. You need to think beyond the investment numbers and make the bigger picture, judgment decisions of a business owner. 

What are your goals? How does this rental property help you reach those goals? How does this decision help you use the rental property to reach your goals?

Those are questions you need to consider when making decisions about your rental property.

But I Have a Property Manager

"I have a property manager, so I do not need to worry about it anymore." Yep, I hear that a bunch. In a future article, we will dive into why abdicating the business owner's responsibility is a bad idea. 

I am not implying you physically do the work; you can hire a plumber to complete the repair or hire a property management company to coordinate the day-to-day stuff. I am saying if the work is not done properly, you are the person who will be financially impacted.

When you own a rental property, the buck stops with you. You are ultimately responsible for the property.

Treat It Like A Business

Yes, a rental property is an investment property, but it is so much more. 

Owning a rental property is a business, and it must be treated as such to be successful.

I love rental properties. I know they can make great investments in the short- and long-term.

How you look at and treat your rental property will go a long way towards your investment being successful by providing short-term cash flow and building the long-term wealth that a properly purchased and managed rental property can and should create.

This article is Part 1 of A Rental Property is a Business.

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