Cute is for Kittens

Last week I got an odd e-mail from the manager of my bank, Jenny. You see, she contacted me because she is interested in buying her first rental home. She knew I was a real estate agent. And, she knew I was a landlord. Could I help her?

I am convinced she must not know any other real estate agents in the entire Phoenix metro area, because Jenny does have access to my rental's bank balance. Even owning a gazillion rental homes, it is safe to say we aren't rolling in dough (but that is for another blog).

On our first journey into rental home shopping, Jenny, Mr. Jenny and I stopped by a condo she had picked out. As soon as I met Mr. Jenny, I knew there was trouble. He isn't on board with this whole rental home thing. It wasn't just his body language or his outward hostility towards me that clued me in, it was these exact words he uttered to his loving wife as we crossed the threshold into the first property, "I don't want to buy a rental home."

I can tell you, as a real estate agent, and more importantly as an investor: if one party isn't on board, there is no reason to continue. If Mr. Jenny had to be talked into driving out to see one condo, it wasn't going to get any better than this--no matter how much Jenny put a positive spin on the situation.

That said, I knew I was in trouble when we entered the home and Jenny started gushing about "how cute" the place was. These are not words spoken by investors. These are words spoken by someone wanting an expensive hobby. A true investor isn't looking for something "cute."

So... Saturday, I sat down with Jenny over iced tea and spelled out the situation to her.

First, she is starting a business. No matter if she is buying her first home or her twenty-seventh, Jenny needs to think like a CEO. CEOs don't look at homes and use the word "cute." They look at homes and say, "I can make $300 a month positive cash flow."

Next, in order for this whole rental property thing to work, both parties in the marriage must be on board. If Jenny forces Mr. Jenny into buying a rental home he doesn't want, no matter what happens there will be trouble. The tenant is a day late, it is a major stress. The garbage disposal stops working, Mr. Jenny won't take kindly to it. Essentially, make sure Mr. Jenny is saying yes to a long-term commitment and not saying yes to placate Jenny and her new shopping hobby. It will not get any better from there.

Jenny and I also talked about what she wanted for a tenant. She started with a "nice family" but not a single mother. When I pointed out she was looking at 2 bedroom condos, and families tended to want 3 bedroom homes, she didn't exactly understand. Spelling it out, I asked Jenny: who rents 2 bedroom homes?

Jenny then changed her criteria to anyone who could afford the rent. Although that is very nice, I know she doesn't mean that either. From there she picked someone with a 720 credit score. I pointed out people with 720 credit scores don't rent for very long. So, expect to turn the property over every year or so.

Eventually we got around to the crux of my question: depending upon where she was looking, would depend upon what kind of tenant she got. Look near the university, she was likely to get a student. Look in Scottsdale, she was likely to get a single white-collar professional. The difference being, Jenny will pay a different price for a student condo than she will for a Scottsdale condo. In exchange, she will get a different rent amount and different headaches.

A student may stay for a few years, but they won't fix much or take as good care of Jenny's asset as someone renting in Scottsdale. Jenny might get more rent in Scottsdale (and pay a higher price to begin with), but she probably won't get a long-term tenant. However, she will have a higher appreciation when she sells. It was an interesting exercise. And, there really isn't a right or wrong answer.

Jenny finally asked me what I thought. My basic response was this:

Buy the biggest, nicest property in the best possible neighborhood for the lowest amount of money. I recommended looking in lower crime areas of some of the suburbs. Try to find places near major employers. Don't be afraid to spend a little more for nicer places or places that have better amenities (such as pools and garages--which are gold for a townhome or condo). These are costs that can be passed along to a renter.

I explained to Jenny that spending an extra $10,000 might be the difference between a neighborhood that is appreciating at a reasonable rate, and a place that was in a neighborhood that probably is past its prime. Neighborhoods that are past their prime will probably not attract desirable renters. I also explained one of the myths about owning rental homes--it isn't a get-rich quick scheme. Monthly cash flow is important. But, the real money to be made is from buying low and selling high--just like with the stock market.

I gave her some hard numbers to look at and left her with a quick thought: because she is starting with a few extra challenges (like Mr. Jenny), it will be worth it to get a property management company involved from the get-go. Let them find the tenant and manage the headaches. Everyone will sleep better at night. Her marriage will be stronger for it. And, she won't have to write a therapeutic blog.