By Dr. James M. Dahle, WCI Founder
In 2016, we finally shed a bad investment that had plagued us for years. That was the year we finally sold our investment property. We lost a ton on this property, although the exact amount was difficult to calculate for various reasons. This was in spite of the fact that the rent was much higher than the mortgage payment, which seems to be the first criterion that rookie investors look at when evaluating rental properties. In this post, I'm going to revisit our mistakes in the hopes that someone else will learn from them.
But first, some general calculations to show how bad the carnage was.
- Purchase price: $138,000
- Sale price: $114,500
OK, that's a 17% loss. That's bad enough, right? But wait, there's more. The IRS lets you add to the basis for various improvements and other costs. As I recall, I got the basis up to about $145,000. Now, we're at a 22% loss. Also, in this price range, to get anyone to buy it, you had to throw in 3% of closing costs, and 3% of $114,500 is $3,400. Now, we're up to a 25% loss. We also had to spruce it up significantly to get it sold—between repairs we did to get an offer and the ones demanded by the inspection, you can add in another $6,000 or so. We're at 29%. Also, you have to pay a realtor (unless you sell it yourself), and 6% of $114,500 is another $7,000. That's a 34% loss.
Now, let's talk about the cash flow over the years as a rental. I think we were cash flow negative—sometimes severely cash flow negative—every year. In fact, for the first 18 months after we moved out, we didn't have a renter in there at all because we were desperately trying to sell it. After 14 months of failure, we then tried to find a renter for the next four months.
All in, we lived in it for four years, and it sat empty for 1.5 years; we had a renter paying rent for 3.5 years, and then we sold it for a huge loss. We walked away with $18,000 in cash but had thrown lots extra at the mortgage over the years. We also had pulled cash out previously to purchase another home. (Thankfully, we more than made up for our losses with appreciation of our big fancy doctor home bought in the depths of the housing crash.)
But you can see how it is hard to give a definite figure on just how bad our losses were. When you consider the leverage, it was at least a 100% loss, maybe 200%. It was bad. It was an investment disaster by any measurement except for the fact that we could afford to lose the money.
Here were the biggest reasons we lost so much money on this house.
#1 Bought at the Peak
We bought the property in 2006 at the peak of the housing bubble. Most people who bought any kind of property in 2006 did not enjoy very good returns. In fact, if I had been in Las Vegas, it would have been much worse. In 2006, the average property in Las Vegas was $299,000. It bottomed out in 2012 at $109,000 before gradually climbing back up to its 2023 status of about $390,000. Despite nine years of holding, the average 2016 home buyer in Las Vegas was still looking at a 36% loss. I did a little better than that in Virginia, getting out with a 17% loss (if you only look at the purchase prices). Despite the general rule that you only have to hold a property for 3-5 years for your appreciation to make up for the transaction costs, it's easy to see there are times when that time period can be much, much longer. In this situation, we clearly should have rented.
More information here:
How to Buy a House the Right Way
#2 Paid Too Much for It
Looking back, I think we could have bought the property for about $130,000 if I had been a better negotiator. I applied the lessons learned when we bought the big doctor's house, but in real estate, you make your money when you buy.
More information here:
How Expensive of a House Can I Afford?
#3 Did Not Pay Enough Attention to Resale Issues
This home was in a diverse neighborhood just off a military base. The schools get poor ratings. We didn't really care about all that. Only one of our kids was going to be in school—and that was just kindergarten—while we lived in that house. We thought it would be easy to resell the property given its proximity to a military base. We were wrong, and it cost us a lot of money.
#4 Did Not Buy as an Investment Property
Like many others who bought homes anywhere near the peak of the bubble and then wanted to get out of them within 3-5 years, we became accidental landlords. We never bought this property intending for it to be an investment. Don't get me wrong, we did all the right things. We put 20% down, got a decent rate on a mortgage (6% was pretty good at the time), negotiated, and made sure it was a place that was very affordable for us. In fact, we used this property to save up for our dream home, such that it was nearly paid off by the time we moved out of it four years later.
At that time, we were having a little trouble selling it, so when we bought a place in Utah six months later, we got a 20-year home equity loan as a bridge loan. The rate wasn't great (although still lower than the 6% we had), but the fees were very low, which was the most important thing since we were only going to have it for a few months. Well, months turned into years, and we still had that 5.35% loan. To make matters worse, we tried and tried to sell it, reducing the price by about 20% from its peak value. At that value, it made for a reasonably attractive rental (cap rate 6.7%), although it still took a few months to get a renter in there. But between trying to sell and waiting to get a renter in, we paid that mortgage without any rent coming in to offset it for a full 18 months after moving out. It was a good thing it was VERY affordable for us. Most importantly, while it certainly met our needs for a home to live in at the price we paid, it was not a good price to pay for a rental property. It only had a cap rate of 4.7% at that price.
Bottom line: we learned a lot about real estate investing over the nine-plus years we owned the property, and knowing what we know now, we would never buy it as an investment; would never use the loan we used; and, of course, would never wait that long to get a renter into it.
More information here:
How We Became Accidental Landlords: Turning a Primary Residence into a Rental Property
The 3 Biggest Mistakes I’ve Made in Real Estate Investing
#5 Absentee Landlord
This “investment property” is located precisely 2,218 miles away from my current home in Utah. I only returned to the area one time in those five years for a WCI speaking engagement. It's one thing to do syndicated real estate deals in another state. It's entirely different to do direct rental when you're the only owner and you have to trust a property manager to do a good job. Our property manager did a reasonably good job finding a good tenant, but they did a terrible job of keeping her happy. After a while, we fired the manager. That boosted our return a bit, but it also made us the primary property manager. Luckily, I had a good friend I trusted who is a general contractor. He did a great job doing maintenance and upgrades for us, but a lot of it was stuff we could have done for far cheaper and easier if we had lived nearby. And forget trying to find another tenant. That's why we put it on the market when this tenant decided to move out.
We also discovered that we dislike being landlords and we're not that good at it. We even argued about who was supposed to cash the rent checks, and that's the easiest part of the whole thing!
More information here:
What Is Market Rent and Why Landlords Should Charge It
#6 Ignorance of the Importance of the Little Extras
This property is in a flood zone, so we had to buy flood insurance. It also had an HOA fee. While low, it added up. Those two extras—especially combined with taxes, insurance, management fees, and maintenance costs—made sure that we were cash flow negative every year we owned it (although we had a slightly positive overall return several of the years.) The general “55% rule” says that your net income is 55% of your gross rent. For us, it was more like 50%, and that doesn't include that 18-month vacancy.
Despite these six mistakes, this whole episode didn't have a huge financial impact on our life. We had very affordable housing for four years, saved up enough for a down payment on our dream house, and did not have to bring money to the table to close. But from the time we moved out until the time the house was sold, we probably had a cumulative loss of close to $60,000 on a $138,000 property. That's the total of the transaction costs, loss in value of the property, and the total of the negative cash flows.
Many people who purchased in 2006 and wanted to sell in 2010 did far worse (I had one colleague with a similar military doc salary who bought a $750,000 house at the same time), so we'll count our blessings. And we more than made up for our losses by being able to buy our big fancy house in 2010. We certainly learned a lot that goes in to every investment we now consider, especially real estate investments. Like with entrepreneurship, you want to fail early in real estate and with as little money involved as possible. If you are interested in learning more about real estate and minimizing mistakes like mine, check out our No Hype Real Estate Investing course.
Although we made mistakes while becoming accidental landlords, there are plenty of ways to make money in real estate investing, active or passive. If you are interested in private real estate investing opportunities, start your due diligence with those who support The White Coat Investor site:
Featured Real Estate Partners
What do you think? Were you ever an accidental landlord? How did you make out? What's your worst real estate investment? Comment below!
[This updated post was originally published in 2016.]
Bought a duplex in 2012 for 350k. Contractor who built it lives next door, great guy and happy to help out if there’s major trouble. In a fantastic neighborhood (unless there’s an earthquake) near a hospital, medical school, and university. Also walkable to downtown. No yard so people with pets are not so interested. People line up around the block to rent it (knock on wood) and we have thus far managed to rent to busy, responsible professionals. We have increased the rent 25% since the purchase with no problems. We don’t make a ton every month, just a couple hundred, but thus far it has paid for itself and will hopefully give us another income stream in retirement on top of our three pensions and SS.
It’s still a pain in the ass and will stress me out until it’s paid off! But hopefully the success will continue.
What I have learned:
1. You make money when you buy
2. Location, location, location
3. Two toilets means a dysfunctional toilet isn’t an emergency
4. Make sure you purchase a good rental property, not your dream house.
5. Screen. Your. Tenants.
6. Fix as much as you can yourself and avoid property managers
7. Shop around for insurance
8. Keep the home warranty as long as you can
I don’t have the personality for it, and it’s hard, but hopefully it will continue to be a modest success! And the tax benefits are pleasing.
Well, what a pessimistic trend – feel like I need to dilute it a little.
We had bought our townhouse for residency in Chicago’s burbs and than decided to buy even for 1 year fellowship in Jacksonville, FL and managed to always make money on resale (back in 1998-2002). Bought our docs house during my 1st year out of fellowship and will pay off the mortgage probably next month (been in the house for almost 13 years and still love it).
Started to buy foreclosed properties back in 2008 and have 20 of those (20% down) – originally as a college fund for kids, and now it looks like those would easily support us in retirement.
Granted – need to go to court friday for eviction hearing – but hey, I am trying to switch to 4 days week anyway))
All of the properties been generating positive cash flow from the first year of purchase and we had already paid off 6 houses – with just the rental income. Granted, we dont outsource property management and divide it between us – I deal with renters and repairs, while wife takes care of paperwork. Overall – best investment I have ever made.
Glad it’s working out great for you! You are not that unusual as a fair number of docs have had success with real estate. As you can see, you avoided many of the mistakes I made.
I don’t mean to add insult to injury, but you are a smart couple…why did you buy a home while you were in residency for such a short time, is it 3 years for EM? Especially when the real estate market was insane. So many couples we knew did the same in 2006 and lost far more than you. I never understood the thinking behind it but then again I’m overly risk averse.
Remember I did NOT buy in residency. We rented. (Should have bought- AZ 2003-2006). This was as an attending for a planned four year stay.
Sorry I misread. Do you feel like your realtor mislead you into believing that the market would continue to climb?
No. I had no realtor. I knew there was a bubble. I underestimated how much it would drop and how long it would stay down.
Here’s an answer: We were a dual-income family as a newly named “Doctor”. How could we lose? We were beginning our lives away from family… We were excited…. I could go on.
Not everyone is a NerdyWife.
While residency is 3 years, we thought that we would stay there for longer “because that’s what you do”… We decided we had to run as far away from that PTSD hole as we could.
I purchased my first home in 2006 (a condo), which I intended from the start to convert to a rental eventually. I bought my first two rentals in 2008, two more in 2010, and one more in 2012.
My total cash flow from 2008-2015 has been ($33,635). Granted it was positive by a few grand a year from 2008-2010, but 2011 was a $24K loss overall, primarily due to horrible tenants, vacancy and vandalism issues at one property. Plus a fire in another. When it rains it pours. I was negative a few grand a year for the next few years (largely because I was buying more properties), and 2015 was positive $2430.
I’ve enjoyed a few tax breaks in there (before I made too much to deduct my losses), and my mortgages have decreased by more than my cash flow losses. In addition, overall, I’ve had some appreciation finally – I think, though you never really know till you sell. So while I have not technically lost money. I have hardly made a killing after 8 years of wrestling with tenants and property managers, contractors and lenders.
In hindsight, the money I used to acquire all my rentals would have been better off staying invested in the total stock market index fund, where it had been for 2 decades before I started selling shares to buy rentals.
However, things are looking up. I hired a property manager in 2013 who is doing a much better job than I ever did; cash flow is up despite that additional expense – and my stress level is WAY down. I’m not buying any more properties so cash flow has also risen due to fewer transaction costs and renovations. The mortgages are accelerating as far as amortizations. 2014 and 2015 were my best years yet, and 2016 should be even better.
Long story short, it’s been a looong learning curve, but it’s finally starting to pay off. Hopefully. I think. 🙂
Wondering why you sold your property knowing you would take a lose as opposed to keeping the property? Seems the benefits of hiring a property manager and yearly tax write offs would out weigh the short term difficulties. Keeping this rental property should not be a cash flow issue. Just curious as my wife and I have a few rental properties and plan on holding them for a number of years while bot living in the same city as the properties.
I assume you’re asking me. It had negative cash flow, negative returns, wasn’t appreciating, seems unlikely to appreciate faster than other properties I could buy, is more than 2000 miles away, wasn’t bought as an investment originally, don’t have a property manager and cannot find a good one in the area…..need I go on?
Thanks for providing such detail on your experience. I’ve actively avoided becoming a landlord because I’ve always suspected there was more ways to lose than my bragging co-workers had identified. Your story confirms my assumptions that:
1) Being a landlord needs to be considered, not accidental. Deciding to be a landlord first is better than deciding to be one because I happen to have an empty house on my hands.
2) If you aren’t able/willing to cover a lot of the property management tasks yourself, you might give up the difference between being profitable or not. I don’t want to find tenants or fix toilets – those that can do both well have an inherent tailwind I will not overcome.
3) Only the right buy really makes it work. The successful ones I know carefully stalk their prey very carefully.
Maybe it is a case of sour grapes, but stories like yours convince me to continue to ignore the siren song that the realtors sing about having “wake up” money from investment properties.
There’s no doubt real estate investing can work out very well. But you have to do it right from the beginning (or else get lucky.)
As is with any other investement – you have to buy low and hopefully sell high. Real estate would allow you to safely wait for that “high” point while making plenty of money in the meantime (positive cash flow). You also dont need to jump in now – wait for another buble to burst.
I had to go through a lot of arguing with my wife for the first few properties – she is the biggest supporter now – especially since income from the houses actually is higher than her lawyers’ salary. And the amount of time we spend dealing with renters is so much less than your regular job would require.
I also just can’t reimphasize how nice of a feeling it is – to have that lovely passive income, vs the active one in our profession. I go on vacations, or work in the OR – no matter what Dow Jones is doing – I am making money. I don’t suggest you only do real estate – but its a very nice way to diversify your postfolio – if done right of course.
I don’t suggest you fix plumbing in your rental house either – plenty of relatively inexpensive help out there – and it’s just one phone call away.
As far as hiring someone to do management for you – prices of those services did go down significantly lately also. You can find someone to manage your houses for as low as 5% of your monthly rent – hardly a deal breaker. But it just really easy most of the time – at least where I am at. Finding a tenant is as simple as putting the add on the Craigslist. CreditCarma would allow you free credit score check. For the last few years the moment one of the renters get out, we have truck with the other one waiting to move in. Easy money.
I was working on taxes today. It was very painful. Especially when I realized I’d screwed up my depreciation deduction for the last three years. So I had to file a 1040X for 2012, 2013, and 2014. That got me $600 back, but mostly I did it in order to make sure my disallowed passive losses (thanks to the depreciation I should have taken) could be claimed now that I’ve sold the property.
The bad news is I lost tens of thousands of bucks. The good news is I have a $51K deduction that I can now use while in the highest bracket thanks to turning it into a rental property. That will certainly soften the blow significantly.
Wow. your article almost makes me wonder whether i should buy or not ?
Buy when you’re socially and professionally stable. At 5 years, it’s a 50/50 proposition. Get much beyond that and you’re very likely to come out ahead in most markets.
Jim, sorry to hear about the loss on the property but thankfully you’ve done well in other aspects of your financial life and are meeting your goals. How much do you think the failure was really due to lack of bandwidth as well as accomplishing your financial goals overall? You said yourself that you still were able to purchase your doctor dream home and this loss was only playing a minor role in your life. Is it possible this would not have been so bad if you weren’t so busy being a doc and running this blog?
No, I don’t think putting more time or effort into this would have resulted in a better return.
Its nice to hear both sides of this. My wife made me watch a 2 hr webinar of one of WCI sponsors who has been on his podcast before and also is a speaker on the NO HYPE Real estate course. Her material was for what she was promoting on her website, I almost fell out of my chair when the speaker said you could be FI in one year. It sounds so easy. Set your “Why” goal, find a good agent, put down 10-20%, run the numbers, stress test them, and with Positive cash flow, amortization, appreciation, and tax loss you can work part time and you can be FI in 5 yrs or less. I would like to add some real estate to our investment plan but I do not believe it is as easy this. I believe some some of these “gurus” are just using the pitch to pad their pockets by saying all the right words-burnt out, overworked, undervalued, passive income, Financial independence, etc. to persuade unsophisticated investors to spend thousands of dollars to pay for their course. So again, nice to hear the other sides to investing in this area.
It definitely takes work. There is definitely risk. But yes, I think it is possible to be FI in less than 5 years with a reasonable amount of leverage building a short term rental business. Honestly though, no physician is ever more than 10 years away from FI just using a boring old index fund portfolio if you apply a high enough savings rate.