1. Archive

You can mine the profits in rental houses

(ran HS edition)

I was having breakfast in a coffee shop at Lake Tahoe. A man dressed in a business suit and seated next to me asked if I was there for the real estate conference. I was, and so was he.

I asked him what aspect of real estate he was in. "Rental houses," he replied. "Would you like to see them?"

My new friend produced photos of his rental houses. He owned several hundred around High Point, N.C., where he was a furniture salesman.

Later at that same meeting, I met a man from Norfolk, Va., who owns more than 900 rental houses. I soon learned that owning rental houses is big business.

As the owner of rental houses that have proven to be excellent investments, I am always interested in learning more about them. With the real estate market escalating in most towns and the new, favorable 1997 Tax Act capital gains rules on the books, rental houses are regaining popularity as an investment vehicle.

The major rental house advantages include appreciating market values, depreciation income tax shelter deductions, leverage, cash flow and resale profits.

There is a nasty four-letter word involved with rental houses, however. It is W-O-R-K.

There is work finding each rental house, acquiring it, fixing it up and renting it, but, if it's done right, managing rental houses isn't hard work, as those investors I met who own hundreds of houses demonstrated to me.

My St. Louis friend, Mike, often phones to brag about his rental house acquisitions. His latest is a sound, well-located, brick, four-bedroom probate-sale house he bought in a good neighborhood for $35,000. It needed about $8,000 of fix-up work, such as stripping off the old-fashioned wallpaper, complete painting, removing the wall-to-wall carpet to expose the beautiful hardwood floors and kitchen repairs. His bank appraised it at $72,000. It rents for $800 a month.

That is fantastically high rent; most rental houses rent for less than 1 percent per month of their market value. Incidentally, Mike makes his tenants supply their own appliances. He says they make better tenants if they bring their stove and refrigerator.

Of course, rental house prices in other parts of the country are much higher, but the basic principles for buying rental houses are the same everywhere:

+ Good location. Stay away from high crime or slum areas because the potential for market value appreciation is low there. Also, avoid high-income neighborhoods because rents aren't high enough in relation to house market values. Top quality school districts add to the profit potential.

+ Sound condition but needing cosmetic fix-up. If the house is in tip-top condition, it will be hard to buy at a bargain price at least 25 percent below fixed-up market value.

Paint, carpets, landscaping, cleaning and the installation of new light fixtures are inexpensive, cosmetic improvements that often add $2 of market value for each $1 spent. Avoid houses needing expensive improvements such as a new roof, foundation repairs, plumbing, wiring and structural work.

+ Motivated seller who offers reasonable price and terms. I have found that the best houses to buy for rentals are those being sold at reasonable prices by retirees who need income. They often own the house free and clear, enabling them to offer easy financing by carrying back the first mortgage for retirement income.

The best bargains are often foreclosures and distressed properties. Some are in the local multiple listing service but haven't sold because they need fix-up.

Don't be afraid to make a low purchase offer on listings that have been for sale more than 60 days. The seller is probably getting anxious and will listen to any reasonable offer.

Be sure your purchase offer contains a contingency for a professional inspection with a five-day deadline. After the offer is accepted by the seller, be sure to accompany the inspector to discuss any undisclosed defects discovered. What often looks like a serious problem frequently can be corrected inexpensively.

The long-term trend of home values is always up, but there are severe peaks and valleys along the way. Even if you plan to keep the rental house for many years, it pays to estimate the resale profits before purchase.

If the invested dollars will be too great in relation to the potential profit, keep looking.

Robert J. Bruss is a nationally syndicated columnist on real estate. Write to him in care of the Tribune Media Syndicate, c/o the Times, 435 N Michigan Ave., Suite 400, Chicago, IL 60611.