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One of the most recommended ways to invest one's money still is real estate. Sure there are different ways to invest in real estate, but why does it make sense financially to buy property and become a landlord?

Here in my region a flat costs around 2500 € / m² while usual rents are at 10 € / m². Say I buy a 60 m² flat for €150,000 and rent it out for €600 / month. All taxes, fees and repairs aside it would take almost 21 years before I start making profits. In reality, however, I would have to pay more than €150k for the flat due to taxes and fees, while at the same time earn less than the €600 due to taxes, costs for necessary repairs, etc.

Compared to investing the same 150k in an ETF portfolio with a conservative 4% in annual returns I would have made around €140k after taxes in the same 21 years i.e. almost doubled the money.

I know that my numbers are a very rough estimate but are they so far off? What am I missing?

psmears
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sigy
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    First, it may not always make sense. Second, the missing piece is equity. – TTT May 05 '17 at 18:10
  • @TTT given that the OP compares investing the money in an ETF vs. buying the rental property how does equity come into play? – Ghanima May 05 '17 at 18:18
  • I have friends and family who are landlords and they do it because they see it as a stable investment if you are able to prioritize your expenses (i.e. mortgage payments). They also wanted to do it so that they can pass it down to their children. – Michael May 05 '17 at 18:20
  • @MichaelC. That's exactly what I am asking. I this simply a matter of taste? But almost all "rich" people I know are also landlords. They are not necessarily rich because they are landlords but it looks like they are landlords because they are rich. – sigy May 05 '17 at 18:27
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    @Ghanima - what is the flat worth 21 years from now? – TTT May 05 '17 at 18:34
  • @ttt Yeah, I got that the minute I wrote the comment ;) – Ghanima May 05 '17 at 18:39
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    Not sure what country you are in, but in the US we depreciate rental property, so a portion of the original house value offsets our rental income, even though the house is likely to increase in value. – Hart CO May 05 '17 at 18:49
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    @sigy I'm not sure there's a causal relationship between wealth and being a landlord. Rental property is much more profitable when it's not using borrowed money, so having extra capital can make it easier, but one does not guarantee the other. – D Stanley May 05 '17 at 18:49
  • @DStanley No, of course not. Correlation does not imply causation. – sigy May 05 '17 at 18:51
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    "but it looks like they are landlords because they are rich" Well the opposite is certainly true, someone without money or assets is not a landlord. So it stands to reason rich people are more likely landlords and vice versa as houses are valuable and having them means one is rich... This seems a circular definition. – Vality May 05 '17 at 19:24
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    @Vality There are many landlords that are not "rich". You can buy property and rent it out with just a down payment on a mortgage. – D Stanley May 05 '17 at 20:56
  • You make money from property from both income and capital growth, you are completely neglecting any capital growth over 21 years. Why don't you look up how much that 150k property was worth 21 years ago to see an example of the capital growth. – Victor May 06 '17 at 01:08
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    As a landlord myself, I can only assume it's because you're a masochist. – corsiKa May 06 '17 at 02:15
  • Plus being the owner of real estate means you do not have to pay rent when you retire. – spickermann May 06 '17 at 10:41
  • @spickermann: How's that related to renting it out? – Lightness Races in Orbit May 06 '17 at 17:00
  • You would have doubled your money though - you'd have €150K in cash, plus a flat that you can sell for another €150K. That's €300K or twice what you started with. – user253751 May 06 '17 at 23:50
  • @user20574, only twice when you don't account for inflation -- and then there's opportunity costs. – Charles Duffy May 07 '17 at 00:40
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    You also have to consider that a bank will be willing to give a loan for a house but not to invest on the stock market. Hence, for most people, the question is not a question as it's better to have 4% on 100K (with loan) than 8% on 10K – dyesdyes May 08 '17 at 11:58
  • Despite what obnoxious seminars will tell you, trying to be a landlord when you have no equity is a recipe for disaster. But if you already have money and you're looking for a good place to park it, rental property is a fairly attractive place to do just that. It's not perfect though, I recently took a bit of a bath on one when the local market tanked. – Jared Smith May 08 '17 at 16:10
  • Do you own your house? If not, you might want to buy your own house and be your own landlord. – Tom Au Jun 29 '17 at 18:32

6 Answers6

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why does it make sense financially to buy property and become a landlord?

Because then your investment generates cash instead of just sitting idle.

All taxes, fees and repairs aside it would take almost 21 years before I start making profits.

No - your profit will be the rents that you collect (minus expenses). You still have an asset that is worth roughly what you paid for it (and might go up in value), so you don't need to recoup the entire cost of the property before making a profit.

Compared to investing the same 150k in an ETF portfolio with conservative 4% in annual returns I would have made around 140k € after taxes in the same 21 years i.e. almost doubled the money.

If you charge 600 € / month (and never miss a month of rental income), after 21 years you have made 151k € in rents plus you still have a property. That property is most likely going to be worth more than you paid for it, so you should have at least 300k € in assets.

Having said all that, it does NOT always make sense to invest in rental property. Being a landlord can be a hard job, and there are many risks involved that are different than risks in financial investments.

D Stanley
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    Property appreciation may or may not be above inflation. It was true in the past, but may not be true in the future. – Mindwin Remember Monica May 05 '17 at 18:45
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    True, but inflation is going to be the same in either scenario (property vs ETF) so it's not a factor in the decision. So the comparison in this case is in nominal value, not real value. – D Stanley May 05 '17 at 18:47
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    It should be noted that quite a bit of the money needs to be reinvested to keep the property in good shape, and it also doesn't run on its own, being a landlord can be hard work at times, dealing with problems, finding new tenants, doing the paperwork etc. – PlasmaHH May 05 '17 at 20:41
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    @PlasmaHH True, but that's not the point of the question (or answer). The question assumed that buying a property is a sunk cost (expense), when in reality you have an asset that's worth roughly the same amount. – D Stanley May 05 '17 at 20:57
  • @PlasmaHH, also, there's something called a "property manager." Of course, there is no totally easy way to make money and if you ignore it, you won't have it. That should be part of financial ABCs. It's not a reason to avoid making money or discourage it, but it is a reason to have a correct estimation of the effort required. :) – Wildcard May 06 '17 at 01:40
  • As the price of bread and milk goes up (inflation), the typical landlord will raise the rent accordingly at the next lease renewal. So I'd say inflation is zero-sum. – Micah Epps May 08 '17 at 02:26
  • Where I am (South Africa), you can buy property on a loan and break even after a few years (bond repayments vs rent received...). The stock market / ETFs might be more profitable, but banks are unlikely to borrow you at large some of money to invest there... – Gert van den Berg May 08 '17 at 09:47
  • There is also this thing called inflation. Unless the property is in a really shitty place, then the rent (not even the value) will also grow over time. Which means that the assumption about how much you earn is even more wrong. Assuming a small rent increase per year gets quite some substantial profit over time. – TomTom Jun 04 '19 at 13:34
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The value of getting into the landlord business -- or any other business -- depends on circumstances at the time. How much will it cost you to buy the property? How much can you reasonably expect to collect in rent? How easy or difficult is it to find a tenant? Etc.

I owned a rental property for about ten years and I lost a bundle of money on it. Things people often don't consider when calculating likely rental income are:

  1. There will be times when you have no tenant. Someone moves out and you don't always find a new tenant right away.

  2. Maintenance. There's always something that the tenant expects you to fix. Tenants aren't likely to take as good a care of the property as someone who owned it would. And while a homeowner might fix little things himself, like a broken light switch or doorknob, the tenant expects the landlord to fix such things. If you live nearby and have the time and ability to do minor maintenance, this may be no big deal. If you have to call a professional, this can get very expensive very quickly. Like for example, I once had a tenant complain that the water heater wasn't working. I called a plumber. He found that the knob on the water heater was set to "low". So he turned it up. He charged me, I think it was $200. I can't really complain about the charge. He had to drive to the property, figure out that that was all the problem was, turn the knob, and then verify that that really solved the problem.

  3. Tenants don't always pay the rent on time, or at all. I had several tenants who apparently saw the rent as something optional, to be paid if they had money left over that they couldn't think of anything better to do with.

  4. You may get bad tenants who destroy the place. I had one tenant who did $10,000 worth of damage. That include six inches deep of trash all over the house that had to be cleared out, rotting food all over, excrement smeared on walls, holes in the walls, and many things broken. I thought it was disgusting just to have to go in to clean it up, I can't imagine living like that, but whatever. Depending on the laws in your area, it may be very difficult to kick out a bad tenant. In my case, I had to evict two tenants, and it took about three months each time to go through the legal process.

On the slip side, the big advantage to owning real estate is that once you pay it off, you own it and can continue to collect rent. And as most currencies in the world are subject to inflation, the rent you can charge will normally go up while your mortgage payments are constant.

Jay
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    ... and at that, you #4 isn't even close to a worst case. Crazy tenants can pour cement down drains, rip pipes and wiring out of the walls flooding the property in the process, or do something like running a meth lab which leaves the property so damaged that demolition is a smaller loss than trying to restore it to livability. – Dan Is Fiddling By Firelight May 05 '17 at 19:57
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    My dad worked with someone who owned rental properties. One of his tenants refused to pay rent, and either eviction was too big of a burden or something, but he took his brother with him and started taking the doors off the hinges and told them, "You'll get the doors back when I get my rent". – Wayne Werner May 05 '17 at 20:29
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    @WayneWerner Interesting story, but many US states (and I presume non-US countries) have renters' rights laws that would likely make such an action illegal. – D Stanley May 05 '17 at 21:00
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    @DStanley Yes. I found that to evict a tenant, theoretically I just had to give them 3 days notice. But in practice neither one just left. So then I had to go to court. They gave me a court date a month or two in the future. Neither tenant showed up to dispute the eviction so I won a default judgment. Great. Then I had to wait another month or two for the police to actually go to the house and order them out. And of course once you start the eviction process, there's zero chance they're going to pay rent, and they can vandalize the place all they want and there's nothing you can do about it. – Jay May 05 '17 at 21:13
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    I've heard many people who own rental properties complain that there may have been a time in the past when heartless landlords exploited their poor helpless tenants, but today the tenants have all the legal rights and exploit poor helpless landlords. – Jay May 05 '17 at 21:14
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    Exactly. If you have good tenants, great! But one bad tenant can ruin you. My parents rented a house out successfully for many years, but their last tenant stopped paying rent, and because she was a single mom with young kids, it took over a year to evict her. By the time they got her out of the house, she had caused over $80k in property damage (not counting the > 1 years worth of rent they didn't collect). – asgallant May 05 '17 at 21:24
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    That is why you have a criteria set for your tenant selection, you don't get emotional about it, and you treat it like a business - never do a favour to a tenant with a sob story. – Victor May 06 '17 at 04:54
  • @WayneWerner: to corroborate what DStanley said, that would likely count as harassment of a tenant in the UK, for which you could be prosecuted. Landlords have no automatic right of entry here (except in emergencies, which doesn't include non-paying tenants). – Steve Melnikoff May 06 '17 at 13:20
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    @Jay: I believe that in the UK, as part of the eviction process, you can ask the court to make a repayment order against the tenant. However, if they have no money or assets, it could take a very, very long time to get anything back, if ever. – Steve Melnikoff May 06 '17 at 13:23
  • @SteveMelnikoff Luckily for him it was in Arkansas, USA, where there are practically zero renters protections. There are some slumlords, but I think it's probably about the same ratio of terrible-to-good people as anywhere else. – Wayne Werner May 08 '17 at 13:36
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    Tenants who pour concrete down the drains (why?) or start meth labs seem like they might be quite rare. They are also the reason you should deduct the cost of good insurance from the rent before you calculate your 'yield'. – jwg May 08 '17 at 16:32
  • @WayneWerner: this is impossible in France. You would be in big trouble. And yes, evicting the tenant s close to impossible when they do not want to. – WoJ May 08 '17 at 16:47
  • @SteveMelnikoff Sure. I won a lawsuit against the tenant who did $10,000 in damage. I have yet to see a penny. Maybe if I knew more about the legal system I could find a way to actually get money from them. I don't want to pay a lawyer thousands more and find I still can't get anything. I took a tax deduction for the cost of repairs and gave up. – Jay May 08 '17 at 20:23
  • #3 gave me a good laugh. +1 – NuWin Jun 30 '17 at 03:50
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with 150K € to invest to "become a landlord" you have several options:

  • Pay for 100% of one property, and you then will make a significant percentage of the monthly rent as profit each month. That profit can be used to invest in other things, or to save to buy additional properties. At the end of the 21 years in your example, you can sell the flat for return of principal minus selling expenses, or even better make a profit because the property went up in value.

  • Pay 20% down on 5 flats, and then make a much a smaller profit per flat each month due to the mortgage payment for each one. At the end of the 21 years sell the flats. Assuming that a significant portion of the mortgage is paid off each flat will sell for more than the mortgage balance. Thus you will have 5 nice large profits when you sell.

  • something in between 1 and 5 flats.

Each has different risks and expenses. With 5 rental properties you are more likely to use a management company, which will add to your monthly cost.

mhoran_psprep
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    It's also worth mentioning that leverage increases downside risk as well. If one unit goes bad and gets foreclosed on, you could lose some or all of your properties. – D Stanley May 05 '17 at 18:52
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    @DStanley Don't cross-colateralise your loans. If one goes bad, it won't affect the others. – Jules May 08 '17 at 05:51
  • Also rent and value should go up.So, it takes less time and over time you actually get a nice profit out of things. – TomTom Jun 04 '19 at 13:36
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There are at least three important aspectss missing from your equation. However they come with some uncertainty as one typically cannot tell the future performance.

  1. Appreciation of the rental units value. When comparing to the gain of any alternative investment an increasing value of the flat is a gain too.

  2. Increase of rent. Rents are typically adjusted either on a regular basis or at least when changing tennants. Calulation with a flat rent over 20 years is therefore way off.

  3. Tax deductions due to capital expenditures (i.e. mortgages), expenses for the upkeep and maintenance of the property, conserving and management, and so on. Obviously those are depending on your local legislation.

There are multiple other issues to consider of course, e.g. inadvertant vacancy, which would not act in your favour.

Ghanima
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    You forgot inflation. Also, the unit's value is not guaranteed to appreciate. – Mindwin Remember Monica May 05 '17 at 18:46
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    #2 is a very good point. As a landlord with financed rental units, my mortgage cost is constant, but rents increase with inflation over time. – JohnFx May 05 '17 at 18:49
  • @Mindwin, second sentence implies "no guarantees"... When comparing different vehicles of investment it makes little sense to not adjust all of them for inflation. – Ghanima May 05 '17 at 18:50
  • @Mindwin - are you saying that over 20 years the price of a property will not appreciate? Over the last 20 years the average house price in the UK has risen by over 306%, and if inflation is taken into consideration then they have increased by 89% in real terms. – Victor May 06 '17 at 05:09
  • @Victor Housing bubbles have existed in the past and no doubt exist in many places in the world today, just waiting to burst. – curiousdannii May 06 '17 at 07:05
  • @curiousdannii - so do share market bubbles, which usually tend to be more extreme - but I don't hear so called long term investors who like to buy and hold share market assets, say that if you invest today there is no guarantee the price will be higher in 20 or 30 years. – Victor May 06 '17 at 07:55
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    @Victor Everyone knows shares are risky, but a lot of people are under the misapprehension that housing is so safe that it will almost always appreciate in value. – curiousdannii May 06 '17 at 08:00
  • @curiousdannii - really, because I see most people writing on here that if you buy and hold shares over 20 or 30 year it is almost risk free (personally I thing this is virtually gambling), yet none of the answers to this answer have emphasised that over 20 years the property would have likely appreciated in price. I think the bias is actually the other way around on this site, that shares are not risky over time but property is. Its funny because both got slammed alot in many countries in 2007/2008. – Victor May 06 '17 at 22:14
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Let me add a few thoughts that have not been mentioned so far in the other answers.

  • Note that for the decision of buying vs. renting a home i.e. for personal use, not for renting out there's a rule of thumb that if the price for buying is more than 20 year's ("cold" / without utilities) rents it is considered rather expensive. I don't know how localized this rule of thumb is, but I know it for Germany which is apparently the OP's country, too.

  • There are obviously differences between buying a house/flat for yourself and in order to rent it out. As others have said, maintenance is a major factor for house owners - and here a lot depends on how much of that you do yourself (i.e. do you have the possibility to trade working hours for costs - which is closely related to financial risk exposure, e.g. increasing income by cutting costs as you do maintenance work yourself if you loose your day-time job?).

  • This plays a crucial role for landlords I know (they're all small-scale landlords, and most of them do put in substantial work themselves): I know quite a number of people who rent out flats in the house where they actually live. Some of the houses were built with flats and the owner lives in one of the flats, another rather typical setup is that people built their house in the way that a smaller flat can easily be separated and let once the kids moved out (note also that the legal situation for the landlord is easier in that special case). I also know someone who owns a house several 100 km away from where they live and they say they intentionally ask a rent somewhat below the market price for that (nice) kind of flat so that they have lots of applicants at the same time and tenants don't move out as finding a new tenant is lots of work and costly because of the distance.

My personal conclusion from those points is that as an investment (i.e. not for immediate or future personal use) I'd say that the exact circumstances are very important: if you are (stably) based in a region where the buying-to-rental-price ratio is favorable, you have the necessary time and are able to do maintenance work yourself and there is a chance to buy a suitable house close by then why not. If this is not the case, some other form of investing in real estate may be better.

On the other hand, investing in further real estate close by where you live in your own house means increased lump risk - you miss diversification into regions where the value of real estate may develop very differently.

Relation between being rich and being landlord

There is one important psychological point that may play a role with the observed relation between being rich and being landlord. First of all, remember that the median wealth (without pensions) for Germany is about 51 k€, and someone owning a mortgage-free 150 k€ flat and nothing else is somewhere in the 7th decile of wealth. To put it the other way round: the question whether to invest 150 k€ into becoming a landlord is of practical relevance only for rich (in terms of wealth) people. Also, asking this question is typically only relevant for people who already own the home they live in as buying for personal use will typically have a better return than buying in order to rent.

But already people who buy for personal use are on average wealthier (or at least on the track to become more wealthy in case of fresh home owners) than people who rent. This is attributed to personal characteristics and the fact that the downpayment of the mortgage enforces saving behaviour (which is typically kept up once the house is paid, and is anyways found to be more pronounced than for non-house-owners). In contrast, many people who decide never to buy a home fall short of their initial savings/investment plans (e.g. putting the 150 k€ into an ETF for the next 21 years) and in the end spend considerably more money - and this group of people rarely invests into directly becoming a landlord.

Assuming that you can read German, here's a relevant newspaper article and a related press release.

cbeleites unhappy with SX
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  • What are cold rents? – RonJohn Jul 24 '19 at 19:30
  • @RonJohn: I don't know whether there's a proper English term for this, but in Germany we distinguish "cold" from "warm" rent: "cold rent" is what you pay for the right to use the room/apartment/house. "warm rent" includes operating costs for which you reimburse the landlord: e.g. heating, waste collection & insurance fees, certain taxes, water & waste water, electricity, ... (list varies of course depending on whether tenant or landlord actually contracts service provider). Heating is usually the biggest chunk of the operating costs, that's why it's called cold/warm rent. – cbeleites unhappy with SX Jul 24 '19 at 20:08
  • Interesting. In the US, it's "utilities included" or "not included" in the rent. Some can be included, and some not. Taxes are always paid by the landlord, though built into the rent. – RonJohn Jul 24 '19 at 20:57
  • @RonJohn: thanks, I updated the text accordingly. wrt. taxes: only taxes bound to the property that is rented can go into the utilities, taxes to the landlord as person or business cannot. – cbeleites unhappy with SX Jul 25 '19 at 09:48
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As a landlord for 14 years with 10 properties, I can give a few pointers:

  • be able and skilled enough to perform the majority of maintenance because this is your biggest expense otherwise. it will shock you how much maintenance rental units require.

  • don't invest in real estate where the locality/state favors the tenant (e.g., New York City) in disputes. A great state is Florida where you can have someone evicted very quickly.

  • require a minimum credit score of 620 for all tenants over 21. This seems to be the magic number that keeps most of the nightmare tenants out

  • makes sure they have a job nearby that pays at least three times their annual rent

  • every renewal, adjust your tenant's rent to be approximately 5% less than going rates in your area. Use Zillow as a guide. Keeping just below market rates keeps tenants from moving to cheaper options.

  • do not rent to anyone under 30 and single. Trust me trust me trust me. you can't legally do this officially, but do it while offering another acceptable reason for rejection; there's always something you could say that's legitimate (bad credit, or chose another tenant, etc.)

  • charge a 5% late fee starting 10 days after the rent is due. 20 days late, file for eviction to let the tenant know you mean business.

  • Don't sink yourself too much in debt, put enough money down so that you start profitable. I made the mistake of burying myself and I haven't barely been able to breathe for the entire 14 years. It's just now finally coming into profitability.

  • Don't get adjustable rate or balloon loans under any circumstances. Fixed 30 only. You can pay it down in 20 years and get the same benefits as if you got a fixed 20, but you will want the option of paying less some months so get the 30 and treat it like a 20.

  • don't even try to find your own tenants. Use a realtor and take the 10% cost hit. They actually save you money because they can show your place to a lot more prospective tenants and it will be rented much sooner. Empty place = empty wallet. Also, block out the part of the realtor's agreement-to-lease where it states they keep getting the 10% every year thereafter. Most realtors will go along with this just to get the first year, but if they don't, find another realtor.

  • buy all in the same community if you can, then you can use the same vendor list, the same lease agreement, the same realtor, the same documentation, spreadsheets, etc. Much much easier to have everything a clone. They say don't put all your eggs in one basket, but the reality is, running a bunch of properties is a lot of work, and the more similar they are, the more you can duplicate your work for free. That's worth a lot more day-to-day than the remote chance your entire community goes up in flames

Sean
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