You Either Win or You Learn
How I Destroyed Value with My First Rental Property
College Housing
I grew up in a college town in the Midwest and as with most college towns the city revolved around the University. Without it, our town would have certainly died a painful death when the automotive industry left a few decades ago.
The automotive jobs leaving left the city disfigured, but not dead.
As the automotive jobs left the drugs moved in. We can thank the UAW for that.
Naturally, when I wanted to buy my first real estate investment, I figured buying student housing was the way to go. Being 26 years old at the time, I liked the idea of renting to college students closer to my age as opposed to older “adults”.
Of all the rental properties I own now a total of zero are student housing. That’s called foreshadowing.
I greatly miscalculated how much I would hate the frequent turnover of college tenants and how rough students would be on the property.
The first house I was able to buy was built in 2000 and was a six-bedroom, two-bathroom home, all brick home that was rented by the room individually instead of the entire house to a single group. It had a communal kitchen and communal living room area with an upstairs balcony. Three bedrooms on the main level and three bedrooms on the upper level. Washer and dryer in the home along with two refrigerators.
First Rental Property Financials at Purchase
I paid $170,000 (25% down) for the property and each bedroom was rented at $400/month. The landlord was responsible for the utilities. Since all six bedrooms were rented upon purchase, I was bringing in $2,400/month in revenue.
Minus my mortgage and utilities, I was clearing roughly $1,000/month in cash flow. The home was a great cash flowing property initially, but my lack of knowledge of the university’s leasing process/timeline is what led me down the value destruction path.
Know the Local Market
I bought this property in September 2019 and what I didn’t know at that time, this university and surrounding housing starts signing/resigning student leases in September.
I figured students wouldn’t be signing new leases until April or May of the following year. The school year starts in August so how on Earth would students sign next year’s lease one month after starting the semester?
With me not knowing this is how the system worked, I didn’t bother trying to get leases signed for the following year until March of 2020. I was five months behind the other landlords.
Upon realizing this a slight panic started to set in. This was my first rental property and it felt like I was about to blow it.
The next problem in my way was of the six guys currently renting bedrooms, only two of them wanted to resign for the following year leaving four rooms to fill ($1,600/month in my mind).
Tenant Search
To fill these four bedrooms, I used every method of finding tenants that I could: Zillow, Facebook, Craigslist, Apartments.com, and a yard sign.
The challenge I ran into was no college student wanted to just rent a room with a bunch of other strangers. I wasn’t sure how the previous owner pulled this off and I was out of time.
Before I get comments on this article, I know renting by the room can be done successfully but the experience left a bad taste in my mouth.
The only people I found who wanted to rent a room and live communally like that wasn’t college students. These people all looked like felons or soon to be felons that just needed a cheap place to crash. They wanted efficiency living so they could focus their other funds on purchasing heroin.
Nothing I did was working and the clock was ticking. If I didn’t find anyone wanting to rent a room with other strange dudes, then I was going to be stuck with a mortgage and utility bills with not enough in rents to cover them.
That panicky voice in the back of my head was getting louder as each day went by. Every night before bed all I pictured was losing $1,000/month and looking like a moron to my friends/family.
Initially, my strategy was to limit the bedrooms to only one gender and rent to college students exclusively. Asking men and women to live together during college seemed like it would just lead to trouble or unexpected pregnancies that I didn’t want to be a part of.
During this entire process, I reluctantly delayed having the two current tenants who wanted to stay for next year resign a new lease. My thinking was that with enough luck I would find a large group still looking to rent the entire house. I wanted to maintain my cash flow at all costs. But I was gambling that the $800/month I had guaranteed would be there if nothing else worked out.
Dumb Luck
Through sheer dumb luck, and a little help from Apartments.com, I found a group of five guys (3 students and 2 non-students) who wanted to rent the property. The good news was I knew the parents of two of the young men which alleviated some of my concern. The bad news is I knew some of them weren’t students which meant they were living on campus for one reason…partying.
It wasn’t a question of if they’d party, but how hard they’d be on the house during parties.
Turns out those guys loved Bud Light and having a good time but were fairly respectful to the property itself. Every time I mowed the yard I had to pick up a few dozen empty beer cans and other miscellaneous trash, but no major damage was being done.
At least they all paid rent on time.
Financials Post Ownership
With me taking over the property and going through my first leasing round, I was now only renting five of the six bedrooms for $395/month and I was still paying all utilities.
I destroyed $425/month in value/cash flow.
When I was negotiating lease rates with the tenants the group of guys could sense I was somewhat desperate to get their large group in the home and they beat me up on rent rates a little.
I learned something about negotiating from those 19 year olds. It cost me some money, but it was a valuable lesson.
Mistakes Made
My mistake was simply not knowing when college students signed their leases on that campus. I made assumptions based on my own collegiate experience and it blew up in my face.
Exit Strategy
At the same time this new group of five tenants moved in the utilities basically doubled overnight. To this day I have still not figured out why this new group of five used so much more energy than the previous six guys. The previous tenants always kept the house ice cold in the summer and warm in the winter so not sure how the group of five was doubling the utility bill.
It is one of life’s great mysteries. Who built the pyramids and why did the utilities double at my rental?
I lucked out entirely having purchased this property in September of 2019. I got into the real estate game right before the real estate bubble really took off.
Like the saying goes, “you make money when you buy real estate, not when you sell it”. I wasn’t a real estate guru but timing was on my side.
After reducing the cash flow from around $1,000/month to about $300/month(less rent and higher utility bills), I decided to list the property and just get away from it. I had enough. My stress wasn’t worth $300/month.
Even with the reduced rents and higher utility bills I was able to sell the property for $195,000. I sold in August of 2020 after the real estate bubble had started to grow which saved my pride.
Other than marrying my wife, the best decision I’ve ever made was selling that house. By the time I paid realtor fees and capital gains taxes I hardly made any money but I learned a lot in the 11 months I owned the house.
You either win financially or learn a valuable lesson. Either way there is always value to be found if you’re paying attention.
Real Estate
The more I’ve invested in real estate I’ve become fonder of it simply because investors with local knowledge can out compete the big guys. It is hard for me to buy and sell stocks or bonds better than a hedge fund, but local real estate knowledge is a competitive advantage to the little guy with boots on the grounds.
Thankfully my first attempt in real estate was right before a massive price bubble. Without that bubble I would have come out on the losing end.
Don’t forget to tip your landlord.
Scott Kohler