How To Make Your Money Make Money Series: The college town rental house

I’m planning to make this a series of posts on investments I’ve made or didn’t make in the past and how they turned out.

The first investment I’m going to review is a rental house my brother and I purchased in 2006.  The plan was to purchase a rental house and have my brother live in and manage the house with 2 other roommates while he was at college.

We searched for a house for a fairly short time before deciding to buy the one we did.  My brother’s lease was going to be up soon, and so he needed another place to stay, and we wanted to lock in our new renters before the school year started.  It’s considerably more difficult to find renters after the semester has started.

The house is in a college town, and is not too far from the university itself.  Although it’s not exactly walking distance, you could ride a bike or take the bus.  It’s not a luxury home, but it’s nice enough to live in for a college student.

When we purchased the house, it had 2 bedrooms and one bathroom.  Part of our plan was to have at least 2 renters besides my brother.  So for some reason I decided it would be a good idea to build a wall in one of the rooms and divide it in two.  At the time I forgot that this meant we would also need another door to get into and out of the new room.

I am by no means a mechanically inclined person, but for some reason I thought we could do this.  We measured the space, and made a list of supplies we would need which included 2x4s, a circular saw, screws, a door, and some kind of wallboard.

We then hit Home Depot and purchased all the supplies.  We hauled them back to the rental house and built the frame of the wall on the floor of the room.  When we went to raise the frame in to place in the middle of the room, we found that our perfectly squared frame did not exactly fit in the not so squared room.

That’s kind of how the whole project went after that.  Things were slapped together enough to be functional, but definitely not quality workmanship.  I do remember enjoying knocking that first hole in the wall to make the new door.

In any case, the wall and door went up in one day and have served their purpose of accommodating 2 roommates where before only 1 could be accommodated.

Tenants

There have been a number of different roommates.  My brother has been the one to go out and get all of them.  We did try posting an ad on Craigslist, and got some interest, but have always found someone he personally knew instead.

Most of the tenants were just fine and moved on when they graduated or wanted a bigger space.

Of note was the one girl that we asked to move out after the police arrested her in the middle of the night for shooting at her boyfriend from the front door of the rental house.  Evidently they were having a domestic dispute.

Financials

Getting down to the actual numbers, we paid around $80k for the house including closing costs and made a down payment of about $12k at closing.

The mortgage payment including taxes and insurance is about $600 per month, or $7200 per year.

There have been a few occasions of repairs being needed which so far have totaled about $1800, or $450 per year.  And we’ve been able to keep it fully rented for 11 months out of the year on average.

The monthly rental income is $825.  For the 11 months it’s rented that’s $9075 per year in rental income.

$9075 – $7200 – $450 = $1425 net rental profit per year.

Given the initial investment of $12k that comes out to about an 11.8% return on initial invested capital per year.  This doesn’t include the tax benefits or the possible appreciation of the property.  Note that since my brother and I are splitting the profits, my individual return on this investment is actually about 5.9%.

Risks

There are a couple of substantial risks that this investment suffers from.

If the house value goes down, instead of going up, we could end up losing money overall.  So far it looks like the value of the house has stayed constant or possibly gone up.  We won’t really know until we sell.

If we can’t keep renters in the house we could end up losing money overall.  So far my brother has done a great job at keeping the house rented.  I’m certain that if I was trying to run this thing on my own that it would not be as successful.

Overview

So far this investment has been fairly successful for me.  However I attribute most of that success to luck.

My idea for splitting the room in two probably was a determining factor in the profitability of the house since it allowed us to get more rent.  But overall if my brother had not been as good at keeping it rented, or we had larger repair bills, the house could still have easily slipped into a negative cash flow situation.

It is possible that when we sell the house we’ll net an even higher profit, but it’s crucial not to count on that to make the investment work out, and instead to shoot for a positive annual cash flow.

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