My First Rental Property: Not Really a Great Investment

Update: As it turns out, this rental property IS a really great investment. Vacancies have been zilch, rent was raised by $100, and there have been minimal expenses related to repairs and maintenance. See my current cash flow analysis here showing returns around 10% (even with principal payments included).

Looking for your first rental property? Check out our How to Find Rental Properties guide or start your property search at Roofstock.

Previous update: Some have suggested I remove the principal from this expense since that is coming back to me in the form of equity. Principal is on average $207 per month in 2012, making my total annual expenses $17,940 – $2484 = $15,456. This would produce a return of 10% with 0% vacancy rate. Is this an appropriate way to calculate return?

My First Rental Property
It’s got a great kitchen!

Are you interested in owning a rental property to create extra cash flow?

Well, follow along with me over the next few weeks and months and watch me make all the rookie mistakes for you.

I’m officially a rental property owner. Here are the stats on my rental unit:

  • 2182 square foot townhouse
  • 3 bedrooms and 2.5 bathrooms
  • Built in 2007
  • Excellent school district

This property has a lot of things going for it: good schools, low crime, plenty of jobs, quick access to shopping, education, and the city. It’s also a townhouse so the maintenance would only be on the inside.

The Purchase

Nothing too exciting about the purchase of our rental. It’s actually our old home. We just purchased a new place and have decided to keep this property as rental. We purchased this rental property in 2007 for 205,000, putting 20% down. We refinanced in August 2011 back to 30 years at the new rate of 4.875%. The current payoff amount is 156,004.31. values the property at $197,800. Therefore, you could say I currently have $41,796 invested in this property.

Failing the 1% Rule

A good rule of thumb when evaluating your first rental property is to see if it meets the 1% rule. Meaning, does the price you can rent the property for each month equal at least 1% of the purchase price of the property. For many real estate professionals this is a way to quickly know if the property will be able to produce a positive cash flow annually.

Using this rule, my unit was purchased for $205,000 and should be able to rent for $2050 a month to pass. Unfortunately, I’m not able to rent it for that much. I should be able to get $1750 a month, or 0.85%. This isn’t bad, but it lets me know it may be cutting it close as to whether I can cash flow this property. Some have suggested that 0.7% is the absolute cut-off point when initially evaluating properties.

What About Return?

As for expected return, first real estate investment is going to be cutting it close. We should be able to collect rent on the property of $1750 based on what I’m seeing with similar units in the neighborhood.

Gross Rental Income

Rent – $1,750

  • x 10.5 months (10% vacancy) = $18,375

Alternate Vacancy Rates

  • x 11 months (7.5% vacancy) = $19,250
  • x 12 months (0% vacancy) = $21,000


  • Mortgage – $842
  • Property Taxes – $353
  • HOA – $175
  • Insurance $25
  • Repair and Maintenance $100*
  • Total = $1495
  • x 12 months = $17,940

*HOA fees include lawn care and external structural repairs.

Note that insurance is pretty cheap. That’s because I kept my original homeowners insurance coverage. Nowadays I’m forced to use a special landlord insurance (which is really a smart choice) and the monthly fee is much higher.

Net Rental Income

Now let’s subtract our expenses from out gross income and determine our net income and potential return on investment.

Per Year Net Rental Income = $18,375 – $17,940 = $435

  • Return on Investment = $435 / $41,796 (cash invested in the rental) = 1.04%

Alternate Vacancy Rates

  • Return with 7.5% vacancy = $1310 / $41,796 = 3.13%
  • Return with 0% vacancy = $2060 / $41,796 = 4.93%

Based on those numbers it looks like I could make anywhere from $400 to $2000 in the first year. The returns could be worse, but are pretty bad considering the money I have tied up in it, the debt I’m carrying, and the amount of time I’m using to manage it. The returns don’t come near the 10% suggested by Jim Randel in his book on investment properties.

Alternatively, I could take the $41,796 and earn 1.25% in an FDIC insured online savings account right now. I could also take it and invest it in the market and get a much higher return for no effort.

The bottom line is that even if this property performs at its highest potential (i.e. no major repair and no long vacancies) it’s still not that great of a return on my money. I do have potential appreciation to look forward to one day, but that may be a pipe dream.

I suppose I could up the rental price to $1800, but that would only net an additional $500 and would likely increase my vacancy time.

What are your thoughts, guys and gals? Should I keep the property for this type of return? Is there something I’m missing? Can I somehow increase the return on the property (either by adding value or increasing leverage)?

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  1. Definitely I agree that a rental property is one dependable income that can be used for a long term. I have my first rental property in 2001 and I purchased this for my daughter. I am a single parent so I really need to have some extra bucks for her future.

  2. Avatar Squeezer @Personal Finance Success says:

    It sounds to me like there’s too much risk with not enough return.  I would not count the principle in your figures because you will not get that back until you sell the house (or pay it off and can start pocketing the portion that went to principle).  You’re just slightly over breaking even, and there are costs associated with the ownership that come up every so often, such as a new a/c unit, new roof, etc.  Having one major expense like that in a year will kill your budget.

  3. Avatar AustenNut says:

    Until very recently, I was a landlady.  I had originally bought a duplex, living in one side and renting out the other.  When I got a new place, I decided to hold on to the old one and rent out both sides.  The rent from both sides just covered standard expenses (mortgage, with escrows, the water bill, and minor repairs).  And some years (when there was a big hike in home insurance), it was a negative outflow property.  But we had the thought of holding on for the long haul, and eventually having cash flow for retirement, so that any cash outflow was really just an “investment” in our future, which wasn’t a terrible idea considering the instability of the markets. 
    But we just sold the property about 2 months ago.  Why?   Even though we’d had remarkably good tenants, I still freaked out whenever there was a vacancy (and it was always rented at 23/24…the one side was always rented, and the other was never vacant more than 1 month a year).  Maintenance costs were getting bigger.  Fixed expenses were getting bigger.  And if we took the equity out and invested it in index funds, chances were that we’d come out in the same place financially.  For us (more like me), the stress just wasn’t worth it. 
    That being said, Romeo’s post about the tax advantages certainly holds true.  But when you do sell, though, your profit will be considered anything over expenses plus the DEPRECIATED value of the house, not the original value.  Also, if you rent the house for more than 3 years, then any gain will be taxed differently then if it was considered a personal property (at a higher rate).  If you rent for less than 3 years, and can show that you didn’t sell earlier because of the real estate market, then you can consider more of the profit as personal gain (and it’s taxed less).  With the same caveat as Romeo, I am not a tax professional. 

  4. My wife and I have kicked around this idea as well when we sell our $100,000 starter home.  However, in our area, we’re looking at less than 1%, about $800/month.  We’d be much better off buying two $50,000 properties or even three $33,000 properties than we would be with one, $100,000 rental.  If I were you, I would sell the condo and a)buy a smaller property with equity or b) apply the equity to your new house.  In your current situation, carpet replacement from one bad renter could wipe out 2 years of profit.  TOO RISKY!

  5. Wow, your insurance is really low! Did you get landlord insurance? We have a rental property (about the same year as yours), and the landlord insurance is about $50 a month. Must be difference in areas, or the fact that yours is a townhouse. Unfortunately, ours seems to go up every year (grumble grumble, inflation, grumble). 

    1. Avatar Philip Taylor says:

      It’s condo insurance, which is a little like renter’s insurance. The HOA dues cover the insurance for the outside and roof. Good catch.

  6. Avatar Mike Holman says:

    Hey Phil – great post.  It’s nice to read a real estate investing post which isn’t all “win-win-win”.
    I think your analysis is worthwhile, but there are a lot of assumptions in it.  Given that you already own the house and have decided to rent it out, I would give it a go for a year or more and see how those assumptions play out.
    It might not end up being worthwhile, but it’s also possible that you get good tenants, have a low vacancy rate and enjoy being a landlord.  
    In a year or two you will have actual numbers for rent/vacancy rate/pita factor/time spent and can make a very informed decision at that time. Capital gain is also a possibility.
    Good luck!

    1. Avatar Philip Taylor says:

       @Mike Holman Well I know enough to know you just dont fall into successful rental properties. Getting a great deal upfront is one of the easiest factors to control and I was just thinking about a place to live in when I bought it. Thanks for your perspective, Mike.

  7. Avatar FinancialBin says:

    This is a great analysis, PT. Really appreciate you sharing this. My wife and I talk about renting property all the time. We haven’t pulled the trigger on it yet. However, her parents put her through college with the money they made being landlords. You certainly give some food for thought here.

    1.  @FinancialBin
       We have two rental properties and that is exactly what we plan to do with them.   Our children are ages 3 and 1.  Our first rental property will be paid off in about 14 years and our second will be paid off shortly after that.  This will be just in time for our kids to be almost ready to graduate from high school.  We are going to use the rental income to pay most of their tuition.  Once they finish college, it will just be a passive income stream for us. 
      I don’t think that real estate in general is a good short term investment…but I think it can be a great long term investment if you can stick around that long. 

  8. Hey, @Philip Taylor , don’t forget the fact that pretty much all of your rental property expenses are tax deductible via the schedule E, the biggest of which is the depreciation expense. You can deduct your home’s depreciated value (line 18) over 27.5 years, minus the land costs. This means that you’ll have an immediate tax deduction of, say, $180,000/27.5 = $6545 per year, assuming your land’s value is $20,000.
    Add to this your cost of HOA fees (line 19), your mortgage interest (line 12), insurance (line 9) and management fees (line 11), if any, and you just found yourself a yearly tax deduction of at least $15,000 from your Total Income! 
    Also, this $15,000 deduction will be in addition to the mortgage interest that you can deduct from your primary home using the schedule A, itemized deductions, and your standard married with children deductions.
    Once you said that you can get as much rent for your NICE home in a good area, as your total expenses, it became a no brainer. 
    Disclaimer: I’m not a tax professional, so go confirm this information with your tax attorney, or CPA. 🙂 I only read the IRS pubs so I can tax advantage of the rules that the 1% knows all to well. 

    1. Avatar Philip Taylor says:

      Great job bringing in the tax elements. +1

  9. I agree with Mr. Sammy. Owning a rental for a mere $2000 per year might be more hassle than it’s worth. I’d count on the middle ground between your $400 and $2000 so chances are you will be pulling an even more mere $1200 per year. $100 per month. Start a lawn mowing service and mow four lawns and you can rake in $100, plus you get exercise, resulting in better health and then lower medical bills! On the other hand, if you have to sell for a steep discount from purchase price, that’s not so good either. Selling for less than the purchase price may not be all that bad, though, if you are wise and do not consider a home as an investment. Think of a home as a necessary part of life–you need a roof over your head. Compare outflow of cash from renting for five years to the net loss of selling (current value minus original sales price).  If the second number is equal or greater than the first number, then in my humble opinion selling for less than purchase price is NOT considered losing money from selling a house that drops in value.

    1. Avatar Philip Taylor says:

       @MarkNeum You hit on a key element, Mark. We paid $205K and Zillow is saying $197K is the right price. We did some upgrading so I do think it could pull over $200K, but then we’d have to pay real estate agent fees and eat $10k. No thanks. I may stick it on the market for sale by owner and see if I get some bites.

  10. Avatar Squeezer @Personal Finance Success says:

    Way to go!  There is a foreclosed house down the street from me I have considered buying and renting out.  It needs a little work and the sale price is still too high, however.

    1. Avatar Philip Taylor says:

       @Squeezer @Personal Finance Success Could you lowball an offer or is the bank unwilling to negotiate?

  11. What about after tax return on investment? Depreciation and tax dollars saved?

  12. $400 profit per YEAR?!?  $35 per MONTH?
    Even at $2,000 per year, I don’t think it’s even worth the hassle.  One unexpected repair bill could wipe away years of potential gains.  HOA, property tax, and insurance will go up every year.  Hopefully the rent increases will be able to keep pace.  I don’t own any investment real estate, and this is probably why.  It’s hard to find a good deal.  
    Good luck, though.  I’m interested in following your experiences as you go through this process.

    1. Avatar Philip Taylor says:

      I think you may be right, Sammy. Great point about the inflating expenses. 

  13. It may not cash flow much right now, or even for the next few years, but you are building equity with each passing month, which is nice. Hopefully you will have a low maintenance tenant and be able to keep it going for a few years, then reevaluate.

    1. Spot on WRT equity.  You have your mortgage as entirely an expense but it’s really only the interest part that’s the expense.  The rest goes back into the equity.

      1. Avatar Philip Taylor says:

         @mbhunter If that’s the case, then I’ve got a little more wiggle room in my ROI calculations.

  14. PT, congrats on your 1st rental. I also have a rental property as well. I’ve been renting out my home for 3 years now. When I met my wife we made her home ours and my home as rental. Even though you may only making $400 – $500 a year initially you have to look at the future investment. You will have your tenant paying down your principal as the value of your home goes up. You mentioned the property is in a great location so you should have no problem with keeping a tenant. My home is in a military community so I haven’t had any issues with keeping tenants in the home. The housing market may be down but it has no way to go but up. Lets say you continue to rent 10 years from now. Check out your amortization schedule and see how much you will owe and can imagine how much your home will be worth in 10 years. I don’t make a lot on my rental each year but I’m looking at the big picture. This is a good investment to add to a diverse investment with the investing in the market.

    1. Avatar Philip Taylor says:

       @CP1906 Thanks for this comment. Very positive responses so far. Is no one willing to talk me out of this thing?

      1. Okay, fine, I’ll try to talk you out of it.  We owned a 4 family house for years (it was our first home) and then bought a townhouse, which we lived in for about 5 years, and then rented out.  Being a landlord is a pain in the backside!  Unless you have at least a month of expenses in an earmarked emergency fund for the rental, and are a month ahead on the mortgage, then you’re always at the mercy of your tenant to get your mortgage paid on time.  You have to pay plumbers an exorbitant fee to remove plastic toys from the toilet, even though the tenant knows that’s supposed to be their bill, because the tenant has no money, and you can’t leave them without a working toilet, or it will overflow and damage the property.   Your income is at the mercy of whatever crisis is going on in your tenant’s life at the moment – and honestly, you get to the point where you just don’t care!  Just pay me already!  We sold the townhouse first, which meant that prices had come up to the point where we lost money, but didn’t have to bring a check to the closing table.  When we sold the 4 family house a couple years later, it felt like I’d just lost 50 pounds off my shoulders.  What a relief!  So there you have it…
        Except I should probably tell you that despite all that, I’m thinking buying another condo as a rental property maybe isn’t a bad idea to generate some passive cashflow for retirement…

  15. Avatar ontargetcoach says:

    Hold it for a year and see what happens. You are forgetting to factor in all the articles you’ll be able to write from this experience. 🙂

    1. Avatar Philip Taylor says:

       @ontargetcoach Now you’re talking. Definitely a content booster.

  16. Avatar lloyddobbler says:

    Great post. I think you’re not giving enough weight to one important thing: debt service. You mention appreciation, which isn’t guaranteed, sure. But real estate, like stocks (IMO), is best when thought of as a long-term investment. And real estate, over the long term, traditionally at *least* holds its value.
    Sure, you may only be initially making 1% per month on the upfront cash flow. But you’ve also got someone paying your principal (& interest) for you. It’s like investing in securities on margin – you’re more leveraged, and thus have less exposure, provided you bought the house for a good price.
    If you’re cash-flow positive, I would consider the amount that goes to principal of your loan every month to be ROI. So long as the property holds its value over the long term, that is. (But if you’re looking for liquidity, you shouldn’t be invested in real estate, anyway). 
    tl;dr: There are worse things than someone adding to your downpayment every month.

  17. Emily Guy Birken Emily Guy Birken says:

    J and I are just now considering this.  Just down the street is a small home for sale for under $70,000.  We could totally swing the down payment, and we would be right in the neighborhood for maintenance issues.  With Purdue down the street, we don’t anticipate having trouble finding tenants.  But still, we’re hesitating.  J is worried about the use of our time, which I can understand (particularly since he’d be the one handling the maintenance).  But I can’t get over the fact that we could potentially be earning income now, *and* have an investment that could come to fruition in several years. 

    1. Avatar Philip Taylor says:

       @Emily Guy Birken Now that sounds like a nice deal if the rent it right. Purdue down the street means vacancy rates would be low, but maintenance might be high (crazy students). What could you rent it for?

      1. Emily Guy Birken Emily Guy Birken says:

         @Philip Taylor, that’s the question!  I think we could probably get anywhere from $650-$800 for it, if neighborhood rents are anything to go by, which does put us right in the 1% rule.  We’re actually more concerned about the risk to our time than our money, but I keep thinking about it anyway.

  18. Avatar HelpMetoSave says:

    @ptmoney Don’t know if the property value will increase to improve your return, house prices falling in some parts of UK?

    1. @HelpMetoSave Actually, lower property value would help, right? It would potentially increase rents due to more demand.

      1. Avatar HelpMetoSave says:

        @ptmoney I thought lower property prices might make potential renters more likely to buy but depends if they can get mortagage.

        1. @HelpMetoSave Yes, the mortgage is key. I was thinking lower values, plus no credit would push more current owners out. Lot of moving parts.

        2. Avatar miscionesmrmhu0 says:


  19. Avatar DenverEric says:

    I would keep on as you are, maybe raise the rent a bit. Selling it has a lot of fees and hassles. Renting it is just income for you. $500 isn’t much, but $2,000 a year is more than the GDP per capita in 36 countries!

    1. Avatar Philip Taylor says:

       @DenverEric I agree about selling. I’d have to sell by owner not to lose my shirt in real estate agent fees. You are right in that income is income, but I value my time too. I guess I can just wait and see how much time it actually takes from me. I’m suspicious that you guys just want me to keep it to watch me crash and burn. 🙂

      1. Avatar DenverEric says:

         @Philip Taylor I am actually considering trying this myself. I just bought my place in September, but I am already saving up for the next down payment. I could likely rent my place out for an additional $500 per month over my costs (including all utilities!), so if I can bust my butt and get a few of those going, I would have a nice side income source.

        1. Avatar Philip Taylor says:

           @DenverEric At the very least it would make for good blog material. 🙂

      2. Avatar BeenThereDoneThat says:

         @Philip Taylor You’re lucky the place isn’t underwater…..which means that you don’t have to be an unwilling landlord.  Sell it fsbo to an owner-occupant buyer and use the money to buy a better-returning rental (if you insist on being a single-family landlord) or to invest elsewhere, just NOT in a savings account.  🙂

        1. Even if you place is underwater, you may be able to refinance by using the HARP program. I refinanced my home turned rental property that was $39,000 underwater. 

  20. Avatar krantcents says:

    I recommend keeping a former home to become a rental.  You are familiar with the issues and you already own it.  Congratulations!

    1. Avatar Philip Taylor says:

      that’s true, I do know the ins and outs of this home. would be easy to help maintain.

      1. Avatar Justmike2010 says:

        @Philip Taylor Really you have the mortgage as 842 but in reality every month your tenant pays your profit but also your principal buy down. So on a mortgage of 842 the principal is probably 300 dollars. So you have your monthly profit plus your net worth goes up by about 300 dollars because your remnant paid off that principal for you.

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