Transcription
What's up, guys? It's Graham here.
So, I didn't want to do this, but Shelby Church posted a video titled, "People are admitting real estate investing wasn't worth it." And wouldn't you know it, I am in the thumbnail. The majority of the video is around me. As someone who for the longest time did almost everything correctly on paper, like I bought years ago, I locked in low mortgage rates. And somehow when I looked at the actual numbers, I hate to admit it, but uh she has a point.
So today, I just want to be honest because this is the part of real estate investing that almost no one talks about. Everyone is eager to show you the purchase price, the rents, the mortgage, the appreciation, but almost no one tells you what happens afterwards. I'm talking the repairs, the vacancy, the risk, the expenses, the taxes, and the moment a good deal on paper looks like not a good deal in real life. Because at the very least if a few of you could save some money at my expense then by all means maybe it's worth it.
So thanks so much and also big thank you to Kickoff for sponsoring this video. But more on that later. I'll just give you a quick recap speedrun of exactly how we got here.
I got my real estate license in 2008 and then after saving up my commissions for a few years in 2011. I bought my first bank-owned foreclosure for $59,500 in San Bernardino County. Now, it was not in the best of condition. So, I spent a little money fixing it up. I rented it out. And then from there, I just got hooked on this idea of buying these rundown dilapidated houses that no one wanted to live in and turn them into something nice and liveable.
Now, at first, I will admit it worked pretty well because as a real estate agent, my income increased. I funneled that money back into buying properties. And pretty soon, I had purchased seven rentals across Southern California, all fixed for 30 years at like 3% interest rates. My rents more than covered my overhead. All of them were making money. All of them had a ton of equity. I fixed up every single one of them, and it was working really well. Like, to give you some real examples here, the first property that I bought for $59,500 is now worth about $400,000. I sold two other ones in San Bernardino County a few years ago for a more than 300% return. The home I bought in West Los Angeles for $780,000 is now worth about a million3. And I even sold my last home for $500,000, more than what I paid for it just 7 months ago.
But here's the thing. Even though I was able to get some really good deals, in hindsight, a lot of that success was due to buying in the perfect window. Like I bought in cheap when rates were really low and rents were really strong. But those conditions no longer exist and the rising market really ended up doing a lot of the heavy lifting for me which uh wound up biting me in the end.
So I guess looking back these were my biggest mistakes. And I'll start with the first one that everyone said I was doing it wrong. I didn't listen. I was too stubborn. I thought I was doing the right thing. And that would be I never raised the rent. Look, my entire philosophy here was that I had locked in such low prices at such good rates that I didn't have to maximize every dollar possible. I could just get a good tenant at a lower rent, never raise it, and as long as they paid on time as agreed, I just leave it there. I just want peace of mind. And that worked really well until one day it didn't.
See, here's the problem with Los Angeles. A lot of these properties fall under what's called a rent control ordinance, which means you could only raise rent a small amount every single year. And if you don't take that increase, you don't get to make it up later. Instead, any future rent increases are only based on the lower amount. And that means one missed rent increase can compound into thousands of dollars over time. And that's exactly what I fell into. For many, many years, I operated on just never raising the rents. And then 2020 happened. And even though I had fixed rate mortgages, my insurance costs doubled. My repairs went up by 50%. The utilities went up 30%. And all of a sudden, that meant that some years I would literally just break even when one major repair would wipe out the entire year's worth of profits.
So, I had to raise the rent. Except I couldn't because the city of Los Angeles imposed a three-year ban on raising rents. Anyway, by the time I finally did raise rents that 3%, it only covered a fraction of how much my own expenses went up during that exact same time. Now, had I been diligent and raised rent 3% every single year instead of trying to be a nice guy and just give people a break, wouldn't have been such an issue. But, uh, you know what? That's on me. I thought I was uh doing a good deed here and saving people money if I could, but uh, didn't work out.
On top of that, when it finally came time to sell these properties, the lower rents didn't just affect my cash flow, it also affected the entire value of the property. Like, here's the thing. Investors usually value these properties based on how much money they make. And when your rents are below market and they're capped at 3%. On paper, they're a lot less valuable and therefore investors offer a lot less money to buy them. Again, initially I thought this wouldn't matter at all because I never planned to sell. But things change and by the time I listed it for sale, I wasn't just losing a few hundred a month. I lost in terms of a purchase price about $100,000 because the compounded rent that I could have received over 6 years translated into a much higher sale price that I wasn't able to get because my rents were significantly lower.
Now, yes, in fairness, every real estate investor told me that I was an idiot for not raising my rents, and I was an idiot for not listening to them. Okay, fine. That's on me. But the lesson here is that being a good landlord doesn't mean you have to ignore the math. And you could still be fair, charging your tenants a reasonable rate that allows you to also be able to operate the property at the exact same time.
The second, beyond not just raising the rents, we have another one that's worth discussing, and that would be non-stop repairs. Although, before we go into that, I got to say there is one more part about building wealth that almost no one talks about, and that is just how much your credit can actually affect the amount of money you're able to keep. Like, you could do everything correctly, follow the economy, and invest consistently. But if your credit causes you to pay more than necessary when you're taking out a loan, financing a car, or getting a mortgage, all that work could go completely to waste. That's why building your credit responsibly could be just as important as building a strong portfolio. And one of the ways you could do that is with our sponsor, Kickoff.
For those unaware, Kickoff is a credit building tool that helps you build credit safely and easily. Here's how it works. Kickoff offers affordable monthly plans starting at just $5 that are specifically designed to help improve key credit factors, including positive payment history and lower utilization. From there, you could build your credit by keeping your account open and making on-time monthly payments. And with autopay turned on, your monthly on-time payments to Kickoff are automatically reported to all three major credit bureaus. Essentially, this is a line specifically meant to help build credit. It's not money that you could spend elsewhere. And this helps. In fact, Kickoff users with credit under 600 and who made on-time monthly payments increased their credit by an average of 25 points in their first month and up to 86 points after their first year. Even better, there's no credit check to apply and you could sign up in minutes with no interest and no hidden fees. Not to mention, they're the number one credit building app in the app store.
Look, from my own experience, building strong credit was essential in helping me qualify for a more competitive mortgage rate. Without it, I would likely be paying thousands of dollars more than necessary, especially now with prices this high. It's crucial that you do everything possible to save as much money as you can. So, if your credit's holding you back, check out Kickoff down below in the description. And when you sign up using my link, you can get 80% off the first month, bringing your initial cost down to as little as a dollar. All you got to do is go to getkcakeoff.com/gra to sign up today. The link is, like I said, down below in the description. Thank you so much. And now, let's get back to the video.
All right, so in terms of the biggest expense that very few people talk about, let's get back on the topic of repairs. Now, here's the thing. Everyone acknowledges that repairs exist. They say go and budget 1% for maintenance. But I don't think people truly understand exactly what that means until you've owned a property for 10 or 15 years. Because there might be several years in a row where nothing happens. Nothing major. It's just minor easy stuff. It's fine. But then there's that one year where just everything goes wrong. Like the roof needs to be replaced. you have a plumbing issue and they get in there and then there's more work than was ever anticipated or the AC goes out in the middle of August during some of the hottest times ever and you got to get it fixed and the one guy who's able to fix it is like double of everyone else and you just have to do it.
Like I'll tell you firsthand, there have been properties that I've had requiring zero maintenance for years. Everything is totally fine and I think to myself, "Oh man, I locked out with this." And then there's one year you get a $20,000 expense and then all of a sudden the entire year's profit for that place is gone. Plus, even with a property manager, it's still work. Like, I'll never forget a tenant complained that their ice maker stopped working. So, they called the property manager. Property manager called the repair person, the plumbing company, and they fix it and they send me the bill. And that bill is $800 to fix an ice maker on a refrigerator freezer. that's maybe only worth $400. Now, for $800, it's common sense. You just haul the thing away and buy a new one for $900. You get a brand new system instead of fixing the same one that's not even worth it for $800. It's common sense, right? But that's what I'm talking about. It's all these little minor things that just add up. But thankfully though, the ice maker works. Makes great ice.
Anyway, even if your repairs seem reasonable on the surface, I will tell you it is only a matter of time until something substantial breaks. And if you don't properly account for that in your rents, you're going to lose a lot more money than you expect.
Which leads me to my next one, and that would be my annual returns. Unfortunately, this was one of my biggest blind spots, and it's something I recently had to come to terms with. When people would ask me how my real estate was performing, I would usually just point to the values. I'd look at the appreciation. I tell them, "Well, it's worth significantly more than what I paid." But as I later found out, that appreciation is worth nothing until you sell it. And again, that later wound up to bite me in the butt.
Now, again, even though on paper, these properties were worth significantly more than what I paid. I had a lot of equity in them. Once I backed out, my repairs, the vacancy, every insurance increase, every utility bill, and every maintenance call, the actual return was only about 4 to 5% a year. And at that point, when a Treasury bill pays the exact same without any of the stress, without any of the work, without any of the illiquidity, without any of the tenant risk and liability, I have to ask myself, was that actually a good investment? Even with leverage, I would have made just as much money with the most basic of index funds when you account for all the time I spent managing phone calls, notices, negotiating with contractors, dealing with random stuff, property taxes, insuranceances. It just wasn't worth it. I was taking on basically a part-time job except assuming all the liability for everything that could have gone wrong. That's why I took a very expensive lesson and I started selling.
Now, here's the thing. If you want to sell a property and get the highest price possible, you can't just stick a sign in the front yard and call it a debt. Instead, you have to make that property appeal to the widest demographic possible to try to get the highest price. And that's exactly what I did. Over the last few months, between three properties, I've spent over $100,000 just getting these places ready to sell, including renovations, staging, landscape, and other miscellaneous expenses to try to get the best possible price, including offering a tenant a voluntary buyout to be able to sell the unit without it being tenant occupied just so I'd be able to show it.
Now, I fully recognize how fortunate I am to be able to do something like that. But for a lot of small mom and pop landlords who are not able to just write a check, selling a tenant occupied property is really, really difficult. Anyway, my point being here is that yes, you could just do the bare minimum and just list it on the market with a sign out in front and try to get offers. But if you want your place to look nice, to get multiple offers, to sell it over asking, you have to do the work upfront. You have to make it look really good. And when it's been tenant occupied for like 8 to 10 years, it's inevitable that you're going to have to renovate it and make upgrades just to appeal to people today who want something turnkey.
Anyway, beyond the cost of selling, there's also another secret limitation that not enough people are talking about, and that is depreciation recapture. Basically, for those unaware, when you own a rental property, the IRS lets you depreciate the cost of the structure over 27 and a half years, which could make your income look a lot lower on paper. But the catch is when you finally sell, the IRS doesn't just forget about those deductions. Instead, they could come back as depreciation recapture taxed at 25%. Meaning all those early tax deductions need to be repaid back when you sell. Unless you just 10:31 that into another deal and keep it going, which a lot of people do. But for anyone just exiting the real estate game like me entirely, that's a tax bill you just have to take into consideration. Not to mention, my properties were also located in California, which means I have to pay an additional 10% plus tax to the California State Franchise Tax Board on top of the federal capital gains tax.
Now, don't get the wrong idea because yes, to pay taxes to begin with, you made money. And a lot of the depreciation upfront can make a significant difference on paper for people who just want to do real estate long term. But remember, depreciation is just a deferral. And in the event you sell and realize those gains, it's all going to have to be repaid back.
And then last but not least in real estate, there is the one that I like to call the hassle factor. Unfortunately, this is the one thing that never shows up in spreadsheets or projections. Anytime you buy a property, you're going to have to budget a few hours every single month to make sure everything runs smoothly, whether you like it or not. Even with a property manager, they're just the ones that get the phone call first. They're going to still run everything by you. You're going to be the one who will have to approve or look at things and just say yes or no to certain items or be the one who is responsible if something goes wrong. But there is also a lot of passive overhead that people just don't think about like insurance renewals, property tax bills, city inspections, permits, compliance, rent registries that have to be filed, utility notices. None of these things are catastrophic on their own, but each one of them takes up a little bit of mental energy that just chips away from anything else that you could be focusing on. And that's something that I never took into consideration until recently.
Now, look, I just want to be clear that this is not me complaining, but it is me showing you what it's actually like behind the scenes. When everything goes right, there is still the opportunity costs, the taxes, the repairs, and the hassle factor that just needs to be taken into consideration. I'm also not saying that real estate is a bad investment. The early properties that I bought were fantastic. I bought them at a great price with great rates. I saw a lot of appreciation and it's even how I started this entire channel. And so for that, I wouldn't be here today. But I do think I would be doing a disservice not to show you the full picture from start to finish now that I'm almost done selling everything off. And at the end of the day, the returns I got were nowhere near as good as I expected them to be. Again, some of this was my fault. I take ownership for that. People told me to raise rents, didn't listen, but a lot was also outside of my control with policies that were implemented without any warning whatsoever. So, sometimes you just have to build in a margin to expect the unexpected.
Now, I'm sure a lot of people want to know, would I still buy real estate today knowing what I know now? And my answer is probably yes. If I were buying for myself with a property that is nearby to where I live and I had the capacity for the hassle factor that needs to be considered right now that profile does not fit me. I live out of state. I don't live in those properties and I don't have any capacity for the hassle factor. I just want to be done with it. But I do think it could be a good opportunity for someone who has it in them to do the work, live in one of the sides, rent out the other to cover a significant chunk of their cost. And for those people, I would say it's probably worth it still. Again, that used to be me, but it's just not me today. Just don't have it in me anymore.
Now, of course, in terms of my advice for everyone else watching, unfortunately, I hate to say it, but as I learned, if you have a rental property that's under rent control, you have to raise the rents every single year to the maximum allowable that you can. I hate saying that because it goes against what I tend to believe, but just the math says otherwise. And if you don't do it, it's going to come to bite you later down the line. you have to. The city forces your hand to do it even if you don't want to. On top of that, you also have to budget aggressively for repairs, probably 30 to 50% more than you expect. Add that on the top line and if it comes in under, just apply that towards the next year. And finally, you then have to factor in your opportunity cost of time. every phone call, every thought, every management expense, every little thing you do, factor that in and then compare it to what you could be getting doing something like a set it and forget it index fund to really determine is real estate the right path to take.
To me, yes, there is still a world where it makes sense, but a lot of people I just think don't realize that it's not fully passive and instead what you're really buying is customer service with property taxes.
So, with that said, thank you so much for watching. As always, feel free to hit the like button, subscribe, and if you want an extra video from me, by the way, every single week, including early access to videos like this, feel free to join as a channel member. And as an extra perk of that, I've started doing channel member financial audits where channel members can send me their finances and I will rip them to shreds. I will go through your savings, where your money is going, and just critique you. So, if that sounds good, feel free to join as a channel member. All the info, I'll include that there where you could reach out to me.