Profitable Investment or a Good Part-time Job?

Question

I am going to pose a question that may get a knee-jerk negative response from some real estate investors. However, I believe most veteran landlords will agree with the premise of my argument if they take an objective look at it.

Do you have a profitable rental property investment or just a profitable part-time job?

This was a question I pondered several years ago when I was still relatively new to real estate investing. Yard work, painting, fixing leaky faucets, collecting rent, posting accounting entries, paying bills, taking phone calls from current and prospective tenants, managing handymen are all jobs that are required to be done when you own rental properties. One day while I was mowing and raking leaves at one of my properties I realized I was spending every weekend doing some job for my properties. That’s when the following question crossed my mind. If I paid myself $25/hr to do all the odd jobs I do on my properties would these investments still make money on their own? After all, if I just want to generate some active income I can pick up some part-time jobs mowing, painting, raking leaves, etc. without having to invest a dime on a piece of property.

The benchmark that I use for a passive investment return is a 5% annual return. This is taking Warren Buffett’s advice and investing in a low fee mutual fund that tracks American business; ex a Vanguard S&P 500 tracking fund. Buffett points out that the stock market returned roughly 5% from 1900 to 2000 and he feels relatively confident that results will be similar in the current century. Given his track record over the past 50 years, I’ll trust his wisdom. You see, a Vanguard S&P 500 tracking fund is truly a passive investment. You can set your online account up to automatically withdraw a fixed amount from your checking account each payday and never have to think about your investment again. This is because you aren’t having to manage the 500 American businesses that are in the S&P 500. These business have employee that perform the work, management to manage the businesses and boards of directors to review management’s performance. This is truly a passive investment since you don’t have to do anything, but invest your money. I therefore want to make sure that the passive investment part of business [Net Rental Property Cashflow – (Hours Worked x $25)] earns in excess of a 5% return on investment.

Homework Assignment

An enlightening assignment for any real estate investor is to add up all the revenue and subtract all the normal cash expenses for their property for the prior year. This will give you a ballpark idea if the property is cash flow positive. I believe about 90% of real estate investors cross this threshold. Next, calculate the number of hours a year spent on the following jobs:

Painting

Property Management – Renting unit, showing property, phone calls, contracts

Handyman Services

Cleaning units

Yard work – mowing, raking leaves, picking up sticks, trimming bushes, etc.

Be honest. Go back and think objectively about the number of hours spent on these tasks in the past year. Write them down and multiply the total number of hours by $25. This is how much money you earned on your part-time job. Congratulations! We could have made this money without taking any risk by investing in rental property. Now subtract the part-time earnings from the above positive cash flow number. Is the property still profitable? I have a feeling for a large percentage of newer real estate owners the answer is “No.” That was the answer for me as well. Since I was young and had spare time I was trying to save money by doing these jobs on my own versus hiring contractors to perform these jobs. While I was able to cash flow each year on my overall real estate business, it was only because I was providing free labor to my rental property. Looking at it another way, I had a negative cash flowing passive investment in real estate and several profitable part-time jobs managing and maintaining my properties.

The reason this point is so important is as real estate investors we are trying to build a business with passive income. We want to put our time into allocating capital intelligently. Put another way, this is earning income without having to put a lot of time and muscle into generating money. If we have to spend hours and hours working on the properties to keep them running, we cannot grow our portfolio as we run out of hours in the day. This leads to landlord fatigue and is why most real estate investors do not last more than a couple years. There is nothing more frustrating than working hard all year dedicating your nights and weekends to your real estate business only to see that the properties generated little to no cash at year end.

The Lesson Learned

The lesson is to only buy properties that are truly profitable after you pay yourself a part-time wage for the day-to-day jobs. These properties are fewer and harder to find, but if you can find one every year or two you are less likely to suffer from landlord fatigue. To be clear I am not against investors also performing these part time jobs. As a matter of fact I recommend most new investors, particularly young investors, do all of these jobs when they are starting out.  However, I want these part-time jobs to be bonus money that is in addition to the passive income you earn from your passive investment. That’s how you quickly build a scalable real estate portfolio.

Best of luck and I would be interested to hear from some of the other part-time plumbers, handymen, and lawn mowers out there.