What It Takes to Be a Landlord

The residence at 3809 Shannon Drive in northeast Baltimore has seen better days. Way better, to be honest. A two-story red-brick row house built in 1952, the 900-square-foot, three-bedroom unit has a tiny kitchen, rickety stairs, worn carpets, dingy and obsolete bathrooms, and, most off-putting, a concrete basement floor that curls up at either end in the shape of a half-pipe skateboard run. That's a sign of ominous settling and water damage. The nearest bus stop is a hike of four blocks. No supermarkets or restaurants are nearby. You're five miles from downtown. It feels like 25.

In a city rife with empty and deteriorating homes, no wonder the family of the elderly owner, who moved out last year to live with relatives, couldn't get their original asking price of $119,900 in February 2010. Nor could they attract a buyer when they lowered the price to $99,900 in May, or to $65,000 in October. Once they dropped the price to $55,000 in January 2011, professional real estate investors sensed an opportunity, like bottom-fishers snaring distressed stocks and bonds. So 3809 Shannon is getting a new lease on life.

The entrepreneur who bought it as-is in April for $42,000 is 45-year-old Baltimorean Fayz Khan, an automotive engineer turned full-time landlord. Khan thinks he can earn a return that would make Wall Street financiers envious. That's conceivable if Khan can recondition this pile of bricks quickly, at minimal cost, and get a reliable tenant who qualifies for a government rent subsidy. Khan thinks he can get $1,400 a month -- twice what plenty of nearby homeowners are paying each month on their mortgages, and about the same as the rent on a luxurious downtown condo. But that's what the federal government sets as "fair market rent" for a three-bedroom townhouse in Baltimore. Allowable rents are higher still in places like New York City and San Francisco.

Going down-market
This deal highlights the essential truth of property investing today: To boost the odds that you'll make a profit, you need to go down-market, where the rents are exorbitant relative to the cost of ownership. This is due to a drastic shortage of decent low- and middle-income rentals. For many years, it paid to buy rental houses even if the monthly expenses exceeded the income because you could count on leverage, high appreciation and tax breaks to produce a profit in a few years. But that business model does not make sense in 2011. Property values are not appreciating, so you can't expect to buy a place and flip it for a fast return. You might be able to profit from a modest small apartment building or duplex, but overbuilt high-rise condos and foreclosed suburban homes aren't economically feasible as rentals. The idea now is to insist that every house or apartment deliver "positive cash flow" (a net monthly operating profit) with no exceptions. If a house cannot "cash flow," as the pros say, you need either to walk away from the deal or to offer so little that if by chance your bid is accepted, the numbers work.

Accomplishing that isn't as easy as buying cheap stocks. First, you have to come up with enough cash to launch your business with a couple of properties because banks have all but ceased lending to inexperienced landlords. Then, take a hard look at your handyman skills: If you can barely hang a light fixture, you're vulnerable to all kinds of unpleasant surprises. It also helps to know the local real estate market, local politics, and which neighborhoods are stable and which are in irreversible decline.

Shannon Drive is a tidy street in a neighborhood of homeowners with a strong community association, and bringing a property up to snuff could help preserve the area. But Peter Giardini, a veteran real estate investor whom Khan has hired to be his coach and adviser, has a tough litmus test for would-be landlords: "What if you were faced with evicting a family in the month of December? Could you do it? If you hesitate more than three seconds, I'd say you don't have the temperament for this business."