Landlords Provide Significant Value To Tenants

In today’s COVID environment the world economy has been turned upside down.  Many businesses are shut down, people are out of work, and financial problems exist for millions.  One particular effort that has taken hold is a moratorium on evictions. This concept asserts that government has a right over the property of individuals, that landlords are slaves, and that people are entitled to goods and services at no charge.

The most alarming part of this mindset comes from the far left.  I often use the TikTok app and have come across several posts on rental housing and invariable in the comments section there will be dozens to hundreds of posts claiming “Mao was right” or “We need to follow what Mao did”.  To be clear these people are referring to Chairman Mao of China’s policy of violent murder of landlords across China which systemically killed up to 3 million people directly, followed by the starvation of up to 20 million people. These are the same people who need safe spaces when an opposing viewpoint is stated that are advocating to violently murder millions of people for participating in the economy.

While I’m inclined to ignore them, calls for my death do at least entice me to state my argument as to why this worldview is extraordinarily incorrect and to defend the fact that landlords create an immense value proposition for tenants.

Chairman Mao and Chinese Land Reform:

Mao’s overarching goal was to transform China from an agrarian society to an industrial one.  He defined landlords by the way, as owners of farm land and not residential real estate. This land was worked by the peasants who paid the landlord for the right to use the land for farming. Homes in China at this time were nothing like US homes are today.  The houses that people lived in were inconsequential to the value of the land, which provided food.  Even after Mao took over and built new housing for peasants, you would have families living in a single room with shared cooking and toilets with others.  The houses bared no resemblance to houses and apartments in the United States today in terms of size, comfort, and cost. Mao’s focus was on grain production and physical farm land.

Mao had landlords killed so that he could create a common enemy and so that he could seize the land for the government.    When the landlords were exterminated this land was split up into communes.  These communes had quotas to produce a certain amount of grain.  Failure to produce could result in certain death, so they gave ever increasing percentages of their yield to the government, while starving themselves rather than report not meeting targets.   Mao’s revolution directly killed millions of landlords followed by tens of millions of peasants through starvation. Read more: Mao’s Great Famine: The History of China’s Most Devastating Catastrophe, 1958-62

I think that most rational people who have a distrust and disliking for landlords don’t openly advocate for their murders, so for the rest of this article I will focus on the value landlords provide economically vs. a rationale as to why we shouldn’t be murdered in mass. I primarily wanted to highlight just how extreme some of the rhetoric towards landlords has become.

Housing Is A Service:

Like any other product, housing falls into the category of a good or a service.  For it to exist someone had to create labor to make it so.  Although housing is a primary need like food and water, the type of housing we have is far from just a basic need, just as the average American diet is far from the food we need to survive.  We can survive on a 40 pound bag of rice and a 25 pound bag of beans for a month, but whose groceries actually looks like this?  Captain Crunch, Mountain Dew, hamburgers, pizzas, and Doritos are not necessities even though they fall in the food category.  By the same token, hardwood floors, 1,500 square feet, central air, plaster walls, and modern appliances are not required for shelter.  For most of human history shelter has been largely inexpensive and on par with what we would call a shed today.

Furthermore just because it is a need doesn’t mean that someone else is required to provide it for you.  What would you think if while in line at the grocery store you saw someone pushing out an overloaded cart without paying for it?  What if they did that every single week for the past 10 months? This is what some people are doing who are not paying their rent. They are absolutely stealing a service that costs money, time, and other capital to provide.  These houses and apartments didn’t just fall from the sky into the landlords hands.

Our government is creating a massive housing problem 6 to 12 months down the road by eliminating the ability to evict for non payment of rent.  This unfunded mandate causes problems down the line for the tenants, the landlords, the banks, and local governments.  Landlords who don’t collect rent can’t make mortgage payments to the banks or tax payments to the county.  Ultimately the landlord’s will lose the property to foreclosure and both the landlord and the tenant will lose housing.  I firmly believe within the next 1 – 2 years we will see a housing crisis that dwarves the 2008 financial crisis.

If landlords didn’t exist, and the banking system remained unchanged millions or people would become homeless.  If some landlords decided not to provide housing the cost of housing would drastically increase.

Most Renters Can’t Buy:

There is a reason that people are renting and it is typically because the renter can not buy or does not want to buy a home.  Those who can not buy a home would have 2 options if landlords didn’t provide housing as a service.  They could live with friends and family, or they could be homeless.  Neither is a highly desirable option.  For those who can buy and choose not to, they would likely live with family or friends or decide to purchase a home even if it were detrimental to their long term goals.

Most renters I believe fall into the first category and can not buy a house.  Landlords by provided a service or renting out their homes are creating value by solving a problem for these people.  Being homeless is a giant undesirable problem.  Living with your parents can also be a giant undesirable problem.  Paying to use shelter that someone else owns is a great option.

Landlords Creating Value:

As a real estate investor I create substantial value that greatly benefits my tenants. The value I create saves them money and earns me money.  I can operate home ownership at a vastly higher efficiency that a typical first time home buyer.

On the purchase: Typically I am buying from a bank or a distressed landlord.  I am not emotionally attached to the property and look at buying the property as a math equation. I take risks on unknown conditions and repair costs.  I pay on average 30% less than what a first time home buyer would pay for a property. I’m getting better at negotiating and this should be reduced further.

On the rehab: By learning to do work myself I save a lot of money over hiring professionals.  I also save money on materials and appliances because I buy them when they are on sale rather than when I need them, between the labor and the materials me rehabbing a property saves another 20% of the total value of the property.

Just on those 2 points I am effectively ending up with a home that is in newly renovated condition at half the cost of what a typical home buyer could buy. I then continue to add value and save money through efficiencies while owning the property.

On insurance: I pay 1/3 the cost for home owners insurance as the typical person.  By taking on more risk with a higher deductible, paying in full, and getting a bulk discount I pay around $35 a month for insurance on a typical home over the national average of $100 a month

PMI: I pay cash for my properties so I don’t pay PMI (private mortgage insurance), saving about $100 a month on a house valued at $100,000.

On financing: I refinance my properties 6 months after my cash purchase.  I pay less in closing costs and get a favorable interest rate. This is because I always maintain a 25% equity position and have excellent credit.  This of course wasn’t always the case. Although first time home buyers with perfect credit may be able to get better interest rates than I am, most first time home buyers don’t have perfect credit and are not putting down as much money to lower their rate.

On taxes: I always protest my property tax assessments. I know that the vast majority of people don’t do it, in fact I’m willing to wager over 90% of home owners don’t even know the process for it.  In my township of over 10,000 parcels only a little over 100 filed for property tax protests.  This saves me on average another $100 a month.

Lowering these operating costs allows me to offer my units for rent at a competitive price. I try to under price my competition so that I’m in market range but on the low end.  Even as the Covid pandemic was starting and our state entered a lockdown I was able to find tenants and had many people eager to rent our homes.

For someone buying a house similar to one I rent out for $850 a month, they would have to pay around $75,000.   With a 3.5% down payment of $2,625 they would get a loan for $72,373. They would pay another $3,000 in closing costs for $5,625 out of pocket to start.  Assuming they don’t have pristine credit with a 4% interest rate the principal and interest payment would be $367 a month. Adding in $62 PMI, $121 in taxes, and a $50 escrow buffer, their monthly payment would be around $600 per month. The external costs of building repairs and capital expenditures would transfer to them as well, for $80 and $100 respectively, placing their true cost at $780 a month.

For $70 (the difference between their cost and my rent) the tenant is buying mobility, getting into a house for 1/3 the initial cost, and greatly reducing their risk.  A rental agreement is a transfer of risk from the tenant to the landlord.  The tenant doesn’t have to worry about the house value decreasing, or a roof replacement, or any other capital expense.  The landlord is taking these risks and those risks are part of the spread on the price of rent and the price of a mortgage.

This also illustrates that landlords have costs associated with the property. It’s not like you hand your landlord the rent and he puts the check in his pocket.  The vast majority of landlords own only 1 unit and make under 5% net profit at the end of the year.  This means a $100,000 property that rents at $1,000 a month only nets that landlord $5,000 in profit for the year.  On a $100,000 property with a 75% loan to value on a 15 year note $308 per month would be required in principal payments.  This is deducted from the profit and never ends up as cash in hand. This average landlord ends up with about $108 per month in his pocket after collecting $1,000 in rent and paying all his bills.  You can see how tenants not paying their rent are causing landlords a lot of financial difficulty, and will ultimately lead to them selling the property and the property exiting the rental market. Missing 1 rent payment is the equivalent of over 9 months of cash flow.

Supply and Demand:

The more landlords there are, the more competition there is. When there is competition the quality of services goes up and the cost of services goes down.  Landlords by competing with other landlords moves the invisible hand of the market to require landlords to provide better value for their customers.  If landlords don’t economize like I broke down above, they will be priced to high and have trouble finding tenants. The more landlords that exist in a marketplace the lower rents will become.  The only way for rents to go down is if there are many people willing to invest in rental real estate.  There has to be competition and more supply than demand for rental prices to trend downward.

Does Investing In Real Estate hamper first time home buyers?

I keep reading articles that state that the bottom 25% of house price listings get bought up disproportionately by investors, keeping first time home buyers from being able to compete. In reality the majority of these bottom 25% of listings are not homes a first time buyer could get.

I buy low dollar houses that most first time buyers would love to get at the prices I am, however, first time home buyers can’t and won’t buy the houses I’m buying.  The houses I buy require more work than both a first time home buyer is prepared to put in, and more work than a bank will underwrite.  If a house can’t be bought with a loan, then the vast majority of first time buyers are not competing to buy it. I am increasing the total supply of housing by rehabbing houses that have had significant neglect and are currently outside of the housing supply. This increase in total housing supply helps drive rental costs down, providing value for not just my tenants, but for all tenants in the area.

Myth: Landlords increasing the rent is bad for tenants:

A tenants dream is for their rent to never increase for 20 years right?  Well I’ve seen some properties recently where this has actually happened and it’s a nightmare.  The landlord never raised the rents and the tenant over a long term became accustomed to the subsidy the landlord was providing.  Rather than raising the rents even modestly by $10 to $20 a year, the rent stayed the same.  The result? A house that should rent for $800 a month is being rented out for $400 a month, sounds like a great deal right?  Well this creates several problems:

  1. The tenant has no options: This tenant will not leave because getting a similar place will cost over twice as much.  The landlord has crafted a situation, while trying to help his tenant, that traps his tenant in a make believe world where rent is highly subsidized. The tenant never had to budget for small increases in rent and now if the landlord raises rent to market rate or sells the property, this tenant is in for a world of hurt. Rather than making small adjustments over time, the tenant now has a major adjustment that needs to take place.
  2. Maintenance will suffer.  As time goes on, even if the property is paid off, property taxes, insurance, and the cost of goods and services all go up.  At $400 a month the landlord is not budgeting for major repairs such as furnace replacement, roof replacement, etc. Properties that never have rent increases will have substantial deferred maintenance.
  3. The unit is “out of the market”.  Renters move, generally to find a more ideal location or to get a place that meets their changing needs as their family size or place of employment changes.  When renters move the house comes on the market adding to competition.  If the house never comes up on the market that rental is never contributing towards determining the market price by increasing the supply. This particular tenant who is benefiting from rent subsidized by the landlord may choose to stay, even if the house no longer suits his or her family.  If the rent were priced correctly the tenant may see moving to a 3 bedroom house from a 2 bedroom house would be worth what would normally be a $100 to $150 price increase, but because of the landlords actions, it is now a $500+ increase.
  4. The landlord isn’t able to profit properly from the house and use those funds to buy and rehab more rentals, expanding the housing supply and thus lowering costs for everyone.  The lost revenue from those 20 year of rent subsidies would keep the landlord from being able to buy multiple other properties.

As Landlord’s Mrs. C. and I work extremely hard to create value for ourselves and our tenants. We strive to treat our tenants well and to properly upkeep our houses.  I strongly believe that our actions are having a strong net positive increase in the small city we are investing in.  So far we have transformed 5 abandoned properties into homes and plan to do many more.  I know that there are some slum lords out there who treat their tenants poorly and maintain their homes even worse.  In the long term market forces will eventually shut them out of business.  I hope that for people reading this who are very anti-landlord are able to see from this article that landlords by and large are not some evil entity and they are providing a valuable service to their tenants.

What do you think of the current unfunded mandates that require landlords to provide housing for free?  How long do you think this is sustainable?

 

John C. started Action Economics in 2013 as a way to gain more knowledge on personal financial planning and to share that knowledge with others. Action Economics focuses on paying off the house, reducing taxes, and building wealth. John uses the free tool Personal Capital to track his net worth and posts quarterly updates on his finances. Check out the Action Economics archives section for all past posts.

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