Landlord-Tenant Economics

How landlords make money off of tenants; find out how much your apartment is worth.


How Landlords Make Money Off Tenants

The fundamental thing to know about landlord/tenant economics is that, to a landlord, a house is an investment, while to a tenant it is a home.  If your landlord ever tells you that she or he is "losing" money on your apartment or house, then you are not getting the full story.  So how does a landlord make money?

Rent 

At first glance, it appears that the only money made from owning rental housing comes from rent.  In fact, only a fraction of the profit comes from this source.  Using "other people's money" is the key to making money in rental housing.  Rarely do landlords pay for a rental property entirely with their own money.  Tenants buy it for them.  Once they find a property to purchase, they find a bank to lend them the money.  Even if a landlords had enough money to buy a rental property, they would not.  Landlords only put a "down payment" on the house out of their own money, usually ten to twenty percent of the purchase price.  A bank or other lending institution loans them the remainder of the cost in the form of a mortgage.

Net Profit 

Mortgages allow landlords to buy more properties with less of their own money.  More importantly, for tax purposes landlords deduct the interest payments made on the mortgage, along with other operating expenses, from the income they receive from the property.  The tax system encourages landlords to take out mortgages since the "cost" of the mortgage (the interest paid to the bank) is deducted from taxable income.

Here is an example of how this might work: Let's suppose a landlord purchased a house for $95,000 with $20,000 down.  The mortgage of $75,000 was financed in equal monthly payments over 20 years at a rate of 11%.  Here is what a balance sheet might look like for this house:

Income

Rent (including fees)  $14,500
Interest on security deposits  $200

TOTAL INCOME:  $14,700

Expenses
Insurance  $250
Water and sewer  $300
Maintenance  $1,500
Management  $1,400
Taxes  $2,000
Mortgage payments  $9,159

TOTAL EXPENSES:  $14,609

Cash Flow (Profit) - Income Less Expenses:  $91

In this example, the landlord showed just $91 in gross profit from the house at the end of the year.  This sounds too low, but this is only the beginning of the landlord's money-making scheme.

Depreciation and Tax Deductions 

Landlords can depreciate their properties over time to reduce their taxes.  Every year landlords can deduct a percentage of the purchase price of the rental building (not the land) from the total income they received on that property.  This is a "paper" deduction that does not correspond to any actual expenditure on the property.  It assumes that the building ""wears out"" over time and steadily loses value.

Therefore, for the above example, the landlord might be able to depreciate 4% of the purchase price of the house in a single year. This would indicate a "loss" on the house even though the landlord actually made a profit:

Profit ($91) - Depreciation ($95,000 x .04 = $3,800) = Loss (-$3,709)

The landlord is much happier with this paper $3,709 ""loss"" than she or he was with the measly $91 profit.  Landlords do not want to show a paper profit (or gain) on each of their properties or all of their properties together.  The more paper profits landlords show, the more income taxes they must pay.  Many small-time landlords can deduct losses on real estate directly from non-real estate income such as wages and salaries.

Larger landlords try to offset profits that they show on some of their properties with losses shown on others.  Although large, wealthy landlords cannot deduct real estate losses from their non-real estate income, they can deduct their real estate losses from real estate gains.  This allows them to avoid paying taxes.

Investment Return 

In addition, landlords' mortgage payments are not simply a "cost" for them. They are buying the property over a number of years with the rent tenants pay to them.  In the above example, after twenty years the landlord would own the $95,000 home completely, after investing only $20,000.  If the landlord has managed to maintain a positive cash flow in the meantime, then this is just icing on the cake.  Now that the landlord owns the building outright, she or he can sell it and pocket the $95,000, or continue to rent it out without having to make mortgage payments.  This would give the landlord a net operating income in excess of $9,000 per year.

Appreciation 

Ultimately, the biggest source of landlord profits is the appreciation of the property itself.  Housing in Ann Arbor has been rising in value at rates in excess of 15% per year.  This means that the value of our hypothetical landlord's house will have risen approximately $14,250 in one year.  Thus, whatever small profit or loss may appear on the landlord's cash flow accounts, she or he will have made in excess of $14,000 on an investment of $20,000.  As long as housing prices continue to rise at anywhere near current rates, landlords will be earning fantastic profits, regardless of what figures appear on their cash flow statements. Also, it is likely that rents will rise at approximately the same rate as housing prices, so that in future years our landlord will be charging higher rents for the house, even though the costs will not have risen as rapidly.

In Summary: 

Tenants pay and landlords collect.  Do not believe landlords who claim they are not making money.  They would not be in the business if they were not making money.  Supposed losses that landlords report merely disguise lucrative ways of making profits.

To learn more about housing rights in Michigan and where to get help:    

Consult the Michigantenants.org website for local housing resources and tenant counseling services. 

Consult the Michiganlegalaid.org website for legal education articles and local service information.

If you received court papers or otherwise need free or low cost legal advice:

This article appears courtesy of the Michigan Tenant Counseling Program.