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Tip No. 1: Make sure you know what you’re getting into.
Determined to profit from the
housing boom, many Americans are acquiring rental properties. But some of them
may be underestimating the risks and complications that come with being a
landlord.
“We
get a lot of inquiries from naïve people,” says Mike Phillips, who owns Century
21 All-Pro, a real-estate brokerage firm in
Kansas City, Mo.
He gets calls from people in California,
Florida and New York who
figures property in Kansas City
must be a steal.
Mr.
Phillips tells inexperienced investors they need to examine such factors as the
health of the local economy and the supply and demand for rental housing. In
much of the country, the fundamentals look bleak for landlords. Low interest
rates have allowed many former renters to buy their own homes in recent years,
removing some of the most reliable tenants from the mix. According to the
Census Bureau, the vacancy rate for rental housing in this year’s first quarter
was 10.1% that rate has been gradually rising since the late 1970s, when it was
around 5%.
Investors
also need to ask whether they can cope with the hassles of dealing with
tenants. “What if the renter’s kids shove G.I Joe in the toilet?” Mr. Phillips
asks. “You have to have a game plan, because they’re going to call you.
Yet
American’s faith in real estate is remarkably strong. During this year’s first
four months, investors accounted for nearly 10% of new mortgage loans used to
buy homes in the U.S, up from 6% in 2001, according to Loan Performance, a unit
of First American Corp.
For
those willing to put up with the ordeals of owing rental property, here are
some tips from seasoned landlords.
Figure Out Your Total Costs. Unless you take into account all of your costs, you
won’t know whether you’re making money.
“Most people underestimate their expenses
dramatically,” says Jonas Lee, a managing partner at Redbrick Partners LP, a
New York firm that invests in single family rental
housing in Baltimore,
Philadelphia and other Northeastern cities.
The costs include obvious things like insurance, maintenance and property
taxes. But they also include some items that landlords overlook, such as
periods of vacancy, bad debts, the occasional need to replace expensive items
like roofs or furnaces, and time spent managing the properties, Mr. Lee says.
All of these costs can easily
eat up half of expected rental income, Mr. Lee figures. And that’s before you
consider financing costs, which may absorb the rest of your rental income, or
more.
Screen potential Tenants. Many landlords use a variety of Internet services to
check on applicants’ credit histories as well as any past evictions or criminal
troubles. “My theory is that if they don’t pay Citibank, they’re not going to
pay me,” says Jean Yevick, a veteran rental housing owner in
Pittsburgh who is president of the Western
Pennsylvania Real Estate Investors Association. Some landlords also consider
such things as whether the applicant shows up on time for an appointment and
can communicate clearly. Neatness helps. “If they have a car that’s full of
junk and is disgusting-looking, the likelihood is that they’re going to keep a
dirty house, say Ms. Yevick.
Don
Wener, a Denver Landlord who is chairman of a committee of independent rental
owners who belong to the National Apartment Association in
Alexandria, VA,
requires tenants to have monthly income of a least three times the rent.
Understand The Fair Housing ACT. Among other
things, this 1968 law prohibits discrimination in the renting of housing based
on race, color, national origin, religion, gender, family status or disability.
That
doesn’t mean you have to rent to anyone who comes along. But you should strictly follow written polices about your
criteria for selecting tenants so you can’t be accused of bias. It is lawful,
for instance, to refuse to rent to convicted criminals. But you could be
vulnerable to complaints of discrimination if you applied that rule only to
certain applicants. If you want to run criminal check on some applicants, run
them on all. “When people get into trouble is when they eyeball a situation and
just go with their gut,” says Bryan Greene, a senior official at the U. S.
Department of Housing and Urban Development who helps enforce the fair-housing
law. HUD and local housing agencies last year investigated more than 9,000
complaints about possible violation of the law. The penalties can include fines
of as much as $11,000 per discriminatory action as well as damages to victims.
React quickly when tenants cause trouble or don’t pay. “There are a lot of people who have convincing
stories” about why they haven’t paid the rent, says Chris Ballard, who owns
rental house in the Atlanta area as well as
Century 21Gold Medal Realty in Atlanta.
But “you have to stick to your standards,” he adds. “You learn over time to be
polite but firm and direct.” After 30 days, he starts the eviction process.
Some landlords start even sooner.
Many
rely on the courts to evict dead beat renters. But Rich Sommers, a landlord in Stevens Point, WI,
says he can usually work out problems informally by visiting tenants. “Most
often a five-day notice will encourage them to leave,” he says. If tenants
violate Mr. Sommer’s rules, which include a ban on kegs of beer, he urges them
to find another home more suitable for their lifestyle choices. To show his
good faith, he sometimes shows up with a check refunding part of the deposit
and promises to pay the rest if the tenant leaves within a few days without
causing damages.
Inspect the property regularly. Mr. Ballard, in Atlanta,
makes sure to inspect each unit once every six months. In the past, he was less
disciplined about inspecting. He then discovered that one tenant had let people
move into the house without Mr. Ballard’s knowledge. That eventually caused a
septic tank to overflow and leak into the backyard. During his inspections, he
carries a camera so he can record any evidence that a tenant isn’t fulfilling
responsibilities.
Be ready for problems. Landlords need strong stomachs. Mr. Sommers has had a
suicide in one of his apartments and a drug raid in another.
Expenses
can come in big lumps. Mike Weston, a financial planner in Highland Ranch, Co
says sewer lines broke in two of his rental units within a month. “I’m assuming
it was a total coincidence,” he says. The
cost totaled more than $10,000. Other tenants called him in to unclog toilets
or shoo away bees from the backyard. Eventually, he decided the headaches were
too frequent and sold his properties. “Every time I went out of town, I had
nightmares about what would happen to the property”, he says.
Make sure you are properly insured. Ted Webersinn, a commercial property appraiser in
Surry, Maine, and his
wife, Susan Sokol, owned rental row houses in Baltimore in the 1980s. They initially
expected the neighborhood where they invested to improve, but the crime and
blight only grew worse. The property manager they hired carried a gun while
collecting rents. Eventually, the couple sold four of the houses and gave one
to the city.
More
than a decade later, a former tenant sued them, alleging that the tenant’s
children had suffered from exposure to lead paint. The case rumbled on for
years before being settled out of court. The couple’s insurer paid for the
settlement and legal fees. As soon as that suit was settled, a second tenant
filed a similar one. Altogether, Mr. Webersinn and his wife endured about a
decade of litigation. Without insurance, Mr. Webersinn says, they probably
would have had to file for bankruptcy.
Don’t count on rapid appreciation. “People are real high on appreciation right now, “says
Mr. Sommer, the Wisconsin landlord. “ They think they're just going to make
gajillions.” But house prices are unlikely to keep rising indefinitely at the
rapid clip of the past few years. That means some investors may find themselves
remaining in the landlord phase longer than they expected while waiting for a
good opportunity to sell. A landlord for the past 35 years, Mr. Sommer
describes real estate as a way to “get rich slowly”.
Be good to good tenants.
Mr. Sommer’s
wife, Carolyn, bakes Christmas treats for them every year.
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