Investing in real estate sounds really complicated, especially because there are so many ways to do it. In this article I’m going to focus on the most straightforward way that most people are familiar with, single family homes. To a large extent, the rules still apply to most of the other strategies or property types, but there may be some interpretation required to translate from one strategy or property type to another. I hope you enjoy!
Over the years I’ve learned a lot about investing in rental properties. Most of what I’ve learned has been what NOT to do, thankfully some of that information was obtained through my property management business with client/owners who had made some major mistakes, most of which were coming to me to fix them. In most cases if they had done some research and asked around they could have avoided those mistakes entirely, but I’d be lying if I said I didn’t learn most of my lessons the hard way too. I’ve come to realize that there are some simple basics that apply to almost everyone, and I’ve used them as the first steps on the path of testing a potential new investment. This is the first time I’ve ever actually written them down, so hopefully it doesn’t come out a jumbled mess.
Rule #1: If you wouldn’t have lived in the home at some point in your life, you shouldn’t own the property. This is especially important if you plan on managing the property yourself, rather than turning it over to a professional property manager, but even if you are planning to use a manager, it still applies. The reason for this is simple, for anything to be a good investment, you have to have some idea of the cash outflows (purchase price and repairs, debt service, etc) AND the inflows. Each are very important, and often difficult to determine, especially by a rookie investor. If you’re purchasing a “war zone” property that you wouldn’t have even considered in your broke college student days, then I can tell you without a doubt that there’s no way you can guess accurately at what your income OR expenses will be. You don’t have any way to relate to the tenants that will live in that home, and they can’t relate to you. You won’t understand each others behaviors, and generally it will all end in disaster with every tenant, every…single…time. Sound like fun? It’s NOT!
Think about the worst home you’ve ever lived in, if you owned that house and were renting it today do you think you’d know what to expect out of a typical tenant in that home? Most of the people that I ask that question of actually underestimate the quality of a tenant for any given home that they perceive as being undesirable, and that’s actually a good thing. That means your income and expense, turnover, etc numbers will be conservative, and when the property is properly managed it will outperform your expectations. As long as you were doing the right math when you bought the home you should experience a great return on investment!
Rule #2: Doing the math makes EVERYTHING apples and apples. Learn to love math, and you’ll go very far in real estate investing. If you’re looking at two different properties the math can tell you everything you need to know about which one to purchase, or whether you should purchase either one. Stick to your numbers, and your required return on investment. If you don’t have a lot of financial resources (like cash) to work with, make sure you’re adjusting your required return up to ensure that you’re getting your best “bang for your buck” and not just investing in the first thing that comes across the table.
Unless you’ve got a background in construction and feel VERY confident in your ability to estimate construction costs, make sure your first few projects don’t require more work than you can do in 2 weekends by yourself. That way when the bids come in you’ll have something to weigh the costs against (cash expenditure vs 4 long hard days working). Most importantly generate a very conservative estimate of the amount of time it will take to get the project completed, AND account for the carrying costs (debt service, utilities, insurance, taxes, etc) during that time in your cash expenditure formula.
Once you’ve got a ceiling value figured based on the math and your best estimates you have to stick to it. Emotions can cloud your judgement, but if you’ve double checked the numbers and everything checks out and is accounted for it will keep you in the black.
Rule #3: Consider your best use of time, and be honest with yourself about your abilities. When you’re starting out you may have plenty of time available, and it may make a lot of sense to do the renovations and property management by yourself to save your cash and supercharge your cash return on investment, especially if you already know what you’re doing and won’t just be learning on the job. But consider the fact that laborers can be hired for $15-20 per hour, slightly higher if you’re paying by the task rather than the hour (but you have a fixed cost rather than open ended one) for the same work you’re doing. What else could you be doing rather than working on your rent house, and what kind of product will you come out with when you’re done? Can you make more money doing something else? Will it be a high quality job or will it have to be done every few years?
Tasks like property management can usually be contracted out for MUCH less when evaluated on an hourly basis, considering it is just a percentage of rent, and the most time consuming and expensive time is when the property is vacant and they’re not making ANY money. Depending on how much time you have available a good property manager will almost definitely make you more money than managing yourself, because they’ll have better processes and systems to get properties rented faster and keep them occupied longer. Good property managers also should have a broad knowledge of tenant landlord laws, the latest technology, and what strategies other landlords are using to maximize their return on investment. Great property managers are also actively investing in real estate (walking the walk) rather than just managing it for a buck. If you don’t have the time or inclination to go to several conferences a year to keep up with the latest trends and technology, and/or you aren’t investing on the scale that it can be your full time job, chances are you’re going to be better off with a good property manager on your team.
Rule #4: Time is literally money. Don’t get hung up on rent rates, just stick to the math. When you KNOW your house is worth $2000 a month and you just won’t entertain anything less, how long will you let it sit there vacant consuming your time, money, and energy before you accept that $1900 offer? It only takes 18 days to make up that difference over the course of a year, and at the end of the year you can adjust the rent to get to (or closer to) your target rent rate. If you haven’t rented it in the last 18 days at your current rent rate, why do you think it will rent in the next 18 days? If you don’t have any reasonable reason to believe it will rent at your asking price in that time period, then you should take the offer, but always give a counter offer if the offer is more than a $50 discount.
Rule #5: Attempt to determine what tenants want, and find or make that in your rentals. Especially for single family homes there are a alot of things that people don’t consider. Things like fenced yards, deadbolts, ceiling fans, etc. There’s a long list, and every prospective tenant is different. I do my best to ensure all of my houses have deadbolts on every exterior door, ceiling fans throughout the home, and fenced back yards. I also pay attention to things like parking, lighting, and kitchen arrangements. Small investments like that can pay huge dividends if it means your homes are renting faster and/or for more money. Generally tenant quality increases as well, which is reflected more in lower expenses generally than higher rents.
Rule #6: Value is the only thing that matters to a tenant, and it can come from a long list of items. Value is a tough thing to explain, but most often referred to as “bang for the buck” or something similar. It’s not always about cost, but cost is usually a big factor. There are a lot of homes in my hometown of Shreveport, LA that rent for less than $500 per month, but as a consumer I wouldn’t live there even if it were free, because they hold NO value to me. There is a subconscious value that every prospective tenant assigns to each property they look at, and your goal should be to maximize the value of your property as high as it possibly can be, that’s the only way you’ll guarantee it’s income in the long run. You can rent any home, but not at any price, eventually you can get down to a price that someone is willing to pay in rent to live in even the worst homes, there is definitely a threshold at which it’s impossible to generate any profit on a home, even if it’s paid off, which is why I don’t invest in low income housing, and I generally don’t recommend it for anyone other than experienced investors who have a well diversified portfolio of more than 50 properties.
Value can come from nice appointments, large square footage, great location, lot size, energy efficiency, or just a great price. If your home is sitting on the market for an extended period of time, the prospective tenants aren’t seeing the value, so you should either look to make major changes, or my recommendation is usually to just drop the price and monitor results. So long as you have significantly high exposure to the market, the market will tell you what the right price is.
Rule #7: Always stick to the top of the bell curve. I picture every market as a bell curve, with price on the x axis and quantity on the y axis. For those that are familiar with statistics, I like to buy within .50-.75 standard deviations of the average home price, or top of the curve. This means that I don’t invest in low income properties or high income properties. I consider this to be the meat of the market. It’s not a perfect strategy, but the way I look at it, homes in that price range have the most flexibility. If the market were to suddenly lose population, or a boom market occurred where lots of new homes were built, those that would have been in lower price homes would abandon those homes and rent my relatively nicer homes. In a bust market the occupants of the higher priced homes will abandon those homes in favor of my more affordable options. If there is a sudden population influx incoming residents or current residents experiencing unreasonable rent increases will pay a relative premium for my more modest affordable housing.
My rules are a mix of offensive and defensive strategies, some are meant to increase income, some are meant to avoid losses, but all revolve around maximizing overall long term performance of a property. When you really think about it they aren’t rocket science, but you’ve got to think about it! I hope you’ve gained something from this article, now get to investing!
I hear it all the time: “I just don’t like debt” or “I want to get these properties paid off as quickly as possible” and honestly, I totally understand. I had a very similar mindset not that long ago, and when I bought my first rentals I bet I even made the same or similar statements.
Funny thing is, hindsight is 20/20 and I can honestly say that if I had followed that thought process to fruition, I might have 1, 2, maybe even 3 paid off rental units now, which would be great if I wasn’t comparing them to the 91 rental units I currently have, 5 or 6 of which are under renovation and currently have no mortgage.
Think about that! That’s a massive difference, and it’s all due to “leverage” which is just a fancy word for debt. But to clarify, not all debt is good. Personally I take a higher risk approach to all of my investing, which involves utilizing as much debt as possible to maximize my returns. That is one of the factors involved in my cash on cash returns that have topped 60% annually on some properties. In general, as long as you’re going to spend the money anyway, and you have an investment vehicle ready and available to invest the cash, that debt would be “good debt” simply because it allows you to attain the higher returns from your investment using your cash, which would have been foregone if not for the debt.
The biggest factor that determines how good your debt is revolves around the “margin” or difference between your investment return (money in) and your debt’s interest rate AND payment amount (money out). Both of these factors are important to consider, because so long as you have high investment returns, with minimal volatility, and low interest rates with low payment amounts, theoretically you can repeat this cycle indefinitely and make a very nice profit. Reinvesting your returns in this scenario will generate incredibly high compounded return on investment, and you’ll become wealthy much faster than most would believe.
This is why rental properties are so popular, and why the most successful real estate investors utilize debt extensively. An average single family rent house can be purchased with a low interest rate (7% or less) mortgage that is paid back over 15 to 30 years. In most cases, that single family house will generate an unlevered return on investment of around 9-10%. (Example: Purchase a house for $100,000 that nets $10,000 per year after insurance, taxes, and all other expenses EXCLUDING debt payments would have a 10% unlevered ROI). If your mortgage was at 6%, but the investment is returning an average of 10%, then you have a nice margin of 4% to capitalize on! That may not sound like much, but once you do the calculations you’ll realize that the mortgage on that house has changed the cash on cash return from 10% to 21.22% just because of that 4% margin.
The other advantage to this leverage is that now you can purchase 4-5 times as many rental units with the same amount of cash, which allows you to be able to diversify your investments and not be reliant on or subject to the risks associated with all of your invested funds being in a single property. Just like you wouldn’t want to have your stock portfolio comprised 100% of one stock (even the best stock in the world), it’s best to have your real estate investments spread to more than one rental property (even if you think it’s the best rental in the world).
Ultimately it comes down to whatever you’re comfortable with, because I wouldn’t ever want to recommend something that would cause someone to have a mental breakdown from unwanted stress and anxiety, but if your goal is to safely maximize your returns, it’s very possible to do that with some good debt on a well managed rental property. Obviously well managed is the key factor here, because if you’re just letting your property sit vacant and rot, it wouldn’t matter whether it had a mortgage or not!
That is another great question. And like most of the articles I’ve written about real estate there isn’t a simple answer I can give you for it, but I’ll attempt to run down as much information as I can think of to help you get a good enough understanding to feel like you understand the answer.
To start with, there are a number of ways to invest in real estate, each has it’s own up side and down side, and each has it’s own level of risk, knowledge requirement, and capital requirement. I’ll touch on several of the most popular investing options with regard to real estate, but please understand this will be nowhere near an exhaustive list!
To start this information off, I can say there are a number of ways to invest in rental properties, and some of other investment strategies on this list also revolve around rental properties, but what I’m referring to here is a traditional purchase of a home, where you actually own the home, have either paid for it in cash, or have taken out a traditional mortgage. I start the list off with this because it’s my favorite method of investing, period.
With regard to how much it cost to invest in rental properties “the old fashioned way” it really depends on how you do it. There are actually several ways to go about it, and each have their own merits. I purchased my first rental property by taking out a second mortgage on my personal home, and putting down a 20% down payment on the rental property, financing the rest with a normal conventional mortgage. Shortly after that (and having been bitten by the rental property bug) I purchased another home to move into using an owner occupant mortgage, and converted my previous home into a rental property. That required no changes to the existing mortgage on my previous home (but that isn’t always the case, usually best to check with your mortgage company on requirements before you make any final decisions), and allowed me to purchase my new home with a low money down owner occupant mortgage, which in effect allowed me to gain a new rental property with only a few thousand dollars out of pocket.
Converting your personal residence to a rental property is a popular way to gain new rentals, but please keep in mind that this strategy doesn’t scale well at all, and the high ltv and pmi on these mortgages means there’s usually very little margin between the monthly mortgage and the rental income, which means it can be considered somewhat risky. Make sure you’re not over leveraging yourself if you’re planning to use this strategy, and realize this is a LONG term play.
Summary for “Old Fashioned” rental investing – 3.5%-20% down payment depending on your strategy.
“Flipping” property has become abundantly popular in the recent past. There are so many tv shows about it they’ve become difficult to keep up with. Watching some of these shows make it easy to understand why it’s become so popular, I don’t know anyone who doesn’t enjoy seeing before and after photos. Everyone loves a good turn around!
The popularity of this strategy is quickly becoming it’s downfall. Too many inexperienced investors (hobbyist if we’re being honest about it) have no idea what they’re doing, so they pay too much for the property, make several mistakes on the renovation, and rarely make any money. This influx of money and purchasing into the market for dilapidated houses has artificially inflated the prices, and severely reduced the likelihood of making money on any of them whether for rental or flipping purposes. I suspect this is a short term situation and will eventually correct itself.
Now that I’ve gone off on my tangent, I can get back to answering the question at hand. Flips can be financed in any number of ways, if purchased by a normal bank mortgage you’d be required to pay the typical 20% down for investment properties, depending on your credit worthiness and relationship with the bank (and products they offer) you may or may not be able to finance some part of the renovations as well. If you have great credit and a great relationship with the bank you may be able to close the purchase of the house and receive a check from the bank for renovations! In other cases it may be structured more like a construction loan, where the bank has to inspect periodically before releasing another round of funding. Other popular and common practices are to use Hard Money Loans (short term high interest loans, usually underwritten purely on the value of the house being flipped) for the purchase and part or all of the renovations. I wouldn’t recommend hard money loans to amateur house flippers, as an extended timeline or unforeseen problems could drastically increase your costs and the short term of most hard money loans creates it’s own problems if you don’t know what you’re doing.
You may be able to reduce the out of pocket costs by doing the renovation work yourself (this would apply to any of the investment types) but beware if you aren’t sure of what you’re doing this could be a HUGE risk! Depending on permit/licensing requirements on top of the obvious risk of having to have work redone if done incorrectly or poorly. As an example: Purchase a home for $100,000, renovation work would be $50,000 if done by a contractor, so total cost would be $150,000. Most banks would readily write a loan for $120,000 (80% of total cost) on this project, and if materials are only $15,000, then you could actually complete this project with NEGATIVE money out of pocket, and only time/effort invested into the renovations (plus carrying costs of course).
Summary: It is possible to flip a house with less than no money out of pocket, but more commonly there is going to either be very high lending costs, or somewhere around 20-25% of total project costs out of pocket, plus carrying costs. Professional house flippers usually have a medium to large sized line of credit that they work off of that allows them to operate as if they were on a purely cash basis. This helps to speed up transactions, reduce transaction costs, and eliminate the red tape that can come along with investment real estate financing. Even if you have enough cash to do your project out of pocket you’re better off investing that cash into a rental property and then taking out a line of credit on the rental rather than using the cash directly, but that’s a subject for another article!
You’ve heard about investing in real estate with “no money and no credit” right? I’d be surprised if you hadn’t. What people are referring to is usually either owner financing, or more commonly what’s typically called “wholesaling” properties. I’d argue this isn’t investing at all, as you never actually have a vested interest in the property at any point, nor does your profit generate from an input into that property (cash, renovations, etc) but I suppose that’s all irrelevant points.
Have you seen the “bandit” signs on the sides of the roads, posted to vacant houses, up on utility poles, etc that say “We buy houses”? They’re usually hand written and generally poorly done (which is intentional by the way if you can imagine that). If you’re like me you probably wondered how the heck so many people can afford to buy houses non stop. Well the truth is they probably can’t, and in fact they don’t. In most cases these people that “buy houses” may never actually buy a house!
The process works like this: A home owner calls the number on the sign, and the “wholesaler” may or may not even go out to the property. They will negotiate the lowest possible price they can for the purchase of the home, and have the home owner sign an agreement to sell the home at that low price, which is effectively an option agreement, because it doesn’t REQUIRE the “wholesaler” to purchase the home. Once under contract the “wholesaler” will attempt to find a buyer for the home, and will assign their contract to the end buyer, netting an assignment fee of $2,000 up to $100,000 or more, depending on how far the contract price is below market value.
Many people would argue that these homes are problems for the owners and they just want to be done with them, and that “wholesalers” are solving the problems for these owners, which in a way is true. However I don’t think that anyone could argue that if the home were listed on the open market/MLS for the same price that the eventual buyer purchases it for that it would sell as fast or faster and net the owner much more money. For that reason and the fact that the owners of these homes are often the most susceptible to abuse (elderly, impoverished, or generally ignorant) I personally do not approve of the wholesaling strategy. I do believe there may be a middle ground out there that is a more transparent and therefore ethical procedure, and I’m sure there are many “wholesalers” that are taking a path that I would heartily cheer on, but I’d say that’s definitely the exception and not the rule.
Summary: It’s possible to make big money off of other people buying and selling homes with very little risk, but may require you to do things that could be considered taking advantage of the most vulnerable people in society.
Depending on where you live, this type of investing can vary widely. I’ve only invested in tax properties in Louisiana, so that is the frame of reference I’m going to use here. Louisiana uses tax titles rather than tax liens, which other states use. There are several factors including whether you bid down or bid up, the redemption period, your rights as a tax investor, your responsibilities or liabilities as a tax investor, and other nuances that pop up from time to time.
The broad strokes work like this: Someone owns a property, and doesn’t pay their property taxes, the taxing authority (usually the sheriff in Louisiana) is empowered to sell the property at auction for the taxes owed. Considering that property taxes are generally somewhere around 2% or less of the properties value that sounds pretty great, right? Well it’s not quite that simple! It is an auction, so you might picture people bidding up the price, but the price is fixed at the taxes and fees owed, so instead of bidding up the price you actually bid DOWN your ownership percentage that you’re willing to accept in exchange for paying the taxes owed on the property. The only way to guarantee the purchase of the property is to be the first person to bid 1% ownership, otherwise you’re just going to keep bidding the percentage down until no one else is willing to pay the bill for such a small percentage of ownership. Once you’ve got the winning bid you get the keys and move in, right? Wrong again! You may technically own the property, but it will be 3 years before you are ELIGIBLE to gain possession of the property. Even after the 3 years you still have to present your case to a judge and be awarded possession. Your case will need to include documentation of the purchase, and stewardship during your time of ownership (including paying the taxes during that time period). The judge will also consider the ownership percentage you have of the property when determining possession and other rights.
In some cases (I’ve gotten very mixed information from multiple attorneys on this) if a property is vacant you may have the right to gain immediate possession of the home to “maintain it’s condition”. If you are able to gain possession you would have the right to rent the home or occupy it yourself, but keep in mind that right would be immediately removed if the taxes are redeemed.
You might think that the game plan here is to purchase as many of these as possible in hopes that you gain possession of them after the 3 years, and that’s the exact strategy that many tax investors take, however there are many out there that want every on of their tax investments to be “redeemed”.
In Louisiana the redemption period is 3 years, which means that the owner of record can pay what they owe in back taxes, along with a 5-10% penalty and 1% per month it’s owed. So at a minimum a tax investor is getting around 12% per year return on investment on properties that are redeemed. Not bad! There are massive companies that invest only in tax properties, and have an algorithm to determine what properties they purchase at tax sale based on the likelihood to be redeemed. They readily bid down the properties to 1%, because they don’t actually WANT to take possession of the properties.
In summary: So how much does it cost? I’ve purchased tax sale properties for $200 with annual tax bills of $75, and actually wound up owning them because they were never redeemed. Turns out I was only 19 years old at the time and had no idea what I was doing, and I didn’t actually want a vacant lot in the middle of a part of town I’d be scared to walk through in the middle of the day, but that’s a whole other story.
If you own your home, just look at your annual tax bill. Add 50% to that and that’s generally what it would cost to purchase a home similar to yours at tax auction. There are usually at least a few of every kind of property you can think of, and depending on your area between 2 and 8% of the properties won’t be ever be redeemed. The ones that aren’t redeemed are usually the lowest quality, but it’s still a very cheap way to get into investing in real estate.
“Subject To” Owner Financing and More
There are lots of “creative financing” strategies that people us to invest in real estate, I’ve listed the most popular ones I could think of for this article:
-Owner Financing: It’s just like what it sounds like, someone owns a house and sells it to you for monthly payments rather than a cash purchase. The previous owner becomes your bank, and whatever the two of you agree to is generally fair game. I’ve seen owner financing agreements that stretched out 50 years, some with 0% interest, others with weekly or annual payments, the options are limitless. This can be a great solution for sellers that are stuck on a price that is unrealistically high, or where tax ramifications would be severe from selling it outright. Because of the flexibility here it’s usually not difficult to purchase an owner financed property with a low or no down payment, the most difficult part about it is finding someone capable and willing to do the owner financing. Because of the large potential for fraud and abuse here I would recommend seeking the assistance of an attorney and/or expert investor before conducting an owner financed transaction.
-Subject to exiting debt: You’ll hear this called a “subject to” transaction, it just means you’re purchasing a property that already has a lien on it, and you’re taking over the payments. Most buyers/sellers wouldn’t contact the bank or mortgage holder to request permission, because that would trigger the “due on sale” clause of the mortgage and nullify the option. This is a good option for home owners that have very low rate mortgages, where there is a margin to be able to rent a house for a monthly profit, even though it cannot be sold at a high enough price to pay off the existing debt. A “buyer” in this case could even be paid cash at closing to take title to a property by a seller, and the seller is in effect walking away from the property and the loan payments. The loan will remain on their credit however, so from the sellers perspective that’s something to keep in mind.
The bank or mortgage holder could call the loan due at any time after the transaction, so this is an extremely risky transaction, however most buyers look at it from the view point that if they didn’t pay anything at closing they don’t really have anything to lose if the home is cash flowing while they own it.
-Private Financing: This is just a fancy term for borrowing money from a private individual to finance your property. It could be your parents, uncle, grandparents, or just some guy you met in a coffee shop. There are no requirements for this and very little in the way of regulations because it’s an agreement between the two parties. The financing works just like any other would, but has flexibility similar to the owner financing listed above. Whatever terms you both agree to are generally acceptable, but I would definitely recommend getting it in writing, and if you’re doing the financing, definitely file your mortgage lien on the property.
There are a lot of options out there, so if you do your homework and familiarize yourself with the applications of each, you’ll be prepared to take advantage when the appropriate opportunity presents itself!
I’m going to start this off by saying first and foremost evicting a tenant should always be a last resort. The court system is notoriously slow, inefficient, and depending on your location can be anything from inconvenient to really unfair to a landlord. Your focus to avoid eviction should revolve around attempting to avoid bad tenants before they move in through proper screening and requirements, take fast action against tenants in default by contacting them as soon as they are in default and demanding the default being resolved immediately, and not delaying before filing for eviction if all else fails.
I’ve written articles previously about the importance of tenant screening and what you should be looking for to avoid a bad tenant, so I won’t speak in depth about that topic here. Taking immediate action against a tenant is one of many things that many landlords, especially amateur landlords, fail to do. Many landlords prefer to avoid the confrontation, which I can relate to, however avoiding the problem will only make it worse, and more common in most cases.
For the properties that I manage (including the ones I own) rent is due on the first, and tenants that haven’t paid are contacted before 9:00am on the 2nd, even when it falls on a weekend or holiday. This is an important part of our tenant training process, so that they realize that rent is due when it’s due and there are no exceptions to the rules. This sets tenant expectations at a realistic level, and there is no reason for them to be surprised by the rent reminder, or the corresponding late fees. If you delay in contacting late tenants, they will become more complacent, and over time the rents will come in later and later every month, which is a problem.
For the properties that I manage, if a tenant hasn’t responded to our contact informing us of when the rent will be paid, or if they aren’t able to pay the rent before the 5th of the month we will inform them that we will have to file the eviction suit, but as long as they pay on the date they’ve stated (assuming that it’s within a few weeks of the 1st) they should be fine. I also inform them of the fact that they will be responsible for the court costs and an eviction service fee for us compiling and filing the paperwork. This process serves two purposes: 1) It reinforces how important timely payments are, and 2) it reinforces that there are real consequences to late payments and that they are expensive. For our tenants, if paying their rent on time isn’t already their first financial priority, it quickly will become that after they move in. This is one of the reasons our rentals perform better than similar properties in our area.
This part is extremely important: when you tell a tenant that you’re filing for eviction on a certain date, follow through with that. For longer term tenants I may give them a day or two notice before it’s filed so that they have time to find the money if possible, especially if they have rarely been late in the past.
Depending on your municipality timeframes and options for landlords can vary widely. You will need to find out what the requirements are for serving notice to tenants including how they should be served, what information they should receive, and most importantly what the timeframe required is between notice and filing. In Louisiana (where my business and rentals are located) it is possible to waive the notice period with a short clause in the lease. If that is possible in your location I highly recommend it. Without a lease waiver we would be required to serve notice 5 business days prior to being able to file the suit for eviction. Those 5 days exclude the day the notice is posted and any weekend or holiday days. This means it could take upwards of 8-10 days depending on the time of year, and in rental real estate time is literally money, so you should avoid unnecessary delays at all costs.
After you’ve filed for the eviction the tenant should be served with a legal notice of suit, advising them of the date and time to appear in court if they’d like to present their defense. Depending on the local landlord laws tenants may or may not usually show up to court (bad tenants tend to know the relevant laws much better than many landlords and they generally know their odds better than you will). If they don’t show up in court AND your paperwork is all in order, you should receive a default judgement of possession of the property. If the tenant does show up to court they will be given the opportunity to present their case for why they shouldn’t be evicted (often totally irrelevant, ie: lost my job, kid was sick, etc). Assuming there isn’t a problem with you complying with the laws and requirements/timeframes/paperwork, and the tenant doesn’t have a relevant response to the suit, you should still be awarded possession to the property. If there is some reason that the judge can find you non-compliant or can deny you the eviction for some other legal reason they will, and in that case you’ll have to start the eviction process all over again. Some locations have such complicated requirements that you may be better off by hiring an attorney to complete the process for you to ensure that you don’t lose that much more rent by making a simple mistake and having to start over.
Depending on the local laws you may be entitled to possession of the property as soon as immediately, and in other cases as long as 28 days or longer. In my part of Louisiana it’s 24 hours after the judgement before you’re entitled to possession. But please be careful here, just because you’ve been awarded possession doesn’t mean you can just change the locks and kick the tenants out if they’re still living in the home. At this point, you can only reclaim possession if It’s abundantly clear that the tenants have moved out. You will want to document things like no beds in the bedrooms, no clothes in the closets, no dishes in the cabinets, etc just in case the tenant decides they want to sue you at some later period for anything related to the eviction. Even if the home is totally empty you’ll still want to document that fact.
If the home has any property left in it you are required to take actions to ensure that the tenant is able to reclaim that property if they want. In some states/areas you may be required to store the belongings for some extended period of time (30-90 days!) unless the tenant informs you directly of it being disposable (get it in writing). In many areas the only requirement may be to drop it at the curb for 24 hours or so. At no time would you want to immediately take possession of the property in the home, unless the tenant has advised it is disposable.
For the properties that we manage we notify the tenant of the property being removed and available at the curb. If the furniture is particularly nice or potentially valuable we may store it for 30 days and make every reasonable effort to notify the tenant of it’s availability. Depending on your area you may be able to recover the cost of storage, moving, etc and potentially even the total balance owed by the tenant before you release the belongings! Where possible we often donate abandoned furniture and belongings to local charities.
If the tenant HASN’T clearly moved out of the property after the court judgement, you’ll need to contact your local clerk of court (or other relevant authority) for the next step. In most areas a constable or marshall will assist in the physical removal of a tenant. They will provide security for you to bring a crew in and remove all the belongings from the home and change the locks. This is not a common occurrence in most areas, but every once in a while you’ll have a delusional or incredibly irresponsible tenant that will just refuse to leave. Usually the marshall or constable will attempt to contact them before you show up to remove them to avoid that very bad situation.
Overall the eviction process doesn’t work out well for anyone. We always attempt to take a proactive approach by contacting a tenant by phone, mail, email, notes posted to the door, etc advising them of the totally avoidable fallout of allowing their eviction to proceed to a court ruling. Usually when you explain the costs involved, including collections, etc, and how it will negatively affect all of their future housing needs and make them more expensive at a minimum, they will agree to move out and hand over the keys before the court date. I would recommend always attempting to communicate with them in writing so there can be no confusion or miscommunication about what you’re agreeing to.
Under no circumstances should you agree to accepting any partial payment or delayed payment during the eviction process. If you accept a payment from them, even if it isn’t paid in full, between the eviction notice/filing and the court date the judge will likely deny the eviction. You will be under oath during the court process, so make sure you can honestly say that you haven’t agreed to any exceptions for the tenant at any point along the way.
I hope this information helps you in your real estate investing journey. Many landlords with decent quality rentals and good screening and processes will never have to deal with an eviction, but that doesn’t mean they shouldn’t be well informed about the process. If you’re a landlord or hope to be one in the future I highly recommend you find out who the legal authority is in your area that would handle an eviction, what the exact process is and requirements/costs/expected timeline. Preparation will help you avoid this huge downside to real estate investing.
This is a great subject, and I’m glad you’re asking this question, because it’s incredibly important to the overall success of your rental property.
Obviously your tenant is the source of a lot of things, some good, and some potentially bad. The first and most obvious item is the rent revenue, which is probably the reason you’re renting the home in the first place. If it’s not this may not be the best business for you! Aside from the rent there are several other things that tenants may be the source of, and some of those are absolutely not good. I’m going to work down the list in reverse order starting with the absolute worst one.
Why is stress the worst? Rental properties are supposed to generate passive income when you’re doing it right. Adding stress to your life in exchange for a small monthly income is anything but passive. This is the primary reason many people divest from their rentals, whether or not they even know it. Bad/low quality tenants WILL be a source of stress for you without question. Proper screening will help to minimize this as much as possible for the particular property type/class you’re working with.
When you receive a 30 day notice what do you do? If you’re running your property correctly you inform the tenant of the move out process, what you expect of them, and what they should expect of you. You follow up with them on the move out day and make sure they’re aware of how to turn in their keys and that the home should be clean, right? That gives you the time to make arrangements for make ready repairs, changing locks, etc. You may even list it for rent and start a list of prospective tenants so you can minimize your vacancy period, and conversely your lost rent. Low quality tenants rarely give a notice of their intent to move out, they typically move out without regard to the lease status or requirements, and may never actually turn in their key.
A very common situation with a bad tenant is to contact them in an attempt to collect past due rent only to have them respond to you saying they moved out ten days ago and left the key on the kitchen counter and left the front door unlocked for you. I’m sure this makes sense to them, but it’s never made any sense to me.
Many low quality tenants never intend on paying their last month’s rent. When they decide to move out they quit communicating with you all together, quit paying rent and attempt to maximize the free time in the home. If you’re an amateur/rookie landlord it may take you months before you finally get around to dealing with the problem and figuring out what to do or how to get them out of your house. When they get a notice of eviction from the court system that’s when they finally start looking for a new home. They usually know the system much better than you do (unless you’re a professional), and they will work it as much in their favor as they can. If they’re smart they’ll be moved out before the court date gets there, unless they’re confident that you’ve compromised your right to the possession of the house, in which case the eviction process starts all over again! If eviction court is a regular part of your process you should consider a change to your system or process, that is not normal no matter what anyone tells you.
Property Damage/ Direct Expense
Whether it’s punching holes in the walls or unsupervised children flushing inappropriate things down the toilet, bad tenants always cause damage to a property. In some cases you may not even find the damage until the next tenant moves in and the sewer is overflowing because it’s been back up for weeks. Bad tenants are also less likely to report problems, which makes the effects of those problems amplified and more expensive when they’re finally fixed.
Indirect Damage and Expense
The effects of bad tenants are sometimes less obvious than most people would think. When a person is irresponsible in their personal life (finances, etc) they are often irresponsible or ignorant of proper behavior and maintenance that they are responsible for. A big one here is flushing feminine hygiene products or not replacing the air filter in a central air unit. Both of those may seem like common sense to you, but you aren’t your tenant, especially if you aren’t screening appropriately. Low quality tenants are harder on a homes systems overall, which means more repair and maintenance costs.
This isn’t a totally inclusive list, there are a LOT of indirect costs associated with low quality tenants, many of which you won’t even realize until it’s too late. Now that we’ve addressed the importance of avoiding bad tenants how in the heck do we actually avoid them!?!
What makes a bad tenant?
Despite what your most empathetic friends may tell you, bad tenants are not a victim of their circumstances, and you shouldn’t ‘give them a second chance’ without reducing your risk in some manner. Your socioeconomic status doesn’t inherently make you a good or bad tenant. There are a lot of wealthy people with high incomes that will prove that to you if you rent to them, and there are a lot of poor people that are very responsible and considerate of other people’s belongings that would make a great tenant for you.
Bad tenants all share several psychological traits which include being incredibly self centered, having very little foresight, and an absolute need for immediate gratification, usually with no regard to the consequences. If you keep these indicators in mind during your interactions with prospective tenants you’ll usually see the evidence of a bad tenant very clearly. They want the nicest house even though it’s well out of the range of what they can afford, they have cash today and ready to move if you just skip the application, they demand to be shown a property on their schedule rather than accepting your own availability, their credit and tenancy history is terrible, and usually they’re just difficult people to deal with.
Set Reasonable Requirements
If you’re applying for a loan the bank has a set of requirements that you must meet in order to qualify, and while renting a home to someone may not exactly be loaning them money, it is extending credit to them. You need to be reasonably sure that they can make those monthly payments.
Depending on your exact market and quality of your property the requirements often include income (Documented 3-4x the monthly rent is very common), some landlords focus on gross income while others focus on net income. The number of occupants is something that many don’t even think to consider, but I would argue it’s one of the MOST important considerations. 10 people moving into a 3 bedroom home should be a HUGE red flag, on top of it likely being against fire marshal regulations.
Eviction history is another important factor along with criminal activity and collection activity on your background and/or credit checks. Other items worth considering are length of time at their current employer, length of time at their current and/or former residences and the reasons why they moved out. If you really want to get down in the weeds you can consider things like their transportation and other factors that would prevent them from being able to reach their job, especially if your rental property is in a rural setting.
Obviously the more rigorous your requirements are the longer your vacancy periods will be. Smart tenants will ask about your requirements before submitting an application, and if they feel like there’s some chance they won’t meet them they likely won’t apply. Same goes if they don’t feel the requirements are reasonable, as that can be an indication of an overly involved landlord, which is generally a big turn off for most tenants.
Check check check
Credit check….check. Background check….check. Eviction check…..check. Screening is INCREDIBLY important. Your gut feeling may be spot on, but if you don’t have any OBJECTIVE means of qualifying your tenants you’re opening yourself up to a discrimination lawsuit that you’re most likely going to lose, especially if the prospective tenant is included in a protected class. Generally speaking a credit check and background check will tell you everything you need to know about an applicant, and in most cases will help confirm that gut feeling you had about them. Don’t be tempted to make exceptions to your requirements unless they are bringing in a a well qualified co-signer or through some other means of reducing your exposure to their bad habits. Multiple poorly qualified signers doesn’t equal a good signer, but one good cosigner can easily eliminate the problems of multiple bad ones.
Typical red flags on a credit report include collections from previous landlords, collections from utility companies, and evictions. All of those indicate the applicant is someone who doesn’t tend to the most important expenses in their lives, as they’ve had ample opportunity to prevent those charges getting all the way to their credit report. By having that disregard for the most obvious requirements to a stable household they are actively putting their entire household at risk on a near constant basis.
Excessive collection activity on their credit report is an obvious indicator that they are only concerned with the present and aren’t likely to be considering the consequences of their actions. Either that or they are hoping that if they ignore their problem it will go away. Most children learn the facts of life early enough to reassure themselves this is almost never the case, but some people make it well into adulthood never having fully understood that lesson.
Other items won’t show up on a credit report but are just as important to consider, like whether they showed up to their showing appointment on time, are they communicating effectively, do they take pride in their appearance and the appearance of their belongings (think about the condition of their car). Are they looking at subsidized housing but are wearing designer clothes and the latest technology. Are they conducting themselves in a socially acceptable manner, or are they being rude by being on the phone constantly, using inappropriate language, disregarding you when you speak to them, texting constantly while they’re speaking to you, etc.
While “old school” landlords may tell you this is the most important source of information to rely on, I’m here to tell you it’s become one of the least informative or reliable sources of information. Bad tenants are not likely to give you contact information for their current landlord, and due to our overly litigious society if their landlord were to give you and opinion without objective information to back it up they could be liable to defamation litigation, and you could be open to discrimination.
Many professional landlords have limited their tenant references to yes/no questions answered verbally that are purely based in fact. If you think about it, asking another landlord in your market about their tenant is kind of a conflict of interest, because if you approve them to move in, that landlord loses their tenant. If they’re a bad tenant they may tell you good news to get rid of them, and if they’re a good tenant they may tell you bad news in an effort to keep them!
In summary, use common sense, put yourself in their shoes, and don’t let yourself get so worn down by showing your property that you’ll approve the first person with the first month’s rent. Set standards, stick to them, and make sure your decisions are based on objective facts!
I know what you’re thinking, the title sounds ridiculous right? 10 years ago I would have agreed with you that property managers COST money, they don’t make you MORE money! Since then I’ve learned a lot about rental properties, and where the true costs come from, and the fact that a good property manager (good being the operative word here) can substantially reduce your costs, including vacancy, which also increases your revenue. And you don’t have to be a finance guru to understand that lower costs plus higher revenue equals higher return on investment.
Is it just that simple? Unfortunately not, finding a good property manager isn’t easy, and some property managers take the lazy/inefficient/ineffective path because they are only considering their best interests instead of their clients best interests, and they’re ok with just charging you the monthly minimum fee (Mayco only makes money off collected rent, so we only make money when you make money). On top of that you have to be assured that your property manager takes a proactive approach to all things and has solid well thought out systems in place to avoid things “falling through the cracks”. I can’t speak for all property managers, because they are definitely not all good, but I’ll be referring to the property management services from Mayco, and if you’re not in the Shreveport/Bossier area hopefully you can find a company with similar offerings in your area. At Mayco we have invested in all the best tools available for property management, and we know and follow all the industry best practices. This translates into the absolute best possible performance for all of the properties we manage.
These are the things that most rental property owners don’t think about when managing their own properties:
Day Job – Are you a professional investor? Retired? Independently wealthy and really enjoy spending your spare time showing houses and answering calls about stupid questions from your current or prospective tenants? Chances are you have a day job, and if it’s anything like a typical job either it will interfere with your rentals success, or your rental will interfere with your career’s success. There are very few exceptions to this rule, and here’s what I mean in a couple of scenarios:
- Imagine your rental is vacant, and you’re getting lots of calls, emails and texts requesting showings, because you work 8-5 you aren’t able to answer all of them, they go to voicemail, and many go unanswered. The ones you do return or answer are often asking questions that they can answer themselves by just reading the posting for the property where they got your phone number, which adds to the frustration of the volume of calls you’re already receiving, and may even further reduce the likelihood that you pick up or return the calls in the future. Additionally you’re only available on the weekends to show, and possibly some evenings, so you schedule your showings for a few days away on saturday and keep your fingers crossed that they like the place and want to rent it so that your phone will quit “blowing up”. Saturday comes and only 2 of the 6 appointments you’ve scheduled during that week show up, and 1 of those 2 say they’re not moving for a few months and just checking out rentals in the area to get a feel for what things cost, because they have NO problem openly admitting to wasting your time even though the information they’re looking for is widely available on 50+ websites. The other potential tenant says they like it and would like to put in an application, but are planning on doing it later. Lather, rinse, repeat for a few more weeks (or months depending on whether you want to use your weekends for things you actually WANT to be doing) and you’re thrilled to get a tenant that shows up with money in hand ready to fill out the application and move in right away. Since you’re just ready for the phone calls and time wasting showings to stop you accept their money, sign the lease, and give them the keys, accepting half of the deposit because they said that would really help them afford to be able to move in, but they promise to pay the rest of the deposit with the following months rent. Next month rolls around and you discover that they spent all their money on the funds needed to move in, but they get paid on the 12th and will pay what they owe then. You explain about the late fees and how expensive that will be, they then tell you all about their family member their supporting in the hospital which is the reason they don’t have enough money, and you reluctantly tell them you’ll waive the fees this month. The 12th rolls around and they call to let you know you can come pick up the rent, you stop by on your way home from work and they happily hand you a check for half of the rent, letting you know that some unforeseeable catastrophic emergency has popped up in the last few days and that’s all they can pay. Nevermind that they agreed to pay the rent in full today with the balance of the deposit, and on top of that you waived the late fees due to their hardship. They say they get paid again on the 26th and promise to pay your balance then. You don’t hear from them on the 26th, but don’t remember until the 28th to call them and find out where the rent is, they say you can come by and pick it up anytime because they’ll be home. After 3 attempts stopping by you finally catch them at home and they pay the other half of the rent, but still no damage deposit. They apologize and say they for sure will have it paid in another 2 weeks when they get paid….. and the cycle goes on forever. They are getting their rent paid, but just barely and after 4 months still haven’t paid the other half of the deposit, but they definitely haven’t lost your number because they’ve had 5 maintenance requests already. Eventually you quit asking for the deposit balance because you know it does no good and at nine months they quit paying altogether, won’t answer the phone or the door. On month 11 You call your attorney to find out what to do, he informs you of the lengthy and expensive eviction process, offers to do it for you for $800, and nevertheless sends you a bill for a 15 minute phone conversation that’s only left you angry and frustrated, but you begin the eviction process he promised would take at least a month. Finally your court date rolls around, court awards you possession of the property assuming all your paperwork is in order and you’ve followed all the pertinent laws and the tenant is informed they have 24 hours to vacate the property. They tell you they’ll be moved out in 5 or 6 days for sure, they just have to find a new place and a landlord that will approve them to move in, which they say is difficult to find. After 2 weeks of not being able to get in touch with them you finally drive by the house and realize it’s empty and trashed, it will cost at least $500-1000 to get it back rent ready and you only have half a damage deposit to offset those expenses, which still don’t even account for all the lost rent you’ve now effectively forfeited.
Q) Isn’t that how all landlords do it? A) That’s a resounding NO. I can’t speak for all property managers, but at Mayco we show our available properties 7 days a week. We also maintain a database of prospective tenants and have systems in place to do a constant follow up to eliminate the possibility of forgotten or missed appointments, loss of contact information, or unanswered questions. We rarely schedule showing appointments for more than 24 hours in the future, because the longer the wait the more likely the possibility that they find something else and choose a competing property. We also don’t do “open house” style showings because the highest quality prospective tenants often spend more time looking for a property, and are much less likely to put in an application when they know there’s a high level of interest and could be potentially wasting their application fee due to other applicants that could have possibly gotten their application submitted first, after all they’ve lost application fees several times in the past to that same scenario. Here is that same scenario for a house listed by Mayco:
- Day 1 you give us the keys, sign the agreement, and tell us good luck with the house. We send a representative to the house to analyze it and make sure it’s ready to be rented, if not we document the problem areas by photo, send them to you, explain why they may be problems, and ask if you’d like us to resolve them. Since the estimated cost is only $200 we’re happy to pay the cost and get reimbursed from the first month’s rent of the future tenant, because we’re confident in our abilities and we want a long term mutually beneficial business relationship with you. You agree that the house would probably show/rent better and it needs to be done anyway, the estimated cost is much less than you could get it done for yourself so you give us the go ahead. The work is done the morning of day 2, and our photographer goes out that afternoon to take extremely high quality still photos and a 3D interactive tour of the property. The photos are edited to optimize lighting that evening and the property is posted on our website and 100+ other real estate websites. The calls, texts, emails, and messages start coming in the morning of day 3. We contact each of them as soon as we receive the query, and follow up by phone text and email every day for the next 3 days until we reach them. By day 5 we’ve received 31 inquiries, spoken with 24 individuals, had 6 showings, and have 3 more scheduled for the weekend, and since it’s Friday we send you our report of the activity and feedback received from potential tenants. At this point the listing is too new for us to have any recommendations for any changes to our marketing strategy, so we just continue as before. On day 7 the same tenant from the previous scenario contacts us, sees the property and submits an application all in the same day. We screen her application and see she’s had 3 eviction filings in the last 5 years, and has a landlord collection for $1,800, and we inform her that unfortunately we cannot approve her application for those reasons, she says she understands and appreciates the extremely fast manner in which we’ve conducted ourselves and completed her screening, and she understands the decision. The same day that she submitted her application, a young engineer requests a showing of the property, we schedule the showing for 7:30 the next morning, because that’s the only time that works with his busy professional schedule. He looks at the property, says he likes it, and asks if there are any pending applications. We pride ourselves on our honesty, integrity and ethics, so we respond honestly by saying yes we do have a pending application, but we encourage you to also put in your application, and if the pending application is approved and pays the deposit to hold we will refund their application fee immediately. The engineer thanks us for the thoughtful policy and says he’s never heard another company say that, but it’s a relief to know that he isn’t at risk of losing the deposit if we cannot process his application. He puts in his application that day at work, it’s processed before the end of the workday and comes back with a stellar 720 credit score and 6 times the rent in income. He’s informed of his approval immediately and we schedule an appointment for the following day for him to pay his deposit to hold the property for 10 days at which time he will pay his first month’s rent, sign the lease, and receive the keys. On day 9 he pays his deposit and we remove the property from the market for him. 10 days later as agreed he pays his first months rent and signs the lease. He stays in the house for 3 years, has paid his rent online every month at least 10 days early, and rarely has any maintenance requests. At the end of the 3 years he’s getting married and decides to move into the 3 bedroom home you just purchased with the profit from the house he’s been renting for 3 years, and says he appreciates Mayco’s exceptional management strategy and wants to make sure he moves into another property we manage. He moves into your newest investment, leaving his former home in great condition needing only very minor work to get it ready for the next tenant. We’ve been advertising the property on our website ever since he gave his notice to vacate 30 days ago, and because we have a constant flow of interested tenants, and a great reputation in the tenant community we already have 2 approved applications for the property since they were able to virtually tour it with our 3D interactive tour. The next fully screened and approved tenant moves in 8 days after the former tenant vacated, and the cycle starts again.
If you’ve been managing your own properties that scenario may sound far fetched to you, but I can assure you it’s the truth. If you’re new to rental investing you may think the first scenario sounds ridiculous, but talk to any rental investor you know and they’ll assure you that’s a very realistic scenario.
Repairs, Turnover, and Vacancy – Ask any tenant why they are moving, and the answer is usually the same, buying a house, need something bigger, getting transferred for work, or their landlord sucks. I’ve heard the last one more than I can count, and their explanation is always very similar. “They won’t fix anything” or “They take forever to fix any problems, and when they do they don’t fix it right so it just breaks again” or “I can’t ever reach them when there’s a problem, but they always want their rent money”. Vacancy is always your number one cost in a rental, and if you’re in a class c or d rental vacancy is usually preceded by 2 or more lost months of rent before you receive possession of the property back, and several hundreds or thousands of dollars in repairs. That isn’t exclusive to C and D properties, just much more common. I’ve spoken with surprisingly large numbers of landlords that openly admit to committing the same acts complained about above, not fixing problems or not fixing them timely, “rigging” repairs, and never answering their phones when tenants contact them. They usually have the same explanation for their behavior, which is “the tenants won’t pay their rent so I’m not going to fix their leaking pipes” etc etc. My first response to that is usually “you’re just going to let your house get damaged because the tenant isn’t paying?” Or “do you think that will increase the likelihood they will pay by not fixing it? In any case I do understand the frustration that comes with late paying or non paying tenants, but with my background in residential renovation and construction I can tell you that delaying the repair of problems can destroy the value of your home to the point that no one will purchase it except for the guys that only buy the absolute ridiculous bargains. Their bargain = your loss! Don’t do that to yourself. All of this to say that our policy at Mayco is to promptly (in almost every case within one business day or less) address tenant concerns, and to only make repairs in a quality and professional manner. This removes the ability of tenants to justify their bad behavior, decreases the likelihood of permanent damage to the home, and overall improves the tenant experience which translates to longer term better quality tenants. Everything we do we do for the same reason, because it’s in our clients best long term interests.
We have fine tuned a formula that ensures the highest likelihood of success with your rentals, we are extremely proactive and work to keep our property owners informed with weekly vacancy activity reports, monthly portfolio reports, and immediate contact with any major issues that may arise. We also offer the flexibility to allow you to use your own preferred vendors for repairs and maintenance, even though we’re contacting them on your behalf. We’ve structured our entire operation to be for our clients benefit, because we believe that so long as our clients are successful and satisfied we cannot fail.
One of the biggest factors in the return on your investment is the way your properties are financed. Levered (or financed) properties *almost always* deliver a higher rate of return than unlevered (paid off) properties do. Here is an illustration to show you how that’s possible:
Scenario 1: 100,000 purchase price, $1,000 per month rent, 20% down payment, $600 monthly note.
(-) $600 Note
(-) 150 Monthly Expenses
=$250 Monthly Cash Net Profit
$250 x 12 Months = $3,000 Annual Profit
$3,000 / $20,000 down payment = 15% “cash on cash” annual return
Scenario 2: same house paid in cash
(-) $150 Monthly Expenses
= $850 Cash Net Profit
$850 x 12 = $10,200 Annual Profit
$10,200 / $100,000 cash purchase = 10.2% “cash on cash” annual return
This is a VERY simplified set of scenarios that are just for illustrative purposes, but it does clearly show that the rate of return is higher in the first scenario, even though the net income is significantly lower.
There are several different sources of financing for rental properties, I’ll discuss the most common sources in this article. Look for future articles with more information on more sophisticated financing methods.
Fixed Rate Mortgage – This is just like the mortgage on the home you live in. Banks consider rental properties to be riskier than loans on owner occupied properties, so the interest rates tend to be slightly higher, the requirements are higher, and there is no government subsidized options for financing rental properties like there are for financing your home. In most cases you will be required to do a 20% minimum down payment, but some lenders may offer as low as 10%. Beware these options though, because anything less than 20% in most cases causes the need for PMI, higher interest rates and more stipulations, all of which lower your profit on the home, and most of the time your rate of return as well. Banks limit the number of traditional mortgages you can have, generally to 4 or less. Federal regulation limit it to 7, but I’ve never heard of a bank willing to extend credit that far.
Bank Financing – This shares a lot of features with the fixed rate mortgage, but it does have some comparable advantages and disadvantages. As far as advantages go the biggest advantage is definitely the reduced regulations and barriers to approval. These loans are generally obtained from your local banking institution, which means you’ll have an actual real live commercial banker to deal directly with, and hopefully develop a strong relationship with. Commercial bankers usually have an authorization limit that they are allowed to approve themselves, depending on the institution that may or may not be helpful to you. Every bank has different standards they have set for requirements, so there are no “hard a fast rules” that apply to all of them. It’s definitely in your best interest to shop around with several banks to see what they are all offering, when you do you’ll likely discover a range of rates, term options, down payment requirements, etc. In my experience I’ve seen rates generally 1-2% above fixed rate mortgage loans, max term length at 15 years, and max fixed rate period of 5 years. There are absolutely banks that offer better/different terms than those, but it usually comes at a cost (lower rates for higher down payments, etc). Before you venture into bank financing you’ll need to make sure your personal finances are in very good order, and you’re confident in your rental strategy. Confidence comes through experimenting (renting out your starter home instead of selling it) or a much better option would be to find a mentor that can help provide information on how you can and should proceed.
Investor Financing – This comes in several forms. What I’ve seen the most often if loans from family members, but it can also be independent investors, or even merchant bank loans. These are typically much more expensive than other more typical financing options, but in some cases it may be worthwhile to utilize, especially in short term situations (ex: getting a house up to standards for more traditional financing options).
These three options are the most common for rental property financing. I hope this article is informative and helpful for you! Look for more article in the future, or contact me for more information.
I can understand the appeal of managing your rental properties yourself. After all when I started off I managed all my properties myself, and it was years before I hired a property manager to do it for me. I’ve experienced the good and bad of having a property manager taking care of the day to day issues with my properties, and I’d be lying if I said there weren’t potential downfalls to it.
There are several things to consider before making this decision. I can tell you it’s one of the most important factors in your investment strategy. Ask these questions of yourself and if you answer them honestly the decision should be easy.
- Do you have the time to manage your property properly? Depending on the qualify or “class” of your property the typical daily time requirement may be fairly low. (Class A or A- property generally don’t require much time from a landlord, while class D properties are usually extremely time consuming). While this is the case when the property is occupied, it’s the vacant periods that are most time consuming and most important to devote your time to, because that’s when the property isn’t making any money. If you’re avoiding using a property manager just to save money, you may actually be LOSING MONEY by not having enough available time to show and promote the property. The best value a property manager can deliver is having ample available time to manage your property. It is not in your best interest to hire a neighbor, cousin, brother, or anyone else that isn’t a full time property manager, because their primary focus WILL NOT be on your property, it will be on what makes them the most money, which is their day job! (This also applies to the “free rent” some property owners try to offer in exchange for managing their properties, I have never seen that work out to the property owner’s benefit)
- Are you ok with “letting go”? Whether you’ve decided to be a landlord, or purely a real estate investor, you’re going to have to “let go”. I don’t mean to say that tenants and property managers shouldn’t have some oversight, but you have to acknowledge the fact that the tenants have leased the right of possession of your property, so if you are extremely particular about the way your property is kept, owning rental property may make your cardiologist more money than it makes you. Some tenants are fantastic, and will keep your property as well or better than you would if you lived there. On average thought that will not be the case, and tenants may not tend the lawn as frequently as you’d like, or pick up rubbish that is in the yard or on the porch. You have to keep in mind that as long as they aren’t doing anything to permanently damage the property, or cause you direct undue financial harm, everything will be just fine. In line with that idea, if you have determined that it’s in your best interest to hire a property manager to oversee your investments, bear in mind that you hired them because they are a professional (MAKE SURE THEY’RE A PROFESSIONAL!) and breathing down their neck or questioning their every move won’t help to make you any more money, but will likely increase your fees and charges when the management agreement renews. Real estate investment is supposed to be passive, that’s the real value in it! It’s understandable to be hesitant in the beginning, but at the end of the day if you know you are a micro-manager it’s probably best for you to stay out of the business entirely, or invest in a managed pool of funds.
- Do you have a solid grip on laws surrounding real estate? If your tenant doesn’t pay and quits communicating with you tomorrow do you know what to do? Do you know how long it will take to have them removed through legal means? Do you know what your rights are and what your tenant’s rights are when they aren’t paying their rent? Do you know what the alternative options are to courtroom eviction? If you can’t answer all of those questions with a confident “yes” then you need to do some serious studying or hire a professional to do the job. Violation of tenant rights can land you in jail in some parts of the country, if that happens to you a property manager will be looking extremely cheap!
- Are you good at managing and budgeting your money? Chances are if you can afford to buy an investment property you have some financial literacy, but do you manage and budget your money well? Saving up a down payment and making monthly payments isn’t the same thing as being able to pay for a $5,000 air conditioner, $1,200 water heater, or even the $3,000 deductible for replacing the 20 year old roof that a tree just fell on? A good property manager can help to buffer these expenses, but they may not offer the services automatically, so consider asking them about it!
- Do you have a list of contacts for repairs, and would you know who to call for what? I’m a fan of doing a lot of my own work around the house, always have been. So when I started investing in rental properties I tended to try to do all the repairs myself there too. It sounded good in theory, because I thought I was saving money, and it gave me an opportunity to “check in” on my houses and see how things are looking. That was true for the items that weren’t of immediate concern, both for the tenant and for the house itself. I was working a full time job and didn’t have the time to rush to fix some of the small things all the time. I learned that those small things, when not taken care of immediately, turn into big things, and when they turned into big things I wound up contacting several different repair people to get the jobs done, because I wasn’t familiar enough with who I should be calling to do what kind of job! Looking back I would have been better off to pay to have the work done right away, because it satisfies the tenant, which helps encourage them to stay longer, and prevents larger problems from happening, which quickly erase those DIY savings.
- Do you know what potential tenants are looking for in your area? Most property managers operate within a particular segment of market. They can tell you the pros and cons of investing in every type and class of property, because they do it everyday. Beware the managers that only manage subprime or class D properties, as their income comes mostly at your expense (they make their money off eviction fees, late fees, and generally a higher management percentage than others). Once you’ve made a decision on what types of properties you want to invest in, find a property manager whose portfolio resembles your target properties. They already have a pool of potential tenants contacting them regularly, which you can benefit from. You can also solicit advice from your property manager to focus purchases or renovations on what those potential tenants are looking for. Having that information will help keep vacancies low, and return on investment high.
- Do you know how to screen and what to look for in a potential tenant? This is probably the most important out of this entire list. The expense of one bad tenant could pay a property manager’s fee for 4 or more YEARS! Between lost rent, legal fees, and repairs/damages to the property the costs add up quickly! You should do some extensive research on tenant screening before you approve a tenant. I cannot stress how important this is in factoring rental property success.
There are a lot of things that go into determining your strategy when investing in real estate. This is not even close to a comprehensive list of things to consider, but hopefully it helps get you started thinking about the most important factors!
A good property manager can significantly increase your return on investment. A lot of people ask “how can that be when they are costing me money?”. Honestly it’s simple to answer that question.
A good property manager can act as a mentor. They will actually help you be a better investor by giving you information from years of experience. Most property managers have the experience and knowledge of a VERY experienced landlord. One important thing to consider is that you cannot profit from their experience if you don’t ASK for their advice, and LISTEN to what they say!
There is value in having a disconnect between tenant and owner. One of the things I learned early on is to never let my tenants know I was the owner of the property. So long as they thought I worked for the owner and I was just “doing my job” they were easier to deal with and much more understanding. A good property manager can act as gate keeper and referee, saving you a lot of headache, and often times you may never even know they’re doing it.
A professional property manager does it full time, and should be much better at it than you are. Even if you’ve been investing in real estate for years I can tell you that a professional property manager has more and better experience in the field than you do.
Property management companies have better technology and better connections, they have more people contacting them looking for rentals, and all of that adds up to significantly decreased vacancies. Vacancies are your biggest expense as a real estate investor, so anytime vacancy rates go down, return on investment goes up!