Friday, August 20, 2010

Landlord 101

Our society paints an evil picture of landlords. But being a landlord is not an easy job, nor should you approach it with the idea of being "nice".

One of the many problems contributing to the recent downturn in Real Estate was that a lot of amateurs got into the Real Estate business, thinking they could buy homes, rent them out at a profit and then sell them later on for a larger profit.

Yes, I did it, and I made a million bucks.

But many others lost just as much, if not more.  How did this happen?

To begin with, home shows are partially to blame for the trend, by putting on shows that made it seem like everyone was making money in Real Estate with no effort. It put the 'buy and flip' mentality into everyone's head. So TeeVee watchers, who are basically brain-dead anyway, though, "Gee, I can do this - make money with no risk or effort!"

But as I have noted time and time again in this blog, when someone tries to sell you on the idea that you can make something-for-nothing, it is basically a con, or just bad advice.

And nowhere is this more true than in the landlording business.  Make no mistake about it, it can be hard work, and you have to be hard-hearted about it.

Most of us have negative opinions about landlords based on a number of poor societal cues and our own experiences as a youth.  Old-time silent movies show the "evil landlord" in his top hat, evicting some starving young family, while pawing at their nubile daughter.  The communist and socialist movements in this country have, of course, promoted this image relentlessly.

As young college students, we may have had bad run-ins with landlords.   After all, we were just minding our own business, having 50 people over for a keg party in the back yard, and the landlord gets all upset because the other tenants are complaining!  And that hole in the wall that he was bitching about - there is a story there. You see, we were playing touch football in the living room, and, well, things got out of hand.  And just because we were a few weeks late with the rent is no reason to send those threatening letters and charge us late fees!

In retrospect, of course, our experiences with landlords in college were perfectly predictable.  Renting to young people is difficult as they tear things up, make lots of noise, and annoy the other neighbors.   And in most college towns, the sort of landlords who rent to young people charge pretty high rents and spend a lot of time and effort trying to collect rents and manage the properties.

And our college experiences as tenants should be the first educational experience for you as a landlord - try to avoid problem tenants at all costs.   If you can find good tenants and keep them, the job can be a dream.  If you have a string of bad tenants, you can end up bankrupt.

Here are some tips on landlording, based on my experiences over the last decade:

1. Vacancy Kills: The biggest problem we saw with amateur landlords was a blase attitude toward vacancy.  You need to keep your rental properties rented, or they don't generate income . It seems like a simple proposition, but most folks simply don't get it. In terms of cash flow, an unrented property can drag you down, as the mortgage, taxes, insurance, and utilities have to be paid every month.  Most landlords are lucky to break even on a property or make a small profit of 5-10%, particularly if they just acquired the property.  One month's vacancy a year is enough to wipe out that profit.

If you have a house or apartment to be rented, don't delay in fixing it up, advertising it, and getting it rented.   I've seen people let properties sit around unrented for months, because they "don't have time" to get it rented.   And guess where there time is going?  You guessed it - the TeeVee!  Instead of painting the living room on their rented duplex, they are watching America's Idol.   Idiots!  Yes, it is hard work to prep a unit for rental.  But putting it off for two months isn't making it better.

2. Background Checks: When renting to prospective tenants, you have to do a background check, usually in the form of a credit report, to see whether they are going to be good tenants.  Using your "gut instincts" alone can be a very bad idea, as the con-artist tenants out there (and they do exist, in great number, and prey upon amateurs like you) are very good at coming across as nice people - until they move in, of course.

Under the law, you cannot discriminate against tenants based on race, age, family status, religious affiliation, etc. - except in certain instances.  Check your local laws, of course. In some situations, you have great leeway, particularly if you are renting out in your own home.

But discrimination in general is probably a poor way to go about picking tenants, as your white supremacist tenants are probably the most likely not to pay the rent.

A credit history is a much better indicia to use.  Someone with a string of unpaid debts is likely to be a poor tenant, of course.  But someone with no credit history at all (and no verifiable employment history) is probably also a bad bet, too.   We've had good luck with young couples with some bad credit, who both have good jobs and are trying to turn things around.   But walk away from the serial-defaulter.  Chances are, he'll default on you.

3. Types of Properties: The type and location of your property will determine what kind of tenants and how much work it will be for you.   As noted before, if you want to rent in a college town to college students, you can make a lot of dough, but expect a lot of hassles as well, at least in some instances.  You want to be a slumlord and rent poorly maintained properties in the ghetto? Expect more trouble as well.

It is hard to feel sorry for someone who wants to be an exploitative landlord, taking advantage of the poor.   Ditto it is hard to feel sorry for someone who buys cheap houses in bad areas and then expects to make a lot of dough. Both strategies are based on the something-for-nothing concept, and not surprisingly, others are not willing to go along with it.

4. Section-8: In this regard, you should walk away from being a section-8 landlord. Not only is there a lot of paperwork involved, you get the worst sort of tenants, who destroy your property.

One section-8 landlord described to me how he gamed the system. In Fairfax County, the County and Federal government pays 75% of the rent for the Section-8 tenant, directly to the landlord, in a direct deposit every month. The landlord inflates the price of the rent to about 25% above fair market value, so the government pays him full fare. The tenant never pays any of their share, of course. There is a quid pro quo between the tenant and landlord - they don't pay their share of the rent, and the landlord does no repairs to the property.

The tenant, paying nothing for rent and having no interest in developing a good credit record or a good rental history record, literally destroys the property. Entire walls are ripped out, appliances sold off, windows broken, etc. The place ends up gutted, after a few years.

By this time, the section-8 money has paid off the mortgage on the property. The Section-8 landlord hires illegal aliens to re-sheetrock the property and he either starts over with new tenants, or flips the property for a tidy profit.

His example illustrates what is wrong with government programs designed to "help people". They end up helping slumlords and keeping poor people poor. Not surprisingly, most section-8 landlords are staunch Republicans, who want an end to government welfare, but not, of course, to their section-8 subsidies.

If you want to play that sort of game, fine. But for the amateur landlord, it is a risky one. You are better off renting to people with jobs and responsibilities. You are more likely to get paid, and you are not adding to urban blight.

You are not required to accept section-8 tenants. When people call asking if I do section-8, I simply say "Sorry, too much paperwork".

5. Reasonable Rents: Many amateur landlords think they can buy a property and then raise the rents 20-30% and "make more money". It is a bad move. When you make rents too onerous, people have incentive to move out, thus adding to your vacancy problem. If you have a unit that is unrented one month every year, due to tenant churn, then the increased rent doesn't necessarily offset the losses. Add in the cost of advertising and prepping a unit for rental, and you are losing even more.

Good long term tenants are no hassle and can put your property on auto-pilot. If you charge a little less than market value, chances are, they'll stay put. And the money you "lose" by doing this, is more than offset by the lack of vacancy and its attendant hassles. Not having to take a night off to paint a kitchen on a "for rent" unit is worth something to you.

6. Direct Deposit: Rather than wait for rents to come in and then deposit the checks, I would give my tenants a stack of direct deposit slips to my bank account, along with the pre-paid postage envelopes. The tenant can drop the check in the mail, or hand-carry it to the bank. Either way, I don't have to deal with it and instead the money appears when I check my balance online.

You could also set up direct deposit using online payment mechanisms, such as billpay.

7. Late Fees versus Discounts: One clever landlord gave me this idea, which I think is sound. Rather than trying to collect "late fees" for late rent, structure your lease so there is a $25 discount applied if they pay before the 5th of the month. Trust me, they will make sure that money gets there on time! Late fees are harder to collect, particularly if you end up in court (hope that never, ever happens!). But the main thing is the psychology of it. By offering a discount for early payment, you are the "good guy", whereas by charging a late fee for late payment, you are the "evil landlord". Which do you want to be? The net effect of the payment scheme is, of course, the same.

7. Security Deposit: Some States limit how much you can ask for in Security deposit, so check local laws. When I was in college, they asked for first and last month's rent, plus one month's rent security deposit. Ouch! In Virginia, such practices were not common, and in fact, were probably illegal. Nevertheless, make sure you have your security deposit in place before the tenant moves in. And ask for a "pet deposit" (not the brown kind) if they have pets.

You have to pay interest on security deposits, which can be tricky. I basically came up with a number for "interest" based on prevailing rates, and the tenants never complained.

8. No More Mr. Nice Guy (Mr. Doormat): Many folks think that being a landlord is their chance to enact their crazy social theories or make up for the practices of their "evil" landlord they had while in college. I'll show the world that you CAN be a nice landlord and still make money!

Bad idea.

You are running a business, plain and simple, and you are selling a product (a rental unit) to the general public, at a market value price. You cannot try to be "friends" with your tenants, or be a "nice guy" and try to help them out. And the reasons for this are numerous.

To begin with, your tenants don't want to be your friend. One of our long-term tenants would get very uncomfortable when I came by to check the house or do minor repairs. No one wants the landlord hanging around - it reminds them that they don't own the property. So we worked out a good deal. He'd do the repairs on the house and deduct the cost of materials from the rent (and send me the receipts for my tax records) and I would stay the fuck away. It was a win-win for both of us. They were good tenants and got quiet enjoyment from the home. I had less work to do and less worries about the property.

The second reason you don't want to be pals with your tenants is that your interests are diametrically opposed and you may end up on opposite sides of an issue, and your friendship will be damaged.

Which leads to the third reason - well maybe #4 as well. Since you want to be friends and "be nice" you may be tempted to let some things slide a bit, like late rent or damage to the house. Maybe it is no big deal, but 10% out of your bottom line can be the difference between a neutral cash flow and a negative one. And since tenants are no fools, they will try to use friendship with you as a means of manipulating you into being lenient and letting things slide.

No, no, you are better off keeping the landlord/tenant relationship as an "arms length transaction" as we say in the law. Everyone will be happier all the way around.

9. Evicting Tenants: If a tenant doesn't pay, evict at once. Eviction is a nightmarish process for any landlord and in some States can take over a year. It is expensive, too. Many landlords try to delay the process, hoping the tenant will pay. But once they are a month behind in their rent, chances are, they will never catch up. So drop the E-bomb at once.

Other landlords will offer cash incentives to get non-paying tenants out. But beware, these can backfire. One landlord gave a tenant $1000 cash if they would move out in a month. A month later, the tenant is still there - but thanks for the crack money! So the landlord pays the tenant again (stupid landlord!) and the same result. He ends up evicting, but only after the tenant delayed the process by six months or more - in addition the year required for eviction.

Avoid eviction by getting good tenants and doing background checks. But if it all goes horribly wrong, evict right away - don't delay!

* * *

You are risking an awful lot when you get into the landlord business, as many amateurs of the last decade found out. Not only can you lose boatloads of money, but your credit history can be damaged or destroyed - and you can end up in bankruptcy as well!

The tenant, on the other hand, has nothing to lose, except maybe a good reference from a previous landlord. And chances are, you won't even give a bad reference, because you don't want to be sued.

So you see, the deck is stacked against you from the start. In some States, like New York, it can be very difficult to even evict tenants, as this whole hippy-dippy-liberal approach to landlord/tenant law puts a lot of power in the hands of tenants. They can use delaying tactics and the law to stay in a home for a year or more, without paying rent. By the time you evict, they have sold the appliances.

So don't feel sorry for tenants or buy into this "evil landlord" nonsense. Most landlords, even large companies, are pretty tightly financed, and need those rent checks to cover their overhead every month. Very few are making ridiculous profits in the rental business, unless they have owned a unit for decades and it is paid off.

If you don't have the "heart" to run a business, then don't do it. You won't be doing yourself or anyone else a favor by going bankrupt trying to be "nice"