Becoming a landlord is the slow and steady path to wealth creation. If a landlord sticks with it long enough and is proactive in the acquisition of rental property, there will come a time when the landlord is wealthy (at least on paper).
More than any other occupation, more millionaires (and these days you really need to be a multimillionaire to be wealthy) owe their wealth to the accumulation of real estate. One of the major components of wealth creation is the ability to make money while you sleep. Rental properties have the potential to make money 24/7. However, most landlords fail long before they are able to reach the wealthy stage. Most fail because they do not understand the art of being a landlord. They assume that it is just collecting rent checks and making bank deposits. Any long-term, successful landlord will tell you it is about much more than just collecting the rent.
There are two models of wealth creation through rentals. The first is for high cost real estate markets (like the East and West Coast urban areas) and the second is for lower priced real estate rentals found in rural or depressed parts of the county.
In expensive real estate markets, financial gains are realized through tax write-offs (e.g. depreciation deductions) and property appreciation and the pay down of the mortgage. Over time, positive cash flow grows from annual rent increases. Cash from rentals can be pulled out or redeployed via refinancing opportunities created from appreciation and paying down the mortgage principal.
In lower priced real estate markets, there is much greater opportunity for cash flow from the beginning. This cash flow rises with annual rental increases. However, because there is less of an opportunity for property appreciation, equity grows from the paying down of mortgage principle.
The challenge in both of these models is for the landlord to survive long enough to realize the financial gains. So to help current and future landlords reach their financial objectives, here are the top five do's & don’ts for winning at the landlord game.
When determining rental expenses and revenues, consider repairs, vacancies and a stuff happens fund. There are few guarantees in life, but one is that things break and need to be repaired or replaced. Many landlords fail because they are underfunded and not equipped to deal with the costs. You do not want to be one rental payment away from disaster. I have been in landlord tenant court where the tenant says they will pay the rent when the water heater is fixed, and the landlord says they will fix the water heater when the rent is paid. Guess who won? The tenant. When things break, the landlord is responsible for fixing whether the tenant is paying the rent or not. Generously predict expenses and conservatively anticipate income. In addition to the initial funds to get started, assume 25 percent of rental income will go to cover vacancies and repairs. Have at least $5000 in a stuff happens fund (or line of credit) per rental unit.
95 percent of rental management problems can be eliminated through proper screening. Problem tenants leave trails. Pull prospective tenant credit reports, check court records, Facebook and get copies of government issued photo IDs. Verify they are who they say they are. Sometimes folks steal the identity of someone with good credit and apply under that person’s name. Check references with the applicant’s current and previous landlord. The current landlord may be so unhappy with the tenant that they give a glowing recommendation, just to get rid of the tenant. Always check with the previous to last landlord because he has a greater incentive to be truthful. Verify that you are speaking to the real landlord and not a friend of the applicant posing as the landlord. Most importantly, visit the current residence of the applicant. How they treat their current home is how they will treat your rental. Any excuses as to why they can’t provide any of these things should raise a red flag.
Little problems, when caught early, remain little problems. However, if allowed to fester, they can become big expensive emergencies. First inspection should be three months after a tenant moves in and then every six months going forward. Have a schedule for maintenance items and keep track of the age of appliances. Appliances typically fail close to the end of their normal lifespan. Hot water heaters (the kind I buy) normally last about 15 years. The cost to replace a hot water heater is about $250 when it is not an emergency and you purchase it from a big-box store. However, if your hot water heater breaks it costs about (depending on where you live) $600 to have someone come out and replace it immediately. This is something that has to be fixed immediately because it presents a habitability issue. Keep a log of the ages of appliances and replace them before the end of their expected lifespan. Doing this will allow you to handle these issues at times that are convenient to you, price shop, take advantage of sales, reduce your operating expenses and most importantly reduce the number of landlord emergencies you experience.
I am a Landlord Representative on my local Montgomery County, MD Landlord Tenant Commission. I see landlords needlessly getting into trouble because they don’t know the local rental laws. The number one reason tenants take landlords to court is over the return of the security deposit. It is so sad to see a landlord have to return a security deposit to a tenant, who has done extensive damage to the landlord’s property, because the landlord did not follow the security deposit laws. Become familiar with local laws governing how security deposits work. Know what clauses you can, cannot and must have in your rental lease contract. Understand what notices need to be delivered to tenants, associated time lines and acceptable methods of delivery. Have clarity on what you can and cannot do when a tenant:
- doesn’t pay the rent
- isn’t maintaining the property
- has pests
- allows unauthorized residents or pets
Know how much you can raise the rent, how often, and how much notice must be given. Stay on top of local lead paint laws growing concern for many landlords. Be informed about regulations which impact you as a landlord.
Join your local real estate investing group and network with other landlords. Read books on real estate investing and becoming a landlord. I like to read a variety of authors to get a diversity of opinions and perspectives. If you choose to work with a real estate agent, get one who knows about rentals most don’t. I am not an advocate of spending a lot of money on real estate gurus. I think that money is much better spent on books and networking opportunities.
It is always shocking to go to landlord tenant court and hear the amount of delinquent rents. It is not unusual to hear amounts of $5000 and up. A tenant who does not have $1000 in January is even less likely to have $2000 in March and $5000 in May. But again and again, landlords wait until the missed rental payments are exorbitant before they file. It is much easier for a tenant to make up 1 missed rental payment than five. If a tenant has missed five rental payments it is highly unlikely they are going to be able to catch up. If a tenant can’t afford the rent, then they need to move and taking them to court is the best way to make that happen. Coincidentally, if a tenant were to come up with five months of rental payments, what do you think is the likelihood of them handing that money over to the landlord? Don’t accept excuses for the rent, if you do you will get excuses instead of the rent.
Don't fly by the seat of your pants. Have written procedures in place to handle situations and problems before they occur. It is much easier to decide how you will handle a situation when you are not emotionally entangled. When the situation occurs, just follow your written procedures. Have a long-term vision of where you want to take your rental business. No one accumulates 100 rentals without a written game plan. Decide how big you want to grow, how fast, where the money will come from, your support systems and what your end game will be.
This is a for-profit rental business, not your personal residence. Spend what is necessary to make the rentals functional and attractive to your target market and not a penny more. When spending money look for durability. The goal is to make the rental “tenant proof” by minimizing the potential for tenant damage. For example, after many years and thousands of dollars on carpets and carpet cleaners, I have sworn off carpets. They are just too easily damaged by tenants. For flooring, I either use ceramic tile or a product sold at Home Depot called Allure.
For the record I am a huge animal lover and live with both a dog and a cat. But I do not allow pets in my rentals. There are two trains of thought on pets in rentals. One side feels that a significant number of tenants have pets and by excluding pets, you greatly reduce your pool of potential tenants. Additionally, some landlords feel that tenants with pets stay longer because not all rentals allow pets. My feeling is that pets cause lots of damage to rentals and that landlords (depending upon local laws) could be exposing themselves to substantial liabilities from tenant dog bites. After many years on my local Landlord Tenant Commission, my experience has been that whenever there is extensive rental damage, a pet is always involved.
The folks who survive the landlord game long-term learn that this is a business and to treat it as a business. They don’t take anything personally. They view everything in terms of how it impacts the business and do not get emotionally distracted by the drama. And there will be drama. If you do allow yourself to take things personally, being a landlord will quickly burn you out emotionally.
Being a landlord is an excellent and well-proven path to wealth creation. The challenge is surviving long enough to realize the gains. Have a written game plan, know your numbers, don’t over-spend, maintain your properties, screen tenants well, know your local laws, create a good support system and be a continuous learner. The proper attitude, knowledge and preparation are the keys to winning at the landlord game.
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