Four years ago my wife and I purchased our first home to be used as a rental property. That move was the culmination of several years’ worth of reading, discussing and planning about rental real estate. It took us that long to feel knowledgeable and confident enough to put a plan into action that would earn us a steady income stream aside from our daily professional jobs.
For the most part, our experience has been a positive one. Notice I said “for the most part.” We’ve had our share of challenges along the way, like:
…the leaky copper piping that had to be replaced in an entire house
…the dual tenant situation where one roommate left, leaving us with half the monthly revenue stream coming in on that property until another roommate could be found
…tenants who don’t inform you of repair issues in a timely manner (“Really? It’s been leaking how long?”)
…tenants who won’t pay on time…or ever
…tenants, who by their actions, force you into court (that’s a post in itself!)
…managing the finances to account for repairs, taxes and the house that sits vacant for months while you do repairs or find a new tenant
…the emotion that comes when facing these difficult circumstances (“Serenity now!”)
…the time it took (eating into an already full schedule) to take care of all this.
Still want to be a landlord? Then consider these suggestions to help you manage through some of the dark times that will inevitably come.
Approach Rental Real Estate With a Business Mindset
This one comes first because I can’t stress it enough. This endeavor should not be entered into in a whimsical manner. It requires more than half-hearted, ho-hum effort. As I mentioned, we took the better part of two years to research what it meant to be a landlord and come to an understanding of whether it would be a right fit for us at this point in our life. It may not take that long for you but it’s absolutely necessary to think this through, evaluating the pros and cons.
Too often homeowners who are struggling to sell their house decide to rent it without understanding the implications of that decision. They throw their hands up in desperation and say “I guess we’ll rent it,” fully assuming it will be an easy venture that requires little time and hassle but will result in big profits. They rent to whomever, without doing background or credit checks just to get someone in their property. Then, the owners get burned by the less than qualified tenants who won’t pay or who destroy the property (or both!).
Rentals have to be run as a business with a full understanding of funding, return on investment, depreciation, property taxes, building codes, legal responsibilities, etc. This is true even if you decide to rent to a family member or friend (which is very risky and filled with potentially damaging relationship issues).
Have Sufficient Capital to Back Up Your Business
This is my #2 suggestion because rental real estate can be a money-eating machine. From the purchase price to the pre-move in repairs to the continual maintenance, it seems like money is always flowing into the property. That’s why a landlord should have the necessary cash reserves already secured to maintain their investment.
I would not run a rental real estate business unless my financial life met the following criteria:
- No debt (other than the mortgage on my personal residence)
- A 3-6 month personal emergency fund
- Could put at least 50% down on the property (preferable paying in full with cash so as to have no mortgage debt on the property)
- A minimum of $10,000 saved in the business account for continuing repairs after the purchase
That may seem like overkill (especially the paying in full with cash part) but it’s imperative to get your personal financial house in order first. And the best part is all those suggestions are doable, given time to let them happen. There is no rush to buy your first rental house – properties will always be available. You will enhance your chances for success and greatly reduce your stress levels by building a strong personal financial foundation first.
Conduct a Home Inspection Before the Purchase
This seems obvious but many people in rental real estate miss this critical step because they get caught up in house buying fever. A home inspection is not the buyer going around looking at the attic and the crawlspace. That’s akin to just kicking the tires at the car lot.
You need to spend money on a certified home inspector who is trained to see things you’ll never think of. The expenditure is well worth it as they can keep you from making a 6-figure mistake on the purchase of a house.
Use a Clear Contract For the Rental and Never Violate It
We are not just shaking hands with the tenant on this deal. Hire a lawyer to draw up a legal contract (or find one online) that outlines the expectations of the tenant and the landlord. Make it as detailed as possible.
When’s the rent due? What happens if it’s late? When does the landlord make repairs? Can the tenant have a roommate? Do they have to tell you they have a roommate? When does the eviction process start? Can they have a pet? A pool? Can they smoke? Hang pictures?
Contracts should be viewed as a positive for tenant and landlord. We have been saved on more than one occasion by the language used in ours. The main reason is that I, as a landlord, have never violated it. If it says it in the legal document then that is what I am bound to do. And I better follow through on all my responsibilities or the tenant may have legal recourse against me.
Make Timely Repairs at the Property
Respond to major repair issues immediately. It’s the landlord’s responsibility to work in good faith with the tenant to insure the dwelling is habitable. If you drag your feet and neglect repair requests the tenant could again have recourse against you in court.
In some places of the country, that means air conditioning or heating has to be fixed immediately. Water always has to be present and flowing in the house. That leaky roof cannot wait until you return from vacation. You might have to make a phone call from the beach to your roofer back home to get over to the property and inspect the situation. Are you prepared for the pressure of that type of responsibility?
The rental real estate business can be a great source of income when managed and run properly. There are risks and considerations, however, that must be taken seriously before you commit your hard earned money and your time to this endeavor.
Questions: Are you interested in rental real estate as an income stream? What landlord/tenant horror stories do you have?