3 Things I Wish I Had Known Before Becoming A LandlordReal Estate Coaching Financial Planning
BY CYNTHIA MEYER CFA®, CFP®, CHFC®
CONNECT ON SOCIAL
My husband Steve and I are first-generation rental property owners. Friends who owned rental properties inspired us, but we had to figure things out for ourselves when we got started. Some things turned out exactly the way we anticipated, and others were a surprise.
There are three things I wish I had known before becoming a landlord:
#1 – There will be vacancies at inconvenient times
There will be times when your rental property is vacant, and you’ll have to pay the utilities and mortgage without the offset of rental income. Sometimes, this will happen when a vacancy is more inconvenient, such as the middle of the winter. Vacancies happen, are only somewhat predictable, and are a normal part of a rental property business.
When Steve and I bought our first rental properties, we projected vacancies in our rental business budget. We discovered over time that some properties have rented for years without a vacancy, and a few have remained empty for longer than we would prefer.
How to budget for vacancies
Your rental's vacancy rate will depend on the neighborhood, economic conditions, and how well you manage the property. Check with local property managers to get a sense of the market. Many new rental owners assume one month's vacancy per year per unit (not including the time it takes to get the property rehabbed for the first rental). Those with multiple properties typically plan for an overall portfolio vacancy rate of 6-8 percent.
Some vacancies are predictable
Predictable vacancies include when tenants decline to renew a lease and move out. Many of our rentals are single-family homes. We’ve seen long-term tenants go on to buy their own homes or move to another city for work. After they move out, it takes a month or so to clean and paint the home and make any necessary repairs, then put it on the rental market again. Those are the easy vacancies.
And other vacancies are unexpected
We have had situations where we have extended the lease on a short-term basis to good tenants who weren't ready to move out but could not commit to another full year. They often stayed for almost another full year, so on balance, it's been a good strategy. When a tenant has eventually moved out in the middle of the winter, we've found ourselves with a vacancy that lasted until June.
Other causes of unexpected vacancies can include divorce/break-ups, non-payment of rent, and employment transfer. Depending on where your rental is and how you have structured the lease, you may not have as much flexibility to deal with an unexpected vacancy as you would prefer.
Best practices for reducing vacancies
Ways to minimize vacancies include:
Be a responsive landlord - Take great care of the property and you’re more likely to have satisfied tenants. Encourage your tenants to report problems promptly and make needed repairs quickly.
Offer long term leases - Once you have approved a tenant for the rental, consider offering a multi-year lease, which plans for small rent increases in years 2 and 3.
Tenant screening and credit check – The wrong tenant choice can lead to months of unpaid or underpaid rent and possibly an expensive eviction. That doesn't imply you have to only accept tenants with perfect credit, but it does mean that you want to verify all information, check credit scores, and check references.
Rental properties in good school districts – tenants with children are not going to want their kids to change schools in the middle of a school year. If they like the school district and the rental, they are likely to stay until they buy their own home.
#2 – Unexpected things will happen
The more properties you have, the more likely you'll face a new situation that requires your creativity. In our rental business, these have fallen into three categories:
Tenant-created messes – We once had some tenants who regularly flushed baby wipes down the toilet, which blew up the plumbing system. We did not know that was going on until the plumber arrived to make the expensive repairs. Now we explicitly have a “no wipes” policy. I don’t care if the package says they are flushable. Just say no.
One tenant -- who vacated voluntarily after months of not paying rent -- left damage far beyond what the security deposit would cover. When our property manager arrived to inspect the home, they discovered a house stripped of everything valuable, including appliances and wiring.
Mother Nature rearranged something – Just like at our own home, the weather has a way of showing who is the boss of the landscaping. We've removed and trimmed trees, replaced boxwoods lost to blight, and repaired gutters.
Local government decisions - We’ve had unexpected expenses from changes in garbage collectors, property tax rates, and landlord license requirements.
You cannot know what specific unexpected events will happen in your rental business, but you can still prepare for them:
Build and maintain business cash reserves – Strong cash reserves are the emergency fund of your rental property business. To minimize risk to your financial stability, build cash savings to cover one year of the property expenses (mortgage, taxes, utilities, property manager, maintenance, insurance). With your first rental property, consider saving all your net rents for the first year until you’ve built generous cash reserves.
Review your insurance coverage annually – Make sure your landlord insurance coverage keeps pace with any appreciation in the value of your rental, as well as any changes you’ve made to the dwelling or how you use it. Check your liability coverage as well, to assure that it will fully cover you in the event of injury or accident on your rental property.
Have written tenant rules and policies – A written lease or rental agreement which details responsibilities and expectations is essential. If a rule is important enough to you that breaking it would be a reason to terminate the lease, then make sure to put it in the lease. (e.g., no smoking, no subleasing, etc.) For essential but not lease-ending policies, consider creating a separate document of tenant policies and make sure your tenants sign a notice that they have received and read it.
Require tenants to carry renters’ insurance – Generally, a landlord insurance policy does not cover a tenant's personal property. Renters insurance covers the personal property of the tenant in case of damage or theft. Policies also offer liability coverage for the tenant in case of injury or accident to someone else.
#3 – Managing rental properties takes less time than you think
We enjoy managing our profitable rental property business and find that it takes less time than we initially projected. We've managed to build and maintain the company with two busy, professional careers and young kids at home.
We spend most of our rental business time managing the business financials, keeping up with corporate formalities for the LLC, and making decisions about repairs and renovations. During specific periods, such as when we are looking for a new property to purchase, or when there's a vacancy or a non-paying tenant, it takes a bit more time. Except for tax season, we rarely feel pressured.
We chose a professional property manager
We are lucky to have a fantastic property manager who screens and handles tenants, arranges for work when needed, and communicates with us on progress and decisions we need to make. Our current properties are out of state, and we decided before we bought to only invest in properties that would be profitable net of the costs of a property manager. The decision to go with a professional manager was right for us.
Others set up DIY property management systems
Many of our clients and friends with real estate manage their rentals successfully by themselves. Property management software makes it easier to screen tenants, execute leases, collect rent, and keep in touch with tenants. If you’re a more “hands-on” landlord and enjoy doing the work, you’ll save the 8-12% costs of using a professional manager.
Rental real estate is a business we love
On balance, we have been fortunate in our real estate business. Before we got started, we were financially prepared to weather unexpected events. We bought most of our properties during a recession, so we have had some appreciation as well as reliable rental income. The unexpected events – like the baby wipes plumbing fiasco and the theft – affected our profits those years, but we had prepared to handle them.
The bottom line: There will be unexpected surprises in your real estate business.
If you have a topic you'd like us to tackle on The Real Life Blog, we would love to hear from you! Please email us at email@example.com.
This blog is for general financial education purposes. Information contained in this blog should not be construed as financial, tax, real estate, legal or investment advice. For educational purposes, blog posts may contain links to other websites which are not under the control or and are not maintained by Real Life Planning. Real Life Planning has provided those links for your convenience but does not necessarily endorse all the material on those sites. Please consult your financial, real estate, legal, or tax advisor for advice specific to your situation.