Various Real Estate Sources, June 2015
Editor’s Note – Once a year or so I blow the dust off this article and update it with the new and exciting ways landlords can take a perfectly good, income generating property and completely screw it up. I am also including the new and creative ways tenants have to make owning rental property a nightmare.
1) Buying the wrong property or buying at the wrong time – The most expensive and common mistake, especially for out of state or first-time investors, is buying a property in a difficult rental area or buying the wrong property. It is very important to find a realtor who understands the rental market and can provide an analysis to help the determine if the property makes sense. If your realtor does not manage properties find a professional property manager familiar with the area and ask them before you buy. Key factors are location, size, number of bedrooms and bathrooms, rental rates, vacancy rates, HOA dues, age, amenities, schools, condition of the property, deferred maintenance, ongoing maintenance such as landscaping and price. Most buyers ignore vacancy rates. One bedroom apartments are hard to rent. Four bedroom houses are typically easier to rent especially to Section 8 tenants. (Section 8 is a government rental assistance program to help low income tenants get into housing appropriate for their needs. The properties must pass inspection. The rents are paid directly from the government to the landlord.) Cheaper properties are not necessarily better. If a property is hard to rent then the price should be lower. It might be worth paying more for a property if the vacancy rates are low. Buyers should always have a home inspection performed by a licensed inspector to identify future maintenance issues. The golden rule is still location, location, location.
2) No written lease, rental application or credit and background check – Crazy as it sounds a lot of landlords don’t have written leases. A written lease clearly outlines the tenant obligations and deposits. If there is no written lease then the landlord cannot charge late fees and it makes it more difficult to go through the eviction process, collect for damages and unpaid rent. All tenants should fill out a rental application including employment history, social security numbers and prior landlords. The landlord should do a credit and criminal background check, contact prior landlords and verify employment. Though this does not guarantee a great tenant it is a good start.
3) Hiring the wrong or firing a good property management company – An incompetent management company can cost you thousands. Many owners shop for the lowest management fees. Months later these owners complain their management company does not respond to calls or emails, they have not received rents for months, money was sent for repairs but the work has not been completed or the property manager is charging more for repairs than other companies. The bottom-line is a property manager has to clear 8% of collected rents to make money. Companies charging lower fees make up the difference by adding a percentage on the repairs, charging the tenants administrative fees upfront or a percentage in addition to the monthly rent. Charging the tenants additional fees makes your property less attractive than those with lower fees. Make sure your property manager is a licensed realtor as you will have limited recourse if they are not licensed.
Some owners suffer from “property manager amnesia”. The owner changed property managers and the tenant was already in place. The prior property manager did not collect a deposit, check the prior rental and credit history or talk to the prior landlord to see if he or she is a good tenant. When the tenant moves the new property manager, who inherited this mess, gets blamed because there was no deposit and the tenant left the property in poor condition. With no deposit the tenant has no incentive to take care of the property. Owners tend to forget the original property manager was the source of the problem.
4) Not maintaining the property – It is important to keep a tenant in place as turnover is costly in both repairs and lost rent. The key is making sure repairs are taken care of in a timely manner. This will help keep the tenant happy and eliminate potential costly repairs. What is a small leak today could be a flood tomorrow. Vacancies are costly and poorly maintained properties will result in lower rents, take longer to find a tenant and can result in costly fines from the city.
5) Installing the wrong flooring – Carpet is a terrible choice for flooring and it is expensive to replace. Tenants can destroy carpet in a matter of weeks especially if they have pets. Installing a commercial grade vinyl, porcelain tile, a concrete finish or staining the concrete will significantly reduce the unit turnover costs. It may be more money initially but will save a lot of money over the life of the rental.
6) Taking too long and spending too much to make a property rent ready – There are two key factors in maximizing the return on rental properties: 1) Taking too long to make a property rent ready; and 2) Paying too much for repairs. It is very important to have a good handyman and other contractors who are reliable and charge a reasonable price. Using the cheapest labor you can find may cost you big in the future. Hiring a contractor that takes three months to get a property rent ready is unacceptable. Be careful when changing property managers as the contractors may be so busy with those properties they do not have time to work on any other properties. In addition the contractors often have loyalty to the property manager and will not do work for the owner if the property manager changes.
7) Not paying for a pool service – Houses with pools are very attractive to renters. But pools can get damaged if they are not properly maintained. It is far better to pay $80 a month for a weekly pool service than to spend thousands replastering the pool.
8) Expecting the tenant to maintain the property or make it rent ready – It is unrealistic to expect a tenant to maintain a property or to get a property back in good condition needing very little repairs when they move out. If this happens consider it a gift. Realistically, an owner should expect to spend $1000 to $2000 on an 2 bedroom apartment and $2000 to $3000 on a house to get it rent ready. The cost varies depending on the age, size, number of years it has been a rental and how long the tenants have lived in the property.
9) Getting too emotionally involved with the property – This tends to happen when the owner was living in the house and then rented it instead of selling. These owners may have bought at the top of the market. In order to sell they would have had to do a short sale or potentially lose a lot of money so renting for a few years is a way to cover the expenses while waiting for the housing market to improve. Unfortunately, these owners either forget the true condition of the house when they moved or expect the house to look better than it did when the owners moved out. These owners often change management companies in a knee jerk reaction when they see the property after it has been a rental for a few years. As a result, the owner fires a perfectly good management company and hires a different company. Was this the right decision? It depends on the performance of the new property manager. If the prior manager rented the property in an average of 60 days and the new manager took 149 days then probably not. If the rent was $2000 a month, the owner lost $5,900. Ouch! (Note the issue was not the rental rate as it was the same. The issue may have been that the new property manager charged the tenant an administrative fee when the lease was signed and an additional fee each month.)
10) Focusing on renting the property quickly rather than waiting to rent to a good tenant – There is an old saying good things come to those who wait. Which would you rather have – a tenant who pays rent on time, gives notice and leaves the property in good condition or one that you have to beat the rent out of every month, moves without notice and leaves the property in poor condition? It is a big red flag when a tenant says they need to move in a few days as it probably means they are not paying rent to their current landlord and are about to be evicted. A tenant who is considerate of their prior landlord by giving them 30 days notice is much more likely to be a good tenant than one who wants to move in tomorrow. Depending on the location it is reasonable to expect 60 to 90 days for the house to be occupied once it is rent ready.
11) Setting the rental price too high – Vacancies will kill the cash flow on a property. Landlords who ask unrealistic rents are costing themselves thousands of dollars. It is far better to rent a property quickly than to wait months for another $100. Remember a month’s lost rent is gone forever.
12) Accepting partial payments or prepaid rent – Many landlords accept partial payments without a written agreement from the tenant. The tenant has to sign a non-waiver stating the tenant understands failure to pay will result in an eviction. If the landlord already has a Writ and accepts a partial payment without a signed waiver then the landlord will have to start all over with the eviction process and incur all the service, court and attorney fees again. And the tenant is living there rent free during the process. Tenants may offer to prepay rent if they are having problems getting their applications accepted to due past evictions or poor credit. Though the landlord can accept the prepaid rent, it has to be held in trust for the tenant. The tenant has a legal right to prepaid rent as it is not due yet. If the tenant asks for the prepaid rent to be returned the landlord has to comply. In general, do not accept prepaid rent.
13) No Home Warranty or the wrong home warranty – One of the most expensive items to replace is the HVAC unit. In the summer, when Phoenix is two inches from the sun, broken air conditioners are common. Most professional property managers recommend landlords purchase a home warranty and have the HVAC unit serviced at least one a year. If the HVAC units are not serviced regularly the home warranty will not cover the claim. A new HVAC unit may cost $5,500 or more. Tree roots can cause sewer line backups. Be sure the home warranty covers this repair. Home warranties also cover other repairs like the refrigerator, dishwasher, hot water heater, washer, dryer and plumbing stoppages. One major repair will likely cover the yearly cost of the home warranty which ranges from $500 for single family up to $1,800 for a fourplex. Some home warranties are better for single family homes while others are better for multifamily. Check with your management company for the best home warranty provider for your property or read my last newsletter.
14) Not registering rental properties with the City and County – Most cities require landlords to pay sales tax on rents. Maricopa County assesses higher property taxes on rental properties than single family homes. The fines are steep if you do not pay the sales tax and/or have not registered the property with the county. Make sure your management company is collecting and paying the sales taxes and registered the property as a rental with the county. If the landlord has not registered the property, the tenant can give a ten day notice and leave. Out of state owners must have a local statutory agent. The purpose of an Arizona statutory agent is to be the person or entity that can be served with a summons and complaints filed in a lawsuit or receive notices of violations like overgrown yards or abandoned vehicles. In Arizona the statutory agent must be an adult individual who resides in the state and must have an Arizona street address not a post office box. If the landlord has not registered the property the tenant can give a ten day notice and leave. (Yes repeated this to make sure landlords understand how expensive it can be if a property is not registered.) If you change statutory agents and do not inform the city within 10 days you could be fined.
15) Not protecting personal assets by putting rentals into separate LLC’s – What happens if a tenant falls due to inadequate lighting or an uneven curb, fire destroys the structure and the tenant is injured or killed? In our litigious society a lawsuit could result in the landlord losing their entire estate including the house they live in!
Example- Faulty electrical wiring results in a fire where one of the tenants is killed. The family sues, the jury finds for the family and awards several million dollars- an amount far above the property insurance limit. The family seizes the landlord’s 5 rental properties (worth $1,500,000), personal residence ($900,000) plus the bank accounts ($500,000). If the landlord had formed a Limited Liability Company or LLC for each rental property the only asset at risk would be the building where the tenant lived. Each property should have its own LLC. The cost per LLC varies from $700-1400. You should consult with a real estate and an estate attorney to discuss the benefits and risks of placing your personal assets into an LLC, revocable or other living trust.
16) Carrying the wrong Property Insurance – If you lived in the house as your personal residence and later change to a rental property be sure to contact your insurance carrier to change the property to reflect it as a rental property. Typically the rates will go down as you are insuring the building and not the contents. Due to the number of vacant properties being vandalized a lot of insurance companies will not cover if the property is vacant. So, the moment the tenant moves out you essentially have no coverage. Ask your insurance company if they cover vacant properties.
17) Failure to read and Understand the Landlord Tenant Act – Make sure you are familiar with the landlord tenant act so you know your rights and the tenant’s rights. If you are using a professional property manager they should already be familiar with the terms. If you are self managing then it will be up to you to follow these rules as the penalties are severe. Be sure to find a good eviction attorney to help you legally evict the tenant.
18) No pool fence or other barrier – Renting a property without a pool barrier is asking for trouble. It is important for the safety of the tenants especially if there are children. A landlord cannot refuse to rent to someone with small children because there is no pool fence as it is violation of Fair Housing and can result in a hefty fine. If you buy or own a property with an unfenced pool be prepared to install a pool fence or other barrier.
19) No periodic inspections – When the lease is signed the tenant should be made aware the property may be inspected on a monthly basis. A professional property management company will have the repair companies report any issues like unauthorized occupants or pets, excessive wear and tear, maintenance issues or other damages. They should also check the smoke and CO detectors and the HVAC filters while at the property. Some tenants think if they don’t bother the landlord with repairs the rent will not increase. This can result in costly repairs down the line.
Avoiding these mistakes should help keep your vacancies and expenses low, rents high and protect your personal and investment assets.