Are you ready to be a landlord? Here are eight things you need to think through before you find your first tenants.
By: Daniel Caughill
Thanks to HGTV and the allure of passive income, many people dream of investing in rental properties. Of course, becoming a landlord can be a great way to build your wealth or to make use of a second property that you own. However, property management can take a lot of work, too. Whether you’re leasing your apartment to family friends or to tenants you just met, you need to understand one thing up front: You’re not a host. You’re a business owner.
With that in mind, here are eight things to keep in mind when preparing to rent out your first property.
1. Find your rent-price range. You’ve probably put a substantial investment into your rental property, and you’re likely dependent on the monthly income it generates to keep up with mortgage payments. However, depending on your region’s rental market, you might also face stiff competition from other landlords in the area. That’s why it’s important to put thought into how much you should charge for rent. Ideally, you’ll have enough to cover all of your monthly expenses and still make a profit, but you also need to make sure your property is attractive to potential renters.
Some advisers will encourage you to use the “1% rule,” which states that you should charge about 1% of the property value of your home each month. So, a house worth $200,000 would demand a rent of approximately $2,000 per month. If your rental market allows you to hit this benchmark, you’re probably doing well as a landlord. However, the rule is overly simplistic and probably too high for most rental markets.
Instead, you should determine your base rent by calculating the total amount it costs you to own that property each month, and the maximum amount you charge should be driven by the market.
Tally the cost of all your monthly expenses to determine your minimum rent. This calculation should include mortgage payments, insurance premiums, maintenance fees, property taxes, estimated vacancy losses and any other costs you’ll face. If you’re at least earning this amount, you’ll know you’re not losing money on the property. If the rental market doesn’t allow you to bring in this much, you’ll need to decide for yourself whether retaining the property for a monthly loss is worth it—or if you’d be better off selling it.
To determine the maximum amount of rent you can reasonably charge, you’ll need to turn to the market. You can use online house-hunting tools like Trulia, Zillow or RentHop to compare prices in your area. You can also check the newspaper for local listings or ask other landlords and property managers what they charge. Make sure you compare your property with similar homes in the immediate area. You may struggle to find tenants if you’re charging the same price for a studio apartment as a larger one-bedroom apartment across the street.
Once you’ve determined this range, you can decide how to price your rent. Slightly lower rents may earn you less, but they may allow you to minimize the amount of time your property is vacant. Higher rents will earn you more but could take longer to fill.
2. Make rent collection a priority. Since your property is a business, and your rent is the primary revenue that drives it, you’ll need to make sure you collect rent on time. Set clear expectations to your tenants about the day rent is due, and outline how many grace days they’ll have for late payments. If they exceed that limit, enforce a consistent late-payment penalty. Of course, you don’t want to be harsh to someone struggling to make payments. But if they can’t fulfill their obligation to you, you might not be able to fulfill your obligation to your mortgage lender.
The best way to manage rent collection is to offer automatic online payments. Not only will this eliminate the need to cash checks each month, but it will also lead to consistent, timely payments.
3. Purchase and require insurance. Insurance is a crucial part of your rental property business. If you’re renting out a home you previously lived in, you may have assumed your homeowners insurance policy would continue to cover the house with its new tenants. Unfortunately, that’s probably not the case.
Most homeowners insurance policies exclude long-term rental properties from their standard coverage. Instead, you’ll need to purchase landlord insurance. Generally, landlord insurance provides the same basic coverage as a standard homeowners policy, but with a few differences.
First, a landlord insurance policy may offer more liability coverage than standard homeowners policies. On the whole, rental properties face more liability claims than primary residences, so increased liability coverage is a good idea for most landlords.
Second, landlord insurance may provide loss-of-income coverage, either as part of the standard policy or as an optional rider. If you depend on your rental revenue to pay your mortgage and any other bills associated with a property, an extended vacancy could be disastrous. However, with loss-of-income coverage, you’ll be compensated if a covered peril, such as a fire, makes your rental property temporarily uninhabitable.
There may also be additional coverage you choose to add to your policy to fit your property’s needs. However, your landlord policy will also be priced to compensate for this increased coverage—about 25% more than standard homeowners policies on average, according to the Insurance Information Institute.
While your landlord policy will cover your property and qualifying liability lawsuits you could face, it doesn’t protect your tenant’s personal property. It also doesn’t cover any liability lawsuit your tenant may face. Because of this, it’s a good idea to require your tenants to carry their own renters insurance policy. By doing so, you’ll further distance yourself from potential liability lawsuits, and you may lower your own liability insurance premiums.
While not a necessity, it can be a good idea to look into an umbrella insurance policy as well.
Umbrella insurance provides liability protection above and beyond your landlord policy’s liability coverage limit. This could be necessary if, for example, an electrical shortage in your property leads to a fire that damages neighboring property. Such a claim would likely exceed your landlord policy’s liability insurance limits, but umbrella insurance could step in to cover the remaining cost. Umbrella insurance can typically be bought in million-dollar increments and is relatively inexpensive since it provides secondary coverage.
4. Keep clean records. Owning a rental property comes with several desirable tax benefits. You may be able to write off some or all of your maintenance fees, mortgage interest, insurance costs and listing fees. However, you’ll need need to commit to keeping clean expense records to defend these tax deductions—and to gauge how well your business is doing. Develop meticulous recordkeeping habits, and save a record of every expense related to your property. If you choose to keep your records on paper, it’s smart to digitize them for storage purposes. Or you may choose to use a web-based system, such as Quicken or Cozy, to manage your rental expenses. This is advisable if you’ll be managing multiple properties.
It’s also smart to photograph your property before tenants move in, to create a record of its condition. When your tenants decide to move, you can compare these photos with the current state of your property to assess any damage. However, keep in mind that general wear and tear is the responsibility of the landlord, not the tenant, so don’t try to use your tenant’s security deposit to repaint the apartment after they move.
5. Know your local laws. Each state may impose different rules governing how landlords conduct their business, and each city may take those differences even further. For example, do the zoning laws in your area permit residential rentals? Are you required to pay for heating? Do you know how much you’ll be allowed to increase your rent each year? Make sure you fully understand your area’s laws regarding rental properties, rent increases, evictions, building codes and anything else relevant to being a landlord.
Try talking to an experienced property owner in your region about which legal pitfalls to avoid.
6. Screen all potential tenants. When you allow somebody to move into your property, you’re putting a lot of stake in the assumption that they’ll make timely payments, honor their contract and take good care or your home. Taking the time to screen these applicants can go a long way in protecting your investment.
Verify their income
Does your annual rent exceed one-third of your tenant’s total annual salary? If it does, they might struggle to keep up with payments. Check your tenant’s income history, and ask for proof of employment to verify that they can afford your property.
Pull a credit check
Obtain the written permission of each applicant to run a credit check, then pull a full credit report from each of the three credit unions: TransUnion, Experian and Equifax. To do so, you’ll need the applicant’s full name, Social Security number and former address. If your applicant has a poor credit score and a number of concerning debts, it may be a sign that they won’t be a reliable tenant.
It costs around $20 to pull a credit report. Most landlords require prospective tenants to pay this fee as part of the application process. However, even if you decide to pay for it yourself, it’s worth the cost to know the creditworthiness of your applicants.
Ask for references from past landlords
Obtaining references from former landlords is a great way to weed out potential problem tenants. If the applicant was late making payments or left a huge mess after they left their last apartment, their landlord will let you know. If this is your applicant’s first time renting, ask for professional references instead.
Be mindful of fair housing laws
As you screen your applicants, take special care to follow the fair housing laws of your region. For example, even if you do not allow pets in your apartment, you might not be allowed to turn away an applicant due to their service animal. Understanding your fair housing laws can go a long way in protecting yourself from a lawsuit.
7. Plan for vacancies. As mentioned above, loss-of-income insurance may protect you from vacancies caused by covered damage to your property. However, insurance won’t typically cover a decline in demand due to a cool rental market or short-term vacancies between tenants.
Set aside money to cover your mortgage and other costs during periods when no tenant is living in your property.
If you’re having a hard time finding tenants to fill your apartment, it’s probably a sign that you need to lower your rent. However, you should also consider staging your apartment with a few pieces of furniture, such as a table, chairs and curtains, to make it look more inviting.
8. Consider hiring a property manager. If being a landlord is more work than you expected, you can hire a property manager to do much of that work for you—passive income at its finest. This is common practice for property owners who amass multiple homes or apartments.
However, a property manager will also take a cut of your profits. If you already work full time and are only investing in a rental property as a side stream of income, you may be able to afford, say, a 10% deduction in profits. However, if being a landlord is your sole gig, you’ll need to carefully consider whether a property manager is something you need or can afford.
Daniel Caughill Daniel is a Staff Writer at ValuePenguin, covering insurance, retirement and other personal finance topics. He previously wrote about compliance and best practices for K-12 school districts at Frontline Education.
Source: Value Penguin