Where New Landlords Go Wrong

Frazzled businessman Shutterstock_1714665730Assuming too much cash flow, trying to do repairs themselves and not thoroughly screening tenants are among the stumbles first-timers make.

As questions about where interest rates and real-estate prices are headed continue to weigh on the market, more people could be tempted to turn their homes into rental properties instead of selling them.

But becoming a landlord isn’t as straightforward as it might seem. In fact, it comes with far more financial, legal, emotional and time-consuming factors than many rookies realize. Rents, for example, aren’t surging the way they had been in recent years.

We spoke to landlords and experts in the field about the biggest mistakes first-time landlords (and, yes, even veterans who should know better) make when they get into the rental-property business. Here’s what they said:

Not treating it like a business

Many new landlords treat their rental business like a part-time hobby rather than a business, says Scott Trench, chief executive of BiggerPockets.com, an online community with forums for residential real estate investors. That’s a mistake, he says, because renting a house is far more complicated than just owning one. Rookie landlords should be prepared to put in between 250 and 500 hours to learn the ins and outs of the rental business. They need to establish policies on what they will and won’t accept from tenants, how they’re going to deal with contractors, how much money they need to collect in rent to make new acquisitions pencil out and how to manage miscellaneous expenses, among other things.

Many people “don’t invest the time to learn how to screen tenants, manage the property effectively and maintain it,” Mr. Trench says. “Many such landlords are at risk of losing large amounts of money, having experiences with bad tenants and finding that the property consumes large amounts of their free time down the road.”

Underestimating the costs

Another big mistake many first-timers make is underestimating the costs associated with rental properties and assuming they will be bringing in more money than they actually do, says Trench. If a landlord collects $1,500 in rent and the monthly payment on the property (including mortgage, taxes, insurance, etc.) is $1,200, that doesn’t mean the landlord is $300 in the black. In reality, he says, they might be in the red because many new landlords fail to budge for additional expenses that undoubtedly will come up, from new roofs and refrigerators to windows and flooring.

On the clock

“You’ve got to account for maintenance,” Trench said. “You’ve got to account for capital expenses—when you replace the roof every 30 years or have to redo the kitchen or put in appliances. If you’re not budgeting—at a minimum–$250 to $300 a month for maintenance and [capital expenses], you’re probably doing it wrong, even if you have a fairly new unit in good condition.”

New landlords should have money in the bank when they get started in case big expenses come up right away, he says. “For a rule of thumb, I think that landlords should be very, very uncomfortable if their cash reserve is anything less than about $15,000 on day one,” says Trench. “I would heavily encourage landlords to bump that up by $5,000 to $10,000 for each additional property, at minimum.”

It’s also important to understand that what a property owner can charge for rent isn’t dependent upon costs—that is, there is no guarantee that a landlord will be able to charge tenants enough to cover both the monthly costs on the property and needed repairs and home improvements.

Tia Politi, who owns multiple rental units with her husband near Eugene, Oregon, and is the president of the Oregon Rental Housing Association, says first-time landlords will sometimes tell her: This is what my mortgage is and my taxes and insurance, so this is what I want you to charge for rent. “Well, I’m sorry. Rents are not dependent upon what your costs are,” she says. “They’re dependent on what the market will bear.”

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Not valuing your time

It’s very common for property owners to think they can save money by doing repairs or major improvements themselves, but what many fail to take into account is the value of their own time, said Andrew Timms, president of the Illinois Rental Property Owners Association, a trade group. “It’s remarkable how many people, when they’re on their own time, don’t price it and don’t value it for what it’s really worth” he says. “They may save the $70 an hour that a professional would charge who could do it in 45 minutes, but they have taken 2½ hours of their own time to get the job done. And in the end, the numbers don’t add up.”

Lacking a consistent screening process

Experts say property owners can head off many of the nightmare scenarios that come with being a landlord by having a thorough, consistent process for screening potential tenants.

“My biggest mistake,” Trench says, “was allowing tenants to refer one another and for me to allow them to be on the lease without going through my screening process in a formal capacity.”

Mr. Trench and others stress the importance of doing a credit, criminal and background check on every potential tenant, and to maintain a consistent criteria. That helps identify reliable tenants without running afoul of discrimination laws, they say.

That said, “someone can have bad credit for a good reason,” says Dan Mancini, a real estate agent who also owns rental properties in the Philadelphia area. He encourages landlords to meet with applicants to talk about things on their credit report. “Maybe they’re going through something really difficult in life and that’s understandable, with an emergency or someone maybe dies,” he says. “I think the numbers don’t always tell the whole story.”

Getting too friendly with tenants

All sorts of complications can arise when landlords and tenants become friends or start socializing together, Mr. Timms says. A landlord, for example, might avoid discussing an issue with tenants, assuming they will make it right on their own. Tenants might assume that the landlord is OK with them, say, adopting a pet or making changes to the property without getting permission.

Landlords should be friendly, warm and respectful to their tenants, but going to the beach with them or socializing at a restaurant or bar on a frequent basis is probably a bad idea, Mr. Timms says. “You do need to remember that this is, at all times, a business transaction.” 

Not keeping up with law changes

There are laws related to everything, from discrimination to the use of lead-based paint to when landlords can walk through the door of a property. But many lands don’t know the laws or keep up with how they change, and that can end up costing them big.

Ms. Politi in Oregon says failing to keep up with fair housing laws, for example, can lead to hefty fines. In one instance, she remembers when an applicant asked about a service animal living in the unit, and the landlord said he didn’t take pet and hung up. The applicant filed a complaint, and the landlord was investigated and slapped with a $16,000 fine for refusing to consider an assistance animal. “You’ve got know your individual state’s laws because they’re different in every state,” she says. “Some are easy, some are tough. What’s more, some cities have additional rules that overlay state law.

Source: Wall Street Journal