Managing Income Property: A Plan for Success
The phases of ownership for a real estate investor are:
Acquisition/ Management/ Disposition
Although understanding the techniques of buying, selling, and creative financing are exciting, the key to success as a real estate investor lies in your ability to effectively and profitably manage the real property asset. This is a skill, which is often overlooked by the novice investor. Often, a poorly acquired property can turn into a "jewel" because the investor is an astute property manager. Also, a "jewel" of an investment can turn into a "dog", and even worse, an "alligator" if your property management skills are lacking.
Remember that "nothing down" does not always mean "no money down". For you, it may mean none of YOUR money down. Often what you will provide to the "money" investors is your expertise, not only in the acquisition and disposition but also in the property management. This is a necessary part of income property investing which if not handled by the owner, would be hired out to a professional. If you can provide this skill to your investment group, you are actually providing indirect $$$ to the investment. It is your "Sweat Equity."
Managing a property is like managing a business. To do it right you must have a plan, and you must execute your plan. Each property you manage, each new tenant you meet will teach you more about the business of property management. Remember that you will never know "all there is to know" about property management. Like everything in real estate, there is always more to learn. The more you read and study, the better off you will be. Landlord-tenant law and contract law varies from state to state. A good source of information on the subject will be your local Apartment Association and your local Association of REALTORS. This is where you earn your keep as an investor. It can make you or break you.
I. Establishing the Rental Schedule
What will your unit command on the open market? Can you get more if the property is in better condition? What would it cost to put it in better condition? When was the rent last raised? Is there a shortage or abundance of competitive properties on the rental market? What are your competitors doing to rent their properties? The answers to these questions and more are required to manage your property effectively.
Remember that the value of an income property is directly related to the income the property produces. Owning and managing a rental property is like running a business. You must maximize income and minimize expenses. Keeping up with the rental market and keeping your unit rented is imperative. You don't, however, want to rent to just anyone. The poorly selected tenant can cause you the great legal expense and even dampen your enthusiasm for owning real estate!
So how do you establish market rents? It's easy. You call on available rental properties, comparing yours to the competition. You see, it all boils down to the law of supply and demand. Points of comparison are:1. Size
a. number of bedrooms and baths.
a. appliances - which ones?
c. carpets, drapes, etc.
3. Who pays utilities?
a. gas and electric
4. Length of tenancy -- that which is most desirable depends on your market
a. month to month
b. lease for 6 months to a year
How do you find out all this information? You call and ask. Actually, you should have had a pretty good idea before you purchased the property. Fair market rent changes depending on market conditions. You must keep up with the market, increasing rents as appropriate.
II. Marketing - Advertising
How are you going to cost effectively get the word out to prospective tenants?
1. The most effective means of advertising a rental property is a sign, located to achieve maximum exposure to the walking or riding public. It should be easy to read, a number of bedrooms and baths and a phone number is all that is required.
2. Community bulletin boards are free and often effective in advertising your rental. They should be neatly prepared and placed in grocery stores, laundromats, department stores, hospitals, etc. Be sure to get permission before placing the notice.
3. Personnel departments of large companies may be appropriate. Many large companies and military organizations have departments which seek out housing for newly arriving personnel. You should find out which individual in the organization is tasked with the responsibility of assisting new arrivals and send them a resume of your rental, reviewing what is being offered and how much you are asking. Also, include a picture.
4. Resident managers of nearby apartment buildings can be helpful. Establish rapport with several and always let them know when you have a vacancy coming up. May be you can offer them a monetary incentive for referrals. Before you offer any money, check local laws and customs.
5. Newspaper classified advertising is expensive if not done correctly. The categories are usually furnished and unfurnished, with the lowest priced rent being at the head of the column. You will pay by the line so be brief yet descriptive. Be sure to list the address and your phone number. If you are not at home to take calls, invest in an answering machine. Weekends and close to the beginning of the month are usually the best time to advertise. If you have just replaced the carpets, say so. Anything which makes your unit stand out from the competition should be mentioned. If you accept pets, state such. Many owners do not allow their tenants to keep animals.
6. Hotel and motel managers have contact with new arrivals to the area. Distribute information to a network you establish.
Now that the word is out, how do you handle calls and show the unit?
When a prospect calls, be pleasant and also alert. This gives you a chance to gather information about the tenant and also lets you "sell" the unit to the tenant. Speak clearly and distinctly. Be courteous and establish rapport. Make sure you get their name, determine if they have the financial means to rent the property (this includes an appropriate security deposit) and be ready to give directions to the property from almost any location.
Give the EASIEST way, which is not necessarily the shortest way or the way you go. If possible, route them past points of interest, shopping centers, schools, churches, recreational areas, parks, major transportation routes and the like. Mention the amenities, but be careful not to oversell. If you build it up too much, they may be disappointed when the get there. Always try to make an appointment to show and try not to do it at night. It may even be a good idea to have someone go with you if you must show it in the evening. If the power is off, schedule the showing for the next day.
The property should have "curb appeal". There should be no deferred maintenance on the front of the building. Keep the driveways, patios, and walkways clean. Take care of the landscaping. If you take care of the property, there is a good chance that the tenant will also take care of the property. Make sure it smells fresh and clean, if you need to use a room deodorizer or spray, use it.
III. Tenant Selection
This is a skill, and like all skills, you will improve with practice. Be wary of prospective tenants who must move in "right away". Always take the time to check references; business, personal, and previous landlord. If possible, go see where they are currently living. Always have them fill out the rental application and keep it on file. You should charge the applicant a minimum fee($25.00) for the application process. This is a non-refundable fee to compensate you for your time and the expense of running a credit check (check appropriate state law). Proper tenant selection is the key to your success in the managing of your property.
Once you make the tenant selection, it's time for the walk through inspection, prior to occupancy. Do a thorough inspection with the tenant, using a form similar to the one provided here. You may even want to take digital pictures of the property as further proof of the condition of the property when you turn possession over to the tenant.
Select the proper rental agreement (the law of contracts will vary from state to state) and make sure the tenant signs before you give them the keys. Another recommended form is a set of "House Rules and Regulations". Check with your local Apartment Association or Board of REALTORS for forms tailored for your state.
IV. Maintenance and Repairs
Costs of maintenance will vary from location to location and in large part depends on the age of the building and the degree of repair maintained by the previous owner. This should have been an important part of your analysis before you purchased the property. You accomplish this by making your purchase "contingent upon" your inspection of the last two years operating statements. This will tell you if a new roof has been installed; if a new water heater has been installed; new carpets, drapes, plumbing repair, etc.
Maintenance can be divided into two categories:
1. Preventive Maintenance -- This is minor periodic maintenance which can reduce future maintenance and repair costs. Items can actually be placed on a maintenance schedule.
2. Corrective Maintenance -- This is usually comprised of general repairs on an as needed basis.
Unless you are a handyman, you will probably utilize the services of outside vendors such as electricians, plumbers, carpenters, painters, appliance repairman, carpet cleaners, lock smiths, landscapers, etc. Be sure to check the employment and workers compensation laws in your state. You do not want to be responsible for the future support of a vendor who was injured on your property.
Service people should enter the property only at the direction of the owner, with approval and proper notification of the tenant (see sample form "notice of intention to enter") . They should always knock before entering and deal only with the job sent to do unless instructed by you to look at what additional work could be done.
If possible, you should construct maintenance diagrams of the property. This would include locations of all switches,circuit breakers, timers, and shut off valves (both city side and property side).
Tenants should be instructed in the proper use of garbage disposal (show them how to clear jams). Dishwashers should be maintained by trained service people. Heaters or furnaces should be checked periodically (possibly by placing on preventive maintenance schedule). Caulking around tubs, showers, sinks, and toilets is necessary to protect against mold, dry rot, and general deterioration due to water leakage.
V. Record Keeping and Tax Benefits
Owning and managing rental property is like running a business, and, like running a business, you must keep accurate records. The records will not only assist you in effectively managing the property, but will also be the documentation necessary for justifying the tax deductions you claim on the property.
Open a separate checking account for your income properties. Place all rent in this account and pay all property related bills from this account. You should maintain separate ledgers for each category of expense and record all expenses as you pay them (out of your property checking account).
The best guide for setting up records is the IRS tax form schedule E (see example). On this form you will see the various categories of expenses you will incur. The various types of records are:
1. Receipts for rent -- These should be made out whether or not tenant pays by cash or check, and whether or not they want it. Be sure and show the form of payment (cash, check, money order).
2. Receipts for Security Deposits -- Separate from rent receipts and indicate use of deposit.
3. Bank Deposit Slips
4. Credit Applications
5. Rental Agreements
6. Rental Payment History
7. Notices -- Thirty day, three day, etc.
VI. Leases and Rental Agreements
Your individual market and your specific needs will determine if you will rent your property month to month or for a definite period of time (six months, one year, etc). They both have their pluses and minuses. If you plan to turn the property any time soon, you probably do not want an extended lease. A written agreement is always preferable to an oral one. The problem with oral agreements is that they are difficult to prove should you end up in court.
Rental agreements should be clear and unambiguous. They should spell out the understanding between the landlord and the tenant. This will serve to reduce false claims by the parties at some later point in time. The requirements to create a legal tenancy will vary from state to state, but will usually require the following elements:
1. Identification of the parties -- All adult tenants
2. Intention to establish tenancy
3. Description of the property
4. Term of tenancy
5. Rental amount
6. Furnishings and fixtures should be identified. An inventory can be made a part of the rental agreement. It should also be signed by the tenant.
7. Condition of the premises should be noted and signed by the tenant.
9. Maximum number of occupants
11. Tenant will make no alteration without permission of the landlord.
12. No subletting without permission
13. Owners right of access
14. Repossession in case of abandonment
15. Signature of the tenants and date
Check with your local Board of REALTORS or Apartment Association for forms designed specially to meet the legal requirements of your state (see examples). Some form contracts contain unenforceable provisions. Even if a tenant signs such an agreement, the landlord who attempts to enforce such provisions against the tenant may still be held liable.
VII. Landlord-Tenant Relations
Good tenants are a landlords most precious asset. They help you pay for the property! Treat your tenants with respect and insist on the same treatment from them towards you. A good relationship with the tenant will mean $$$ in your pocket beyond the rent they pay.
Due to inflation, rental increases are a certainty over time, and this will increase the value of your property. Adjustments should be made whenever the market permits. "Nuisance" rental increases are intended to test the market and will seldom result in a vacancy. They are usually less than $20.00 per month. Notice to increase rent will usually have to be done in advance in accordance with state law. That period may be the rent paying period and must usually be done in writing.
Security deposit limitations will vary from state to state and are usually NOT "nonrefundable". When tenant vacates premises, the landlord must return the unused portion of the security deposit within a specified period of time. Some states impose penalties for not returning the tenants deposit in a timely manner.
Termination of Tenancy -- Usually a notice must be given by the party wishing to end the tenancy.
Eviction -- If the landlord wants to end the tenancy but the tenant does not want to move, the proper procedure is an eviction and the procedure is very specific. Do not shut off the utilities or lock the tenant out as this is a violation of the law in most state. The process of the eviction must be strictly adhered to.
Discrimination due to race, color, creed, sex, national origin, and ancestry is illegal. In some states it is illegal to discriminate because of age and sexual preference. You must be very conscious of the laws in your locale and use objective tenant screening procedures. Federal law makes the landlord liable even for unintentional acts of discrimination.
VIII. Owners’ Goals
You buy income property for three reasons. They are income, appreciation, and tax benefits.
1. Income -- You purchase income property to obtain the rights to the future income stream of the property. There are three important factors when analyzing income stream.
A. Quantity -- The amount collected
B. Quality -- The financial stability of the tenant.
C. Durability -- Term of Tenancy
2. Appreciation -- For single family or condos, the appreciation is based on the speculation that some one will want to own the property as a home. On multi-unit, the value is directly related to the income stream, used expressed by two formulas.
A. Value = Gross Scheduled Income X Gross Multiplier: This is a rule of thumb method and should not be relied upon without examining other data.
B. Income (net income) = Rate (capitalization rate) X Value:
This is a more sophisticated method based on net income (before debt service) and a capitalization rate, which is a return on investment (yield) and a return of investment (accrual for future depreciation)
C. Tax Benefits - Up to $25,000.00 in passive losses as long as investor earns less than $100,000.00 modified adjusted gross income per year. Deduction is phased out between $100,000.00 and $150,000.00. Unused losses are suspended and can be used in future years. Deductions which make up these losses are any expenses incurred in the operation of the property, whether or not property is producing income at the time of the expense. They include:
2) maintenance and repairs
3) property taxes
5) insurance - make sure you are adequately insured
6) depreciation (theoretical)
Less obvious goals and objectives of owning property are diversification, pride of ownership, and a sense of security. Some owners want to spread the risk and this can be accomplished through diversification of investments (but remember, real estate is the only "wealth creating" investment" all others are "wealth sustaining" investments). Pride of ownership is not measured in financial terms, but is nonetheless important to many owners. Pride in a beautiful building and well kept grounds satisfies a psychological need, which for some, is just as important as money. Owning real estate provides security. The history of the country and its growth was based on the desire for land. It is universally accepted that land ownership is the primary source of stability and wealth.
IX. Investment Property Types
All types of real estate must be managed. No property manages itself. The intensity of management depends upon the type of property.
1. Single Family and Condominiums -- These are not usually considered very efficient as income or cash flow producers (depending upon location and market) for reasons before stated.
2. Duplex, Triplex, and Fourplex -- These are especially popular as a beginning real estate investment. An advantage is that under many conditions a buyer can occupy one of the units and qualify for an owner occupied loan, which usually allows for less down payment and a lower interest rate.
3. Multi-Unit Residential Investment Property -- Usually 5 or more units. If the property is less than 8 units, it will have difficulty supporting a resident manager or professional management company.
4. Office Buildings -- These are very popular investments as they have the advantage of longer term, more reliable, stable tenants. They involve a specialized type of management.
5. Shopping Centers - Their operation is similar to office buildings and usually provide excellent investment opportunities superior to residential, with correspondingly higher risk.
6. Hotels and Motels -- Specialized management is required. They are more "business" intensive than other forms of real estate, providing more services to the tenant. Often times, a major portion of the income will be from sources other than rent such as restaurants, bars, etc.
7. Mixed Use Projects -- A combination of commercial (usually on the ground floor) and residential (on the upper stories). This type of property is becoming more popular in revitalized and redeveloped areas.
X. Types of Insurance
Adequate insurance is a must. The types of coverage are:
1. Real and Personal Property -- This will usually cover casualties such as fire, Theft, vandalism, equipment failure damage (such as plumbing) but will not pay to replace the equipment. Accidental damage such as a tree falling on the property may be covered.
2. People -- Covers injuries to anyone on the property such a tenants, vendors, visitors, etc.
3. Liability -- Covers owner in the event of lawsuits and resulting judgments.
4. Loss of Income -- In the event the property becomes uninhabitable due to fire, water, or other cause, you will not be able to rent the property. This coverage will cover your income loss to a specified amount.
Tenants are not covered under the owner's insurance and it should pointed out to the tenant in writing that they should obtain their own insurance to cover their family and their belongings.
XI. Operational Plan
You must have a plan over the holding period of the property.
What is the anticipated gross income? How much vacancy do you expect? Will the expenses like taxes and insurance increase? Do you expect any major repairs or improvements? If an unbudgeted item appears, do you have a contingency plan to come up with the money required? These questions and more must be considered as you budget and plan for your properties each year.
XII. Resident Managers
In some states a resident manager is required when your building is of a certain number of units. Unless you plan to live in the property, you will have to hire a resident manager. Compensating them can be tricky and may involve the states labor code as well as the real estate law. Be well versed in local laws.
If all of this sounds like a lot of work, it is! But the more you know, the more expertise you have and the more organized you are, the easier and more profitable it will be.
(Saul Klein is CEO of Real Estate Electronic Publishing Company, home of RealTown.)
Negotiating Tip 114: Retreat Negotiations
March 29, 2019
Negotiating Tip 113: Activating Our Opponent
March 28, 2019
Negotiating Tip 112: Misconceptions
March 27, 2019