THINKING OF BECOMING A LANDLORD? The appeal is clear. What could be easier than collecting rent and using it to pay off your mortgage, all the while enjoying some serious tax benefits and property appreciation?
But while renting out a property has its perks, there are also many legal and logistical hurdles. "You can put your stock certificate in your drawer and there's pretty much nothing you can do to make it grow or increase the rate at which it grows," says Janet Portman, an attorney and co-author of the book "Every Landlord's Legal Guide." "But if you buy real estate, whether it's going to end up being a good decision is substantially up to you. There's a lot of work involved in being a landlord, and if you don't do it right, you can end up losing money."
Here's a quick run-down of what every landlord needs to know.
1. Run Your Property Like a Business
You may already have a nine-to-five job. But if you're planning on becoming a landlord, expect your hours to jump to 24-7. Here are the steps that all new landlords should take.
Know the Rules
Getting your business off the ground will involve some paperwork. Some states require that you get a business license for your property in order to rent it out, says Melissa Prandi, author of "The Unofficial Guide to Managing Rental Property" and owner of Prandi Property Management. She recommends that first-time landlords consult with a real estate attorney and a certified public accountant (CPA) before getting started. A CPA can help you figure out how much rent you should charge in order to make your business profitable, while an attorney can be priceless as you learn the intricacies of the fair housing laws. (More on these later.)
Second, says Prandi, take care of the "technicalities" of running your business: Open a bank account for the property and run all bills and rental income through that account. This will simplify your paperwork come tax time. Small extras like business cards will let your tenants know that you're an accessible and reliable landlord.
Find Reliable Tenants
Finding tenants should be the most time-consuming part of your business. Where landlords get into trouble, especially new ones, is that they rent to friends, relatives or people who they feel would be good tenants.
Instead, think of finding a tenant as hiring them into the family business: Check their references (speak with their previous landlords), pull their credit report and consider running a background check. The National Tenant Network and Registry SafeRent sell credit reports from the three major credit bureaus (Experian, Equifax and TransUnion), as well as more in-depth tenant reports including an eviction judgment check, a criminal report, and verification of employment and landlord references.
Toni Midea, an engineer in Cleveland who owned and managed 10 rental properties with his wife for more than 10 years before he quit the business, learned the hard way that being a sympathetic landlord doesn't work. He wrote about some of his most frustrating experiences in his book "A Fool's Guide to Landlording." He writes: "If you're a tough person, very strong-willed and willing to evict people, you'll be fine," he says. "If you're compassionate and buy into [your tenants'] stories...they read that as a weakness. You have to be very business-oriented and not listen to people's sob stories. The bottom line is, 'you have to pay your rent, and that's your job, and my job is to collect it, and there are no in-betweens.'"
Landlording is dirty work. You'll have to get used to Sunday-morning (or worse) calls from tenants complaining of broken pipes, clogged bathtubs, exposed electric wires and other common maintenance problems.
And yet, deciding not to maintain your property can be a costly mistake. If the unit becomes unfit for living, Portman explains, a tenant has the right to stop paying rent.
But you should also be aware of your rights as a landlord. "Normal wear and tear is something you have to pay for," Portman says. "But you shouldn't have to pay for deliberate or extremely negligent damage." (If the toilet clogged because the tenants flushed a diaper, for example, it's their responsibility.) For more details, check out NOLO's "Every Landlord's Legal Guide."
2. Be Profit-Realistic
Robert Griswold, owner of Griswold Real Estate Management and author of "Real Estate Investing for Dummies," recommends that landlords project receiving 11 months of rental income per year rather than a full 12 months, factoring in a likely loss of income from vacancy or delinquent rent. Couple that with repair expenses, and worst-case scenario you might come out with a loss (meaning your expenses and mortgage payments exceed what you collected in rent) at the end of the year.
Midea experienced this firsthand. "There were years when we had $20,000 to $30,000 in losses, just from fixing up damage that was done to the property and going through the eviction process," he says. "And that was all work being done while I had a regular job, so I had to take days off work."
3. Know the Law
Housing laws are like nesting dolls, Portman explains. First, there are federal housing laws that apply to everybody. On top of these, each state applies its own housing laws that are at least as protective and often more protective of tenants than federal law. And some cities have laws that are more protective than state laws. It's imperative you know the laws that apply to your region. Here are some of the most common pitfalls landlords encounter:
Make sure you have legal reasons to reject an applicant, or you risk getting sued for discrimination. For example, you can't reject an applicant solely on the basis of his or her race, color, religion, national origin, family status, gender, disability or handicap. You are allowed to refuse renting to tenants with pets or applicants who have previous bankruptcy filings, insufficient income, or lack positive references from previous landlords.
Steering is encouraging a potential tenant to take one apartment over another. Landlords sometimes entirely innocently end up breaking this law and get slammed for it, says Portman. "A landlord who says to a single mother with a teenage daughter, 'You should take the upstairs unit or the unit in the back': that's called steering and it's illegal," she says. "The landlord may have had the best of intentions, but under federal and state law, he has to allow the tenant to choose the unit they want among those that are available."
The most common type of case handled in small claims court is a landlord-tenant dispute over a security deposit, says Portman. And if the court proves that you have misused the deposit, you might end up paying punitive damages that are two or three times the amount of the deposit.
Some things to keep in mind: Certain states limit the amount of the deposit you can collect or require you to hold it in a separate account that accrues interest. Generally, landlords can use the deposit for unpaid rent and repairs that are beyond normal wear and tear, but there may be additional state-specific limitations. Many states require the landlord to provide an itemized statement of how the deposit has been used. In California, you even have to provide copies of the receipts.
4. Insuring the Property
Whether you rent out a single-family home to one tenant or an entire building with dozens of apartments, you need separate homeowners insurance for your rental properties. And be ready to reach deeply into your pockets.
Whenever you're renting to a lot of people, you're going to be paying more money because you're exposing that home to more risk. If you're renting out a single-family home or a portion of your own home, you could do with a special rider to your existing homeowners policy, but you'll need a separate policy for larger properties.
In today's litigious climate, make sure you have enough liability coverage. If your tenant's dog bites your neighbor's child, they're most likely to go after the tenant, but if there's some negligence on your part let's say the fence wasn't high enough they may go after you.
5. Get Professional Help
Property-management companies basically do the grunt work for you. They market the property, maintain it, screen tenants, collect rent, pay the bills, prepare financial statements for you and keep up with the fair housing laws. All that, of course, comes at a price: Management company fees range from 6% to 10% of the rental income, according to Prandi.
But in certain situations, a property manager can be a lifesaver. If you're an absentee landlord (meaning you live far from the rental property), for example, you may need a management company to run your business. You might also be better off with professional help if you aren't especially handy or if you find that being a landlord is taking you away from your job or personal life.
To find a reputable property manager, go to the National Association of Residential Property Managers and use their Property Manager search tool.