Do you dream of owning property? Perhaps multiple investment properties from which to earn a monthly stream of income? Ah, the life…
But before you contact your real estate agent, consider what’s really involved. If you want to create an income immediately, you’ll need to rent your property. Though the proposition may sound simple, it is anything but. The information that follows details the downsides to property management.
It’s not meant to dissuade you from moving forward, but instead to show you that there are downsides as well as advantages to buying and managing rental property. Don’t let the potential to earn money cloud your vision when considering whether or not you’re cut out for it.
Issues with Becoming a Landlord
1. Start Up Capital
All potential landlords consider the cost of purchasing an investment property, but many overlook the costs to remodel. In other words, don’t expect start-up costs to end at the closing.
If you buy a damaged or out-of-date home, you could spend a significant amount to make it “rentable.” Any damage to the foundation, plumbing, or wiring can cost thousands of dollars to repair. But even if you buy a property in good condition, you may still have to make changes to get it up to code. This is because many states have strict requirements for rental properties that will need to be met before you start renting.
In addition to remodeling, being in compliance with these standards can significantly increase start-up costs. For example, let’s say you purchase a recently built duplex that was previously owner-occupied. Your state’s landlord and tenant laws require that you add safety features to the property before you advertise for tenants. A breakdown of the required changes is as follows:
- Handrails installed along the front and back entrance: $1,300
- Front and back doors replaced with secured, reinforced steel doorways: $300
- Peep hole installed in front door: $50
- Deadbolt entry installed on front and back doors: $50
- Standard dividing wall replaced with a fire wall: $1,600
- Completed code inspection: $35
Total Cost: $3,335
2. Making Repairs
When it comes to being a landlord, two things in life are inevitable: death and repairs. Don’t even consider a property management business unless you’re sure that you can pay for repairs. Landlord and tenant laws require that you make serious repairs quickly. If you don’t, you could be held liable for additional damages.
The thing about repairs is they creep up on you suddenly and often cost a lot. For example, if your tenant calls at 11:30 pm at night to tell you the water heater has busted and is flooding the house, you have to immediately send an emergency repairman to shut off the water and dry out the carpet.
Since it’s after hours, he’ll charge you $100 an hour for each of the two hours he is there. On top of that, you’re informed that you need to replace the water heater. Since this is a repair that needs to happen as soon as possible, you head to Sears and buy the most reasonably priced water heater you see. Not only do you have to pay for delivery and installation, but Sears won’t haul away your old, broken water heater. Luckily, your repair guy offers to remove it as long as you pay him his hourly rate and cover the dump fees.
Here is the total cost for this single repair:
- Emergency repair (2 hours @ $100 per hour): $200
- Cost to purchase a new 50 gallon water heater: $599
- Cost of delivery and installation: $329 at Sears
- Cost of removal and haul-away of the old water heater (2 hours @ the standard rate of $50): $100 + $50 dump fee = $150
Total Cost: $1,278
Major problems aren’t the only issues you’ll have to account for. Some tenants will call you for everything. Be prepared to spend your free time changing light bulbs, replacing air filters, weeding yards, and spraying squeaky hinges.
3. Collecting Rent
You’ll have great tenants who pay the rent on time every month. You’ll have good tenants who slip up from time to time but always let you know ahead of time when to expect the rent. And then you’ll have the tenants that don’t pay and don’t call. As a landlord, you’re going to have to play bill collector from time to time.
Ask yourself if you’re comfortable confronting your tenants before you start renting. Keep in mind that you’ll have to make judgment calls as a landlord. For example, imagine you’ve had a tenant for six months and one month he doesn’t pay the rent. You don’t hear from him for a week. Finally, you decide to call and the tenant tells you he won’t be able to pay for another 7 days. You’ll have to make a choice to either let the tenant slide or to start the eviction process. Make sure you’re comfortable making this kind of decision and sticking to it.
4. Dealing with Problem Tenants
Most of your tenants will pay the rent, treat the property like their own, and keep the neighbors happy. But at some point, you’ll inevitably have a problem tenant.
As a property manager, I saw my fair share of problems. Once, I agreed to rent a property to three college students. By the second month, they stopped paying rent. My coworker and I went to the house to talk to them. When the door opened, I was greeted by a large pole coming out of the ground and extending to the ceiling. The tenants had installed a fireman’s pole in the house, complete with a hole in the first floor ceiling and a pile of concrete on the ground. The tenants promised to pay the rent and repair the damage from the pole. Not surprisingly, they didn’t.
The third month, I filed for an eviction. After the hearing, the tenants went back to the house and removed their stuff before the sheriff and I got there. When I went inside, I found graffiti on the wall, concrete in the toilets and sink, mold in the appliances, stains on the floors, and a bright, shiny fireman’s poll.
If you’re going to be a landlord, you’re going to have to handle tenants fighting with other tenants, tenants doing damage to your investment, and tenants who don’t pay. You’ll need to know the eviction laws in your state well, and be prepared to use them.
5. Surviving Evictions
Your state’s landlord and tenant laws make evictions seem pretty simple. To start one, you go to the local court, file a notice, schedule a court date, and show up on that date. The judge then tells the tenant to leave. The tenant heads straight back to your property, quickly packs up, and walks out the door. No harm, no foul, right?
In reality, evictions are often extremely costly and time consuming. Even if you evict your tenant successfully, you likely will have incurred major expenses and lost significant time in the process.
I’ve been through it before. Here’s an example scenario of how an eviction can work out:
- The tenant doesn’t pay his rent on the first.
- The fifth rolls around and the tenant still hasn’t paid, but you decide to wait five more days to try to avoid filing an eviction.
- The tenth comes and you still haven’t heard from the tenant. You go to the court, pay your fee (which ranges from $35 to $100 or more, depending on your state), and the court clerk tells you that the judge is backed up. They can’t schedule your hearing until next month.
- Once the court date rolls around, you’re out two months rent. The judge decides in your favor, but now you have to schedule a time with the sheriff to complete the eviction. That takes another five days.
- You show up with the sheriff on the 20th and find that the tenant left piles of stuff behind. According to the law in many states, you now have to rent a storage locker to hold the tenant’s belongings. That costs another $50. Now, if you were very lucky, you have a vacant apartment that needs cleaning and re-renting. Even at your luckiest, you’ll probably lose at least one month’s more rent while you look for a tenant. If you weren’t so lucky, the tenant caused some damages, which you will have to repair before you can rent the apartment again.
In the end, the break down looks something like this:
- 4 months lost rent at $750: $3,000
- Cost to file in court: $35
- Cost to rent storage: $50
- Cost to make repairs: $500
Total cost to evict the tenant: $3,585
6. Managing Your Finances
Landlords need to look at property management as a rotating door. Tenants come in, stay their lease, and then go. While some tenants will renew a lease, most will move on to the next place when the lease is through and leave you with an empty apartment.
In down times, the apartment could sit empty for several months. To be a successful landlord, you’ll need to learn to manage your finances in times of feast and famine. Some months, you’ll have full occupancy, rent paid on time, and no repairs. You’ll have to be dedicated enough to save and not spend during those months because during other months, you’ll experience vacancies, late rent, and major repairs.
A landlord’s finances do not stay constant. If you can learn to go with the flow, and plan for the unexpected, you just might survive.
7. Keeping Your Property Safe
If a tenant is injured on a property that you own, there is a good chance you’ll be sued. Sure, you have homeowners insurance, but you always have the duty to keep your property properly maintained and in good working order so as to avoid contributing to potential mishaps. By keeping your units safe, no matter what it takes, you greatly decrease your chance of trouble in this area.
In order to prevent problems, you’ll need to know the building and safety codes in your area and follow them by attending to regular maintenance and checking on your properties periodically. It may take a lot of work, but can save you a costly legal battle later on.
8. Paying Taxes
One thing you can’t overlook is taxes. Renting property is your business and so you’ll have to report the income you earn when you file your taxes every year. But one tax commonly overlooked is property tax. If you own the home you live in plus one rental house, your property tax bill could be double what you were paying before you purchased the rental. Make sure you understand the effect taxes will have on your bottom line and that you are prepared to pay them.
There are some ways in which taxes can work to a property owner’s advantage, particularly in a down housing market. Consider, for example, if you need to sell your home, but can’t recoup what you paid for it. If you sell it as your primary home, you can’t claim the loss on your taxes. However, if you turn it into a rental property first, you may be able to claim the loss as a business loss against any rental income received or your ordinary income. This can decrease your tax bill by thousands of dollars, especially if you claim a large loss and have a high income.
Buying rental properties is a great way to make money. Just remember that being a landlord is not all fun and games. You’ll work hard for your money and may be faced with adversity from time to time. Buying rental property is not for everyone. It should be an investment option you consider only once you’ve achieved a certain level of financial independence.
Not only can start-up and ongoing repair costs be significant, but you’ll want to invest a substantial down payment in order to get the best loan terms and minimize your monthly mortgage payment. That said, be aware that in a down housing market, you could lose money on your investment and become upside down on your mortgage. Still, buying rental properties can be a great way to supplement your income, or even replace your current one.