Easy Money: Becoming a Landlord

1-2-3’s of Becoming a Landlord

Okay, so you have decided you want to rent out your house. Welcome to the world of the land lord. Allow me to help you avoid a couple of the most common pitfalls.

• Don’t rent at a negative cashflow. This may sound like one of those “well duh!” statements, but do you really know how much rent you need to have a positive cashflow? If you said, enough to pay the mortgage – Congratulations you just flunked the exam.
  
  To get a positive cash flow, you have to add up your expenses and your debt payments and the amount you need to set aside for reserves and get more than all that in rent.

Expenses: These are the ordinary costs you have as a landlord such as marketing, insurance, taxes, utility bills, pest control, landscaping, postage, travel, and repairs. These happen on a monthly basis.

Debt Payments: This is the payments you make on the mortgage, principal and interest payments to the lender.

Reserves: This is the money you need to set aside to cover unexpected repairs and other expenses that won’t be covered when the property is not rented out (vacancy expenses). These include mortgage payments (when there is no rental income), costs to paint and put in new carpet or vinyl, a new roof, or a new heater or air conditioner, a broken toilet, or to repair termite damage.

Reserves are the first place most people go wrong when renting out a house; they don’t think about reserves.

If you can add up the rent, subtract expenses, reserves, and debt payments and still have money left over, that is positive cash flow. If you subtract out all those numbers and you end up with a negative result, you have negative cash flow. Negative cash flow is not what you want with rental property.

• Always, always, always, do a background check and financially qualify your prospective tenants. If you rent long enough, it is inevitable that you will eventually have a bad tenant. You can put that off a long time by having good management practices such as background checks, a tight lease, and qualifying your tenants financially.
  

I always check to make sure my tenants don’t have a history of drug crimes, sex crimes or violent crimes. I make sure tenants have a gross household income that is at least three times more than the monthly rent. All prospective tenants have to complete a rental application with a non-refundable application fee. If they won’t pay the fee, they aren’t going to pay the rent.

You can do a lot more in a background check if you want, looking at credit scores, evictions, etc. I don’t, because it isn’t worth all the extra trouble to avoid the few deadbeats that I might eliminate.

• Know your rights and know the tenant’s rights. Make sure your lease is very tight and grants you all the rights you have under the law. On top of that, study the rental laws so that you don’t accidentally violate tenant rights and get yourself on the wrong side of a lawsuit. Your tenants will sue you if they think they can win, and there are a lot of ways you can violate their rights without meaning to. Knowing the law on these points will also allow you to set up systems to quickly and effectively deal with tenants who fail to pay their rent.
  

I know this post seems a bit negative about renting. There are many downsides of being a landlord. You will get late night calls and weekend calls. You will make appointments to show your place and have the confirmed appointment fail to show up. You will have tenants tear up your unit, forcing you make costly repairs.

However, you will also get some great tax breaks and can even get a tax loss while enjoying a positive cash flow (thanks to the magic of depreciation). You can also have the satisfaction of providing people with a decent home at an affordable price and helping them along their way to economic freedom.

The beauty of having a residual cash flow from a rental property, having someone else pay down your mortgage for you, and having tax write offs that decrease your taxable income are wonderful things. To enjoy them, you must be willing to pay the price.

I don’t mind the troubles of being a landlord. I find the rewards are sufficient to offset the risks. But, think about both before you take the plunge.

Tom ~

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