Here are two fallacies that often strike new real estate investors.   The first one bugs me only a little – the second one bugs me a lot. 

The first fallacy is the one peddled by late-night infomercial stars.  It’s the idea that it’s really not that difficult to find an old house, buy it for much less than it’s worth with no money down, and sell it for big bucks.   It’s true that some deals of this sort do happen, but they’re very rare.  If you start your real estate career thinking you’re going to get 50 deals like this on the way to that new Bentley, you’re actually on a fast track to disappointment.  (And if you really have done 50 deals like this – and have documentation, and don’t charge $1 million for people to see it – call me!)

The second fallacy is much more insidious and hits people who are much too smart to be fooled by the first one.  I’ll call it the Every Dog has its Day fallacy.  This means that any property you buy, no matter how big a loser, will eventually make money for the owner.  This view is underscored by two other views, both also erroneous:

1. All real estate rises in value over time.
2. When you own rental property, your rents go up over time, while your expenses stay the same.

We know in our hearts that this assumption is wrong, but still fall for projections that show it.

It’s certainly true that most real estate rises in value over time.  However, that’s not true everywhere.  I’ll give you two examples: Detroit, Michigan, and Buffalo, New York.  Right now in Buffalo, there are almost 800 houses listed for sale for $50,000 or less.  45 of those are listed for less than $10,000. 

 Why do you think Buffalo might have these wonderful deals?  It’s because Buffalo has been one of America’s fastest shrinking cities over the last 50 years.  The population is less than half of what it was at Buffalo’s peak in 1950.  This, coupled with the reason for the decline (there are no jobs to be found), has resulted in a huge drop in real estate values over decades.  Almost anyone who put their money in Buffalo over that time lost much of it.  By the way, this also means Buffalo rents dropped over the past few decades, so those Buffalo investors lost money every year on their way to eventually selling at a loss.

Detroit is in a similar way, with 6,900 homes for sale for $50,000 or less; 3,200 for less than $10,000; and a population less than half what it was in 1950.  Detroit’s motto, translated from Latin, is “We Hope For Better Things; It Shall Rise From the Ashes.”  I sure hope they are right!

This extraordinary hovel can be yours for $100 in Detroit.  Make an offer!

Thankfully, there are few true disasters like Detroit and Buffalo around the United States, although there are many cities where prices have risen only a little, stagnated, or dropped even before the real estate and mortgage crashes.  Even elsewhere, however, you might lose money over time because of the “expenses never go up” assumption.

 Suppose you buy a property for $100,000, with rents of $1100 per month.  Your expenses are as follows:

·         Monthly mortgage payment: $480

·         Insurance: $75

·         Taxes: $200

·         Allowance for maintenance: $100 (0.1% of purchase price)

·         Allowance for vacancies: $55 (5% of rent – assumes a 5% vacancy rate)

·         Utilities: $100

·         Legal, accounting, mileage and so on: $50

Obviously these numbers are going to vary widely for different properties.  It’s worth noting, however, that poorer communities usually have relatively high property tax rates.  They have to provide the same services as wealthy towns but with smaller tax bases.

For this example, however, your monthly expenses are $1060, which means you’re making a profit!  Congratulations!  It’s a very small profit, but should be much higher a few years from now because according to the second assumption, your rents are going to rise, and your expenses will stay the same.  Five years from now, your rents will be more like $1300, which means you’ll be making $240 per month in positive cash flow, which is excellent.  And, of course, you’re building equity.

So many new investors fall for this.  The truth is that every one of those expenses is going to go up except for the mortgage payment (assuming a fixed rate loan).  If they go up by more than about 9% per year, your monthly profit will decrease, even with inflation in rents.  And that can certainly happen.  In particular, property taxes, utilities (mostly heat and water/sewer, the two utilities most often covered by landlords), and insurance have all risen by 10% or more in many communities over the last five years.

The pinch will be even greater in communities experiencing rent stagnation or deflation.  If your rents stay the same and expenses go up even a little, your profit will fade and disappear.

That equity growth that was going to save your bacon?  That won’t happen, either.  If your monthly cash flow stays the same or decreases over a five-year period, your property will be worth about the same, or even a little less, at the end of that time.  Yes, you’ll have added a bit of equity through the principal portion of your mortgage payment, but not enough to make a major difference.

None of this is intended to turn you off real estate investing.  Many thousands of people have done very well with their property investments – yes, even some in Detroit and Buffalo.  They avoided losses by being very, very careful about where they bought.  They looked for towns and states that were growing, particularly in employment, a leading indicator for housing growth.  They avoided towns with a history of high property tax increases.  They looked for houses in neighborhoods where people wanted to live.  And, they sought out properties where they could reduce expenses by taking responsible steps to lower maintenance, utility and insurance costs.

Finally, they made sure they could sell on their terms by making sure they had enough cash to handle emergencies and daily living.

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Tags: equity, housing, inflation, landlord, rental-property, stagflation, tenant

These nice ladies want to share a new apartment –>

This is different than the situation I described in my last blog post. That covered an existing tenant wanting to add a roommate to share the rent. And, of course, you will have situations when an existing tenant wants to add a roommate for romantic or family reasons. Both of those obviously present different issues.

However, roommate situations from the beginning of a lease present plenty of challenges of their own. You can avoid some of them by setting clear rules and having an appropriate legal arrangement. You will also do better with certain kinds of roommates than others. Note here that I’m not talking about married tenants who obviously (unless they are separated) will be sharing the apartment.

But generally, the best roommates will be those who have lived together before. These folks already know each other really well, and are unlikely to discover unpleasant things about each other that make one of the roomies move out early.

I don’t think you should spend any time at all figuring out how the roommates are going to share the apartment. For example, you don’t really care who uses which bedroom or how they figure out long distance charges. There are excellent Roommate Agreements, arranged strictly between the roommates, which they can find on the Internet.

The simplest arrangement might actually be to get a completely separate lease, with separate payments due, for each of the roommates. In this case, you are treating each roommate as a separate tenant.

One problem with this is that the tenants may earn very different incomes, so that one can afford all or half of the apartment, and the other cannot. Frankly, however, such disparities make for very temporary roommates. Unless they are in a romantic or family relationship, when one roommate depends on another for support, the arrangement almost never lasts.

Another problem is that if one of the tenants moves out, the remaining tenant or tenants still have valid leases. Suppose you have two separate leases, each calling for $450 per month. One of the roommate/tenants moves out. Now you are getting $450 per month, total, for a unit that should bring in $900. And you probably can’t do anything about it.

A better bet, I think is to have one lease, signed by all parties, with one rent payment they are collectively and individually liable for. This means that if you have three people in a unit with a lease for $900 per month, it is up to them to come up with the $900.

Using the one-lease arrangement, the remaining roommates or roommate still owe you the full rent. Realistically in that situation, you’re probably going to give the remaining tenants a chance to find a new roommate. However, this is not something to stress before anybody signs a lease! You want the new tenants to believe they have a financial stake in getting along – that way they will treat the commitment more seriously. And, of course, you may want to evict remaining roommates if one of the original two or three breaks the lease – it may be an opportunity to find new, better, or just better paying tenants.

If you do allow the remaining tenant to find a new roommate, you have two options. One is to have a new lease supersede the old one, but with the new names. Cancel the old arrangement, and create a new one, only if the tenants’ do not owe any rent for the current or previous months under the old lease.

Tags: apartment, find roomate, housing, rent, renter, roomate, roommates, tenant

How are you going to handle this so that a) you have some control over the new tenant, b) you are financially protected, and c) you don’t have a lot of extra trouble?

You have four options. The first is to simply allow the additional tenant with no written agreement. Obviously, this is a big mistake. The second is to create a new lease that adds the second tenant (so that both sign the same document). I don’t recommend this because there it adds a lot of complications – who is responsible for which damages, are both equally liable for the rent, and so on.

The third is to put the roommate on an entirely separate lease, and create a new one for the original tenant – charging each (almost always) half of the total rent required. Now you have two completely separate tenants in one unit. The danger with that approach is that if one tenant bails, the first one is still a tenant in good standing, yet you’re only getting half the rent you need from your unit.

Here’s a fourth approach that I think is actually the best. Why not have the existing tenant create a separate arrangement with the new roommate? This is not a sub-lease, although it is similar. The new roommate has to follow your rules (as would any guest staying at the apartment). The legal arrangement is essentially an agreement between three parties; the new tenant, the original tenant and yourself. Key points:

1. The new tenant owes rent and security deposit to the existing tenant, not you
2. The initial term of the arrangement must end at or before the initial term of your lease arrangement with the original tenant
3. The arrangement is null and void and the new tenant has no right to the apartment if the original tenant moves out for any reason
4. The new tenant must follow all the “behavioral” rules established by you in the original arrangement.
5. The new tenant must pass whatever background checks you applied to the first tenant.

There is one legal problem with an arrangement like this. Since the new tenant owes rent to the original tenant, and nothing to you, any agreement between you and this new tenant may not be binding. Generally contracts require consideration to be valid and there is no consideration in your arrangement with the new tenant. Therefore, it makes more sense to create two separate arrangements. The first is between you and the existing tenant, and specifies his obligations in consideration of being able to bring in a roommate. He has to enforce certain rules (the same rules you enforce for him). He can’t sign an agreement with the roommate unless you have approved it (in reality, you will draft it). He can’t bring in a specific roommate without your approval.

Having made such an arrangement with the existing tenant, you can now let him and the new roommate make their own arrangement, previously reviewed by you. The advantage to this system? You get all the rent you are owed without responsibility for a second tenant, and the original tenant gets to keep his place. It’s a win-win.

Obviously you will need to check your local laws to make sure this arrangement is legal.

The new roommate’s obligations are entirely to the original tenant. So if the new guy screws up, it’s up to your original tenant to fix it. He has an obligation to you to do so. For example, suppose the new roommate doesn’t pay the rent owed to the original tenant. It is up to the original tenant to evict him.

It gets more painful if the original tenant doesn’t meet his obligations. Suppose the rent on the apartment is $800. The new roommate faithfully pays his share – say $400 – and the original tenant goes out and blows it all at the track. Now the new tenant is in trouble, because he doesn’t have an arrangement with you, and the original tenant is about to get evicted. That will trigger an eviction of the new roommate according to your arrangement.

That stinks for the roommate, but it’s not your problem. It is up to the original tenant and the roommate to work out.

I’ll be curious to read any comments and suggestions on this idea. My next blog post will cover situations where roommates want to take an apartment together.

Tags: landlord, lease, roomate, tenant

If your in the market to buy a rental, knowing the expected rental rates should be part of your due diligence.   The following will help you find the average property rental price in your area.

1. Read your local newspapers. As you read through the classified adds, make sure you are comparing apples to apples.  Homes with swimming pools and 4 bedrooms is not the same as a one bedroom studio.
2. Consult your Realtor.  Hopefully your real estate team has working knowledge of rentals and can utilize the MLS to help narrow down the rental price range.  Be sure and ask for documentation of their comparable.  Use your advisors to help gather information and to give you feedback, do not rely on them to make your decisions.
3. Go online.  Most metro areas now have online classifieds like craigslist.  This along with other sites can give you great information.  Go google…
4. Go drive around.  As I drive to and from work I notice a number of rental signs.  If you have a location or area targeted, or you just bought a rental, beat the street.  You can learn a lot just by calling your competition.

Remember that rents collected is an important part of cash flow.

Tags: determining rents, landlord, market rent, rents, tenant

This post is really for snow-belt landlords.  Here in New Hampshire, snow season can start as early as November and continue into May.  Unless you are renting SFRs, or have some other arrangement where the tenant is responsible for outdoor care, it is up to you to take care of the snow and ice on driveways and parking lots.

It helps to look at snow removal through the tenant’s eyes.  This is one of the areas where they absolutely depend on you.  After all, suppose there’s a big storm and you don’t take care of the snow.  Now the tenants can’t get out of the lot, which means they can’t get to work… or to their appointments.  Depending on the timing of the snow and their schedules, your bad snow removal efforts might mean they can’t get into the property.

Could you also invite tenant lawsuits through a bad snow removal effort?  After some brief research on the Internet, it looks to me like you would win a lawsuit - which doesn’t mean you would avoid the huge hassle.  In any case, the biggest reason to provide effective snow removal is that it’s the right thing to do.

So how are you going to do it?  You basically have three options, each with advantages or disadvantages.

Option 1 - Do it Yourself

The number one advantage of doing your own snow removal is that you will do it.  The number one disadvantage is that, well, you have to do it.  Because they are your properties and your tenants, you can (presumably) be counted on to get the job done.  However, that also means you will be getting up early, driving through heavy weather, and arranging your personal schedule around the lives of your tenants.

You will obviously need a plow truck and a plow.  You must also learn how to do the job.  Plowing is not as simple as it looks!  I recommend the website www.snowplowing-contractors.com and the associated book.  The proprietor, Chuck Smith, is an encyclopedia of snowplowing.  He knows it the way Bill Belichick knows football.

Obviously d-i-y snow removal makes a lot more sense if you already have a truck and plow, if your properties are close together, if you live close to them, or if you already do some contracting that might extend to plowing for a fee.

Option 2 - Hire a Contractor

This is what most of us will do.  It’s by far the simplest solution.  Unfortunately, you may have to go through a couple of contractors before you find someone who will do the job to your (and the tenants’) satisfaction.  You can eliminate some of this pain by choosing carefully, making your expectations clear, and following up. 

You should never, ever hire a snow removal contractor more than one town away.  This is because snow conditions can vary greatly over just a couple of miles.  They can look out their window and see an inch on the ground, while six inches have fallen on your property.  Start your search by asking other local landlords (ask at your landlords’ association meeting).

A good snow removal contractor will do the job the way you want it.  You will want to determine how early he should make his first visit if there is overnight snow, and how often he should come by if there is continuing daytime snow.  Check with the tenants to make sure they don’t have to leave extra early.

Your primary responsibility to the snowplower, and to any other good contractor, is to pay him.  Good contractors are worth their weight in gold.  They certainly deserve prompt payment.

Option 3 - Hire a Tenant

Don’t do it!  I never recommend hiring tenants for any purpose other than doing work inside their own units, and even then very rarely.  But if you really want to hire a tenant (don’t do it!), follow these rules and you’ll be slightly less disappointed.

1) The tenant must provide his own equipment.
2) The snowplow agreement should be separate from the lease (you should be able to cancel one without cancelling the other).

3) The tenant must have been a tenant in good standing for at least a year.

The Tenants’ Responsibility

Each tenant is responsible for clearing sidewalks, doorways, steps and porches by his unit.  Tenants are also responsible for moving their cars if they don’t want to be plowed in.  Make sure your tenants know that they may get plowed in from time to time if they don’t move their cars; that the snowplower will not make special return trips to plow an area that was blocked by cars; and that the snowplower and you are not responsible for damage to anything left in the parking lot other than a car.

Good luck with your efforts and we’ll see you after digging out next spring!

Tags: landlord, lawsuit, snow removal, tenant

It would be a severe understatement for me to say everyone has an opinion on this mega foreclosure problem happening today. However, it wouldn’t be an understatement to say Sheriff Thomas Dart of Illinois actually expressed his opinion.

If you haven’t heard of him, use your friendly search engine and you’ll see many interesting articles. He decided he wasn’t going to process foreclosure evictions because he didn’t believe some renters in apartment buildings were receiving enough notice of the foreclosure.

He is quoted as saying, “Innocent tenants [will no longer] be victimized by an uncaring, reckless system.” He went further and imposed the requirement that banks must prove they informed tenants of a 120-day grace period as required by state law. This grace period allows tenants to find new housing before moving out.

Simple Solution To Complicated Problem

This seems like a simple solution to a complicated problem. After all, the forecloser is required to provide mandated notice requirements in any type of court action but some don’t always provide that notice to tenants. If I am correct, Illinois does not provide any type of exceptions to the notice requirement. Apparently the sheriff wasn’t provided with his copy of the notices.

I actually applaud the sheriff for taking a stand he thought would help what he termed victims. However, one has to ask if the foreclosure process was followed to the letter of the statutes, can the sheriff make the determination, based on social consciousness, that he will not follow the law as written?

If he can, then other sheriffs would be able to say something like the problem is simply too big to let continue and, they too, have to stop conducting foreclosure sales because too many people will be on the streets.

You can probably construct the logic stream that would follow so I won’t continue along that line. Rather, I’ll pose a question or two.

First, if Dart’s action actually happened in every jurisdiction in the U.S., would we have put a crink in the political/financial free-for-all called bailout?

Second, would that be fair to those of us who pay our mortgages on time?

Third, do we want social conscience to be our determinant in what laws are, or are not, followed?

Since the question stream can continue for pages, I’ll simply stop with three. I wrote the above scenario because those of us in the trenches should be aware that any type of policy can come at us from any quarter involved in the process. When it does, we are the ones affected and that affection is usually monetary in nature.

Also, this problem has left the old school thought theology rocking and reeling. What was once a known system with known procedures has been altered to an identifiable situation with maybe procedures. I am finding I have to test as I go. What was a sure fire submit package is now sometimes merely a baby step into the process.

I’d appreciate hearing what others are finding as they find properties, make offers and attempt to close their deals. Maybe I am off base and need an attitude adjustment.

Photo Credit: prestoncovillaud

Tags: evictions, Foreclosures, housing, sheriff foreclosure, tenant

Have you ever seen those polls which list different groups and industries by how much respect they get from the public?  Real estate agents and used car salesmen usually rank near the bottom.  And while I’ve never seen the rental property industry evaluated in any of these polls, suppose we were included?  Suppose the American public was asked how much they respect landlords and rental property agents.  What would they say?

Answer: they would rank us way, way down the list – possibly even lower than those guys who try to sell you 20-year-old Buicks.

Reputations are driven by the media. Why does everyone respect the Coast Guard? Most stories about the Coast Guard involve boating rescues, drug busts and other heroics. Unfortunately, most stories about landlords and real estate investors are sordid, embarrassing or even criminal. That gives us a horrible reputation. Good landlords – who provide a useful service to the community while trying to earn an honest living – are tarred with the same brush as the rotten jerks who shaft their tenants, allow their buildings to be grungy and dangerous, and let down their communities.

(caption: You don’t rent slums, so why get thrown in with the slumlords?)

We pay a real price for our reputation. Remember that government decisions are driven by two things – effective lobbying and public perception. Landlords and real estate investors don’t have effective lobbying because we are fragmented. And our public perception is awful. For those reasons, governments on the federal, state and local levels are happy to stick it to us. We get hit harder with new mandates, higher taxes and increased liabilities.

How are we going to reverse our public image? One of the best ways is to police ourselves. We should denounce those landlords and investors who deserve their bad reputations. It’s challenging to make that mental switch, because our natural tendency is to defend people that we think are like us. Consider the recent story about the landlord who was charged with homicide after his tenants died from carbon monoxide poisoning (hat tip to Richard Warren).

When you first see this story, your natural inclination is to defend the landlord – he’s one of us! – or to hunker down and think “I hope that never happens to me.” I think it’s actually a great opportunity to defend our industry, in part by throwing this landlord over the transom. He’s not like us. Read the story and you’ll see what I mean. Of course, he hasn’t been convicted of anything yet, but if the charges are true, he committed multiple crimes even before the horrible act of negligence that left his tenants dead.

When you see a newspaper story like this, write a letter to the media outlet and condemn the behavior in the strongest possible terms. Point out that responsible landlords don’t behave anything like this. Note that we do a vital service for the community by providing housing for people who can’t afford to buy their own homes.

Of course, this is playing defense. You can also play offense. One way is to make sure the public knows when you or your fellow landlords do something good. Get the word out when you do something to beautify the neighborhood or improve your properties (if the improvement is significant). Become an effective advocate for affordable housing in the community. Go to meetings. Get in touch with housing organizers and politicians. Make it your business to educate people who don’t know how landlording works, but should.

While you’re doing that, don’t ever whine about your hard lot. Believe me, nobody wants to hear how hard it is to be a landlord. The non-landlording world thinks of us as wealthy people who don’t really work. Challenging that perception is going to be really difficult. It would be far better to avoid the subject and instead focus on what we do and how we help.

Almost every community wants to increase its affordable housing and become a bigger, better and stronger city or town. Because we do this for a living, we know the solutions to creating affordable housing, which are:

1. Have a free market in rents
2. Reduce regulations that limit or prohibit building
3. Eliminate unnecessary regulations that increase our costs or liabilities
4. Eliminate transfer taxes.

By taking these steps, we can do more to improve our reputation, remove some of the burden of government, improve our communities, and yes, grow our businesses.

Tags: housing, landlord, landlording, Media, renters, tenant