Are you capitalized enough to be a landlord? Can you really afford the true cost of a bad renter?
I see it all the time: A prospective landlord looks at the numbers and says, “Rent will be $1,000 a month. My payments will only be $800; I can pocket the rest.”
If you are any type of investor, at least one who reads here, you know that this is a losing proposition. There is $200 worth of cash flow — before expenses. After expenses of 50%, there is a negative cash flow of $300. And they are even managing the property for free.
But to the naïve investor, on the surface it looks OK: $200 a month in your pocket. And that is if you get a renter, if you get a renter who pays, if you get a renter who doesn’t damage the place, and if you do not have any vacancy.
The Start of Trouble
So the investor does the deal anyway. They are thinking that even if the cash flow is even, they can make up for it on appreciation. They somehow lose the point that a house has to appreciate about 10% just to break even on a real estate commission. And they forget the number one cardinal rule of real estate investing: Never have a negative cash flow.
After the offer is accepted, they get “lucky.” They burn up most of the cash they had on the sidelines, but the closing goes successfully. Then the investor gets even get luckier: A tenant sees the advertisement and wants to move in “right away” (red flag). The investor does not want to make a mortgage payment without rent to supplement it, so they accept the tenant despite not really knowing what they are doing. They do not know a good tenant from a bad one.
Slipping Down the Slippery Slope
The investor knows about background checks, and the reasons to do them, but they have not yet figured out how to do them (red flag). They do not want to lose this renter waiting on an on-site office inspection. Besides, they know how to “judge” people. They have a great skill of being able to tell a person’s character just by meeting them (red flag). The renter seems to “click” with them. And, as will most con artists, the professional renter reels the investor in hook, line and sinker.
And if you think it’s just investors who get fooled, think again. A property manager will know the renter might be suspect, but will also have their own personal bills to pay and will need a commission. Besides, if things go wrong, they can just get the investor a new tenant, “free” of charge.
Are All Tenants Bad Tenants?
If you got the one applicant out of ten that was a great tenant, you can consider yourself blessed. If you were like many landlords, you “settled.” You did not consider that bad tenants move at least twice as often and apply to at least four times as many places as a good tenant. And here is what you were rewarded as your investment returns.
In a medium bad tenant, after a year, the renter moves out. They paid on time, most of the time, but despite several showings, the place is still empty, and it looks like at least another month of vacancy while you wait for a tenant. It was just too cluttered while the tenant was in — and too messy — that no one wanted to rent that place for your price. There is some damage and some painting and cleaning to do. Maybe even new carpet.
If you were unlucky, you would have had late payments and maybe even missed payments. In Minnesota, you might have had to file an eviction. If you were thinking that the renters’ late rent story was actually going to pan out, you would have waited until at least the 20th to evict, and some new landlords even wait months. In other tenant-friendly states, even if you start evicting right away, it may take months.
The True Cost to Evict
The cost to evict is huge in all states. Vacancy is your largest expense. Even worse is not getting rent and having a tenant in place. It’s like a vacancy, except it irritates you even more. In Minnesota it’s $320 just to ante up at the Court house. You also have to serve the papers. An attorney might charge $100 for that, and if you knew the number one defense for an eviction is improper service, you will gladly pay it. You do not want to waste another month for lack of proper service.
Once you win the case, in MN, it’s another $55 to issue the writ and ~$150 for the Sheriff to serve that. So, allocate ~$625, unless the tenant denies everything and needs a court hearing about two weeks later. Your attorney will be the only one who is happy.
Forcing the Tenant to Comply (It’s Your Right!)
Maybe you thought you would be “smart” and force an inspection on a tenant who tells you to stop harassing them for the rent. Or they might not even tell you to stay away. You are a newbie, and you know the law demands that you can enter your property with a 24 hour notice. You want to see how much damage they are doing, being too naïve to know the damage doesn’t stop, or even matter, until they are physically out.
You post a 24 hour notice, and before you can get into the rental, the Sheriff serves you with a notice to stay away from your own property with a court issued restraining order. It’s just a civil case now, but if you ignore the restraining order, you will get arrested. It’s your property, you complied with the law, and they have this right?
That’s right, the very tenant that you thought was so good on day one has turned into a formidable legal challenge. And if they are low-income, they even have a free lawyer. They may have even lied to get the order. You will have a chance at a hearing coming up in two weeks to refute the order.
And if they call or text you, and you respond or call them back, you are also in violation of the order. They just set you up to be a criminal.
You hire an attorney to represent you in the hearing ($$), as you know someone who represents themselves in Court has a fool for an attorney. And if somehow you lose at the hearing, you will lose even more than the attorney will cost. They have an attorney; you better have one. Any “tie” will go to the renter.
Finally, You “Win”
In the end, you get the property back — after two months of non-payment while you were waiting for the court to issue the vacate order and the tenant to actually vacate. If you had to fight a harassment order, it is even longer and you have no idea what condition the property is in.
When the tenant moved in, the place was immaculate. It was a turnkey rental you purchased off the MLS. Everything was painted fresh, the appliances were new, and the carpet still smelled of fresh formaldehyde only a few months ago.
You get the place back, and it looks like some of these pictures. All of the pictures came from various rentals over the years. All have the same thing in common: low income tenants with low credit scores. None of the tenants would be considered a criminal upon moving in.
Do you think a good tenant wants a stove like this? It will have to be replaced. Maybe you can charge the damage deposit, if you got a decent sized one. If you went with a lower deposit, it’s an expense you will have to eat yourself as the deposit was long used up before this.
This is another example of an improper job of cleaning. Imagine a kitchen with all the cabinets like this. It takes time, or money, to get cabinets like these back in shape. And they may need repairs. These cabinets were discarded and new cabinets and counter tops installed.
All these belongings need to be stored for a tenant to retrieve. Store it in the apartment, and you have extra vacancy expense. No one will rent a place that looks like this; you have to move it out. Then dispose of it. And do not think for an instant that charities want a tenant’s junk. All the charities want nice, nearly new, stuff.
Maybe the tenant left some extra “pets?” In this case, it is goldfish. In other cases, it may be a dog or a cat or some other furry or feathered animal. You may have to hold a tenant’s belonging for a longer time than you want. Are you going to turn pets over to the city’s animal control? Maybe a dog or cat, but they do not want fish. Donate it to a pet shop? Do that, and a Judge may have you replacing some expensive “koi” that you no longer have.
[Editor’s Note: We are republishing this article so the landlords newer to BiggerPockets can benefit from it.]
Can you afford the vacancy and repair expense of a bad tenant? If you have ever had a bad tenant, did you ever look back and see how you could have avoided them?
Leave a comment, and let’s discuss.