What’s More Costly: Rental Vacancies or Filling Rentals With Subpar Tenants?
One of the most important factors that today’s real estate investors need to watch out for is choosing partners and professionals who have really mastered the dynamics of tenant screening and occupancy. Each investment opportunity is only as good as the execution. Without a great handle on tenant management, the results can be disastrous.
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Glance through the BiggerPockets Forums for a few moments, and you’ll discover plenty of threads debating tenant screening versus occupancy versus rental asking prices. You’ll find plenty of good tips and lots of rough rules of thumb to use. Unfortunately, many investors are still incredibly lost in this area. And that can get extremely expensive very quickly.
Both poor tenant performance and rental vacancies can kill cash flow for real estate investors.
How Much Does Credit Score Matter?
It is smart to have systems in place for these things, but many are getting hung up on the wrong data points. Credit score is the most common one. Through screening tenants, I have seen that you can still walk out of bankruptcy and have a 700 credit score very quickly because you no longer have any debt. That doesn’t mean this tenant will ever pay their bills on time. Someone else might have one misdemeanor on their background check from 4 years ago, but is otherwise the ideal tenant. Ever heard of miscarriage of justice or innocent people being arrested? Someone else may have a low credit score because they don’t use credit but have awesome income, a great job, and good assets.
It takes both a detail-oriented property manager and intuitive expert who knows how to evaluate the whole picture to nail this.
Finding Correct Rates for Rentals
Another reason that investors fumble the ball is unrealistic asking prices for rental homes. Never take what a real estate agent told you that you could get in rent as the truth. Always verify it for yourself from other sources, such as Rentometer, Zillow, Trulia, etc. If there are similar units for $500 less a few blocks away, they are going for the cheaper units. The market will tell you how much your property will rent for. It’s best to listen and make any necessary changes.
All too often my partner and I see units around ours sitting vacant for 6 months or longer. Normally, these are freshly renovated by newer investors. Some have done an amazing job at the rehab. They may have put in a little too much money for the neighborhood, but they look great. Still, they often lose because they’ll refuse to budge and drop the rent on a $900 a month unit by $50 to fill it with a good tenant. Or they’ll flat out turn down an average tenant who may have been willing to pay $50 extra.
The True Cost of Vacancy
Do the math. If you’ve got four $900-a-month rentals sitting vacant for 6 months, you’ve just lost $21,600! You’ve made zero returns. In fact, given you need the utilities on and have property taxes, you are actually incurring negative returns. Then we all know that risks of damage are higher on vacant homes.
If those properties were mortgaged, you might be pulling $10,000 extra out of your pocket during that period to hold on to them as well. You’ve got to ask yourself, “How many properties with negative cash flow each month can I handle, including if my earned income is cut?”
It’s not just the little individual investors who are stumbling here either. There are a lot of new players out there. Even some of the biggest funds are stumbling here. They are trying to manage and screen by the data from out-of-state, with no real connection to the local neighborhood. Drive around some apartment communities in the country, and you’ll find they are a third or more empty, even where there is no shortage of eager tenants.
It’s worth noting that some of these firms are securitizing and selling the “potential” rents from these properties to secondary market investors. That’s another huge disaster waiting on the sidelines — but that’s way too big to get into here.
The bottom line is that whether you are investing in rental properties solo, with partners, through a fund, or via a crowdfunding platform, make sure you and the property manager really know the local market, know how to decipher the data and make common sense decisions, and are putting as much consideration into the math of vacancy as you are flawed credit scores.
Investors: How do you make sure you’re getting the best possible tenants into your rentals without risking vacancies?
Leave your best tips below!