The COVID-19 pandemic has shown many people the importance of being ready for the worst. Landlords have been negotiating with struggling tenants to create rent relief plans. The federal government has placed moratoriums on evictions and foreclosures. The pandemic (and the legislative response) has left both owners and tenants wondering if their contracts are still binding.
While the COVID-19 vaccine is rolling out, you, as a landlord and real estate investor, are probably worried about maintaining your properties and paying your mortgage. Meanwhile, unemployment numbers are at record highs; your tenants are worried about their own financial futures and may be unable to pay rent.
It is important to know that complaints of nonpayment may be exaggerated—the National Multifamily Housing Council found that 93.5% of renters paid February 2021 rent in full.
In the months to come, some real estate sectors, including hospitality and apartment REITs, could experience strong demand. The outlook for other sectors is mixed.
How can you as a landlord balance your own financial needs with your tenants’ to give both of you a way through challenging circumstances?
How prepared is your business for when things head south?
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Challenges property owners are facing
There are three significant problems that you are likely to experience as a landlord during a recession.
- It becomes more difficult to collect rent.
- Old tenants might want to vacate.
- It is more difficult to find new tenants.
These problems will continue to dog landlords struggling to recover their footing after the pandemic.
As a landlord, the best way you can prepare for a market downturn is to have policies and processes ready to implement and clearly communicated to your tenants. This gives you a legal and financial grounding in the event of economic recession or downturns in specific markets. Additionally, your tenants will know their options ahead of time.
Types of rent relief plans
One of the possible processes is to have a rent modification arrangement on standby. You can also create plans to handle garbage, water, and any other bills when rent is no longer as reliable.
One of the common incidents you are most likely going to experience during a long recession is your tenants requesting rent relief. There are several strategies to approach this as a landlord.
- Rent deferral. In a rent deferral, you can choose to defer a tenant’s rent until a later time. Based on your agreement with the tenant, the deferred rent can be paid in smaller installments or in a single bulk payment. Another approach to this is to create a cap on operating expenses over a set period.
- Rent reduction. You can also choose to reduce a tenant’s rent for all or some part of the total amount of time they have left on their lease. This reduction can be on either the base rent or the operating expenses.
- Loan conversion. This is converting the past due rent of a tenant into a repayable loan over a longer set period. Loan conversion is evidenced by a promissory note cross-defaulted with the tenant’s lease.
- Rent abatement. This is another strategy used if the client is due on several past payments. In rent abatement, you can choose to simply forgive some or all of the delinquent rent.
Regardless of the approach you choose in handling rent relief, it is important to look out for the tax implications. Apart from this, you should also perform due diligence. Check out recent and previous financial records of the tenant to ensure you do not leave out any loopholes in the process.
Why is rent relief important?
As much as possible, you should try to find a workable package. It is important to be understanding and retain good tenants using any of the strategies listed above.
Generally, tenants found defaulting are not considered for most relief considerations. However, the circumstances of the recession might not make this workable, as most tenants are already in or would soon be in default when requesting rent relief. Document everything, and clearly spell out all details of any arrangement you and your tenants make.
The effects of a recession can be severe for everyone. If tenants are no longer able to keep up with their rent, making your maintenance and mortgage payments can become difficult. This is why it is often advised to have a contingency plan to pay these bills. With the proper preparation, flexibility, and good tenant communication, you can come out of recession stronger as a landlord.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.