June 1993
Vol 16 No 10
I’ve been involved with real estate for over four decades now and I still haven’t found that mythical ‘management free’ property. Like the pot of gold at the end of the rainbow, it always seems to be just beyond my reach. For that matter, I haven’t found any kind of performing assets that are truly management free. Most of us yearn for a financially secure life far removed from the hurley burley of business concerns. We can have that only if we’re content to sacrifice yield, income and efficiency.
I’ve owned all kinds of property, real and personal. Houses, Apartments, Condos, Mobile Homes, Offices, Retail space, farms, acreage, timber forests, industrial land, time shares, and they all required my attention on a regular basis. I fled into non-real estate investments with stocks, bonds, T-Bills, Commodities, currency hedges, mutual funds, money market accounts, insurance. If I hoped to avoid loss I still had to monitor the way in which the various money managers and markets were performing on virtually a day to day basis.
Possibly the first person who said ‘Money can’t buy happiness.’ was an investor. And the first person who asked ‘Why was I born?’ was a landlord. Monitoring investments is a completely different proposition that dealing with people who just happen to be living in or on your real estate investment. That’s why I always referred to the management system that I developed over the years as ‘People Management’ rather than property management. But that doesn’t mean that the property doesn’t require management too. Like any other kind of investment, even vacant desert land must be managed.
We live in an age of environmental mania. The witch hunt is on for anyone anywhere who can be accused of despoiling mother earth. Interestingly enough, when the U.S. Forestry Service suffers the loss of 100,000 acres due to forest fires because of its failure to properly manage it’s forests, there’s no hue and cry for restitution despite the loss of millions of trees and pollution of the atmosphere. But let a private citizen do the same on private land, and woe unto him or her. Even passive land investment can creep up on you and cost you years of grief and expense if someone dumps toxic waste or any other environmentally damaging material on it.
Environmental law is the most promising of all the legal specialties these days, and the environmental police state is upon us. Even now, I’m spending thousands of dollars cleaning up vacant property that our tax dollars couldn’t get protected from illegal dumping. The law in most states makes the owner responsible for the clean up regardless of who made the mess. You’re guilty as charged under the regulations without the benefit of trial jury or judge. If you’re innocent, you have to prove it.
TENANTS ARE LIKE THE LITTLE GIRL WITH THE CURL . . .
We’ve all had house guests who were perfect. They’ve helped with the work around the house, made up their rooms, never complained and did their best to fit in to the schedule. Then we’ve had the other kind who just add to our workload and never offer to help out to compensate for the burden of their company – or to leave. Tenants fall into the same approximate categories. I’ve had one tenant for almost 15 years who’s never called about maintenance or repairs, never been late with the rent, never created a problem. As a matter of fact, I’ve had several who’ve rented from me for periods in the 7 – 8 year range who’ve been almost as good. Then there are the others.
I can’t fathom the way many tenants think. Moving day ranks among my least favorite days. In the past 25 years, I’ve lived in 4 houses. Yet, I’ve had tenants who’ve moved every six months or so. Each time they move, it seems they abandon a quarter of what they own in the property. Clothes, furniture, furnishings, toys, appliances vehicles, and assorted residential residue – all representing money they’ve spent – have to be removed and disposed of. And it seems to me, that those most prone to move are also those who damage the property the most. They’re the first challenge management must meet.
The key to effective Tenant Management is PATIENCE. Because of the commission structure, property managers are paid more for filling vacancies than for selecting tenants. Consequently, they tend to rent to anyone who’s warm without regard to the potential damage to property or management effort a particular applicant might pose. Those who leave property management as a result of burn-out are invariably those who had lax tenant selection procedures and who lacked the patience to find the right tenant.
Professional property managers should have a clear understanding with owners as to whether the owner is willing to pay for vacancies which are waiting for the best tenants. And this relates, in turn, to the pricing of the vacant unit. Tenants are the worlds most active comparison shoppers. An owner who prices a vacancy above the market usually loses money over the long run because of turnover and slow rent-up. The key to cash flow from rents lies in attracting tenants who feel the rental is a good value for the money, and this goes to the condition and location of the property compared to the price and terms of the rental agreement. Landlords have to develop a philosophy regarding their rentals. Over several decades of property management, here’s mine.
My ideal tenants must see the property they rent as an attractive proposition both in terms of the monthly rent and amenities offered. This first goes to location. For some reason or other, beginners seem to pick the cheapest houses in the worst locations. They haven’t the experience to know that these are the hardest properties to finance. Furthermore, they have the least potential for long term gain and rental income as well as being management disasters. Junky properties attract junky people as tenants. Ask yourself why people live in low priced housing.
Because they haven’t marketable skills which would enable them to live in better housing. Worse yet, for the most part, they have no intention of acquiring those skills. Thus, they’ll never be able to qualify for a loan to buy a house. As permanent tenants, they acquire ‘tenant skills’ which usually spell expense and anxiety for the landlord. They have access to free legal aid to defend suits for eviction and recovery of repair costs. What’s more, most of the really large suits against landlords have been filed by contingent fee lawyers representing these people. Buying the right house in the right neighborhood is the key to management.
A HOUSE IS NOT HOME . . .
In moving away from cheap properties, it can be just as ruinous to buy one that’s too expensive. Beginners also buy houses for investment that resemble the houses they live in. Let’s make an assumption that an investor is someone with surplus income who lives in a house that’s above the median price. This recession is confirming what we’ve always maintained. White collar employees are by far the more vulnerable among the EMPLOYED work force in America. They are bearing the brunt of the cutbacks in government spending at many levels over broad geographic areas.
SKILLED BLUE COLLAR workers haven’t had it particularly good for a long time, but they’re still working. Who are these people? My tenants include Mechanics, Salespeople, Bookkeepers, Computer Programmers, Barbers and Beauticians, Plumbers and Electricians, Heating and Air Conditioning people, roofers, carpet installers, cabinet makers, Shop Keepers, Secretaries, Nurses, Masons, Locksmiths. By and large, these are decent people who can’t afford the down payment to buy, but who want to live in decent housing.
It’s great fun to be able to collect $1500 per month rent from those white collar workers who can still afford it, but vacancies can be extremely costly when they occur. In my area, the house priced just below the median costs about $60,000 and rents average about $550 per month. As prices rise above that, rents fall as a percentage of the cost of the house. The property we’re renting for $1500 has a market value of about $250,000. Rents would thus be .6% per month, or 7.2% per year gross return on value. Let’s compare that to $550 per month on a $65,000 house. We’d be receiving .846% per month, or 10.2% per year gross. The arithmetic gets simpler here.
Suppose we had a 8% mortgage based upon 100% of the value of the house, the smaller house might just squeak by IF WE NEVER HAD A VACANCY and we did all our own repairs. The larger house wouldn’t make it at all. You can see that financing and the price we pay controls the amount of patience owners can tolerate in selecting the proper tenant. And you’ll also see why all those ‘nothing down’ schemes are financially worthless unless a person has enough income to support negative cash flows over the long term until appreciation bails him or her out. So management starts with buying right.
When buying an investment house, don’t use the same criteria that you’d use in buying a second home for yourself. Instead, think of the tenants you want to attract, and buy the house they’d want to rent over the long term. Near schools, jobs, shopping and major access routes. Then buy it with terms that the rents can afford to pay after management, maintenance, vacancy and financing costs. Obviously, you’re going to have to learn how to negotiate financing as well as price when buying. You’ll need to practice.
The best way to practice negotiation is to contact owners and offer to buy their houses. This has several hidden benefits. First of all, it will get you out into the neighborhoods talking to real people. You’ll notice I didn’t say anything about contacting brokers. Except for professional negotiators, middlemen clutter up the deal more than they enhance it. Do it yourself. You might start with the newspaper ads and ‘For Sale By Owner’ signs, but your objective is to graduate to doing ‘cold calls’. This simply means writing, calling, visiting owners and asking them if they’d like to sell their house. Isn’t that where all those listings come from that the Brokers always seem to have? Why can’t you do it too? It doesn’t require a license. And with each contact, you’ll learn a little more if you’ll remember one rule: You’re only practicing!
Bear in mind, that you KNOW you’re practicing, but the seller doesn’t. The last thing you’ll want to do is to actually buy something until you’ve perfected your ability to evaluate a property and to negotiate a feasible price and terms. So, rejection of your offer become an objective of the exercise. This will help develop the courage to make offers that meet your financial objectives in the future, and to deal with rejection then when it really counts. And you’ll be developing people skills which will help you to evaluate and negotiate with potential tenants at the same time. You’ll also be getting an idea of the difference between real property values and prices that sellers want to get. If you can avoid paying too much, you’ll have a real head start on profit.
HOUSES DON’T HEAL THEMSELVES . . .
O.K. Now you’ve bought the right house on the right terms, it’s time to get it into condition to attract tenants. It’s funny how owners play games with their properties. My across-the-street neighbor refuses to fertilize and water his lawn and expensive landscaping. Consequently it looks terrible most of the time. Yet he still has his property on the market for a high price. Many owners do the same. They act as if the roof leak will heal over if they just leave it alone. Ditto with many minor blemishes in paint, plaster, plumbing, heating and mechanical systems.
When buying a house, I put a little clause in my contract which gives me the right to thoroughly inspect the premises prior to closing after the people have moved out (assuming that they’re going to move out). It’s amazing how many defects you can find with all the furnishings removed. The pathways in the carpets, rub marks on the walls, cigarette burns, slow drains, inoperable windows, sticking doors, under the counter leaks jump out at you. The list I make of these undeclared defects becomes the basis for further negotiation at the closing when the money is on the table. Remember, you’re going to pay for all the repairs the previous owners should have made unless you can get them to pay for it at closing. Usually, this payment takes the form of a reduced down payment and price, but there’s no law that says an amount can’t be left in escrow to cover undiscovered latent defects that might appear later. It’s negotiable.
From this point on, it will pay you to formulate some sort of preventative maintenance schedule for each property you own. The system we use is to get the tenant to inspect the property upon taking possession of it to establish a base line condition and to get all hazards reported so no claim can later be made that we’d been informed of a problem which we’d neglected. We also include one scheduled and one unscheduled inspection during each year to assure ourselves that the property isn’t being abused and that required repairs are being made. Finally, we give the tenant a rebate each month for making rent payments early and for doing minor maintenance. While we still do a lot of repairs ourselves, this hold down the unscheduled emergencies and ‘slow damage’ that leaks and termites can cause. This also slows down tenant turnover. A happy tenant is a stable tenant, willing to meet market rent increases and to renew year after year.
This brings us full circle back to selection. With the right house in the right location much of the time you can get tenants to compete for occupancy. With lots of applicants – and patience – you can run rigorous credit checks and ‘tenant checks’ to assure yourself that the people you select will be good for you over a long period of time. You’ll be looking first at character. Do they meet their commitments with creditors and landlords? Pay their bills? Stay the full lease term? Are they litigious? Clean? Then you’ll want to check their ability to pay rent. Long term employment stability? More than one paycheck needed to pay the rent? And you’ll want to investigate their ATTITUDE to assure yourself that they’ll cooperate fully in meeting the terms of your rental agreement.
In the rent-up process, there are several ways to approach the task. Remember, you want to find tenants whose performance you can control, not vice versa. One way to do this is to impart to them that they’re competing for your house. We’ve used a tape recorder for years to do this. Pick a moment when you feel great, and let this show through in your voice as you tell callers where a house for rent is, and why they should rent it. Call yourself up and listen to your tape. If it’s listless and flat sounding, make a new one. Remember, this is an initial impression. Sell yourself as well as the rental. Be sure and mention that there will be a charge for a credit check and references required. This will scare off the deadbeats and will seem reasonable to the people you’re trying to contact. Furthermore, being picky creates a good impression of your rental.
Include a time at which you’ll be available in person so they can call back ONCE THEY’VE DRIVEN BY THE PROPERTY. This will concentrate all applicants into a time frame when you’re prepared to deal with them on the telephone. Only after you’re convinced that they’re attractive applicants need you give them access to the property. You can work out several schemes to get the house opened for their inspection after you’ve qualified them as desirable. These might include leaving the key with a neighbor, hiding it on the property, having them pick it up and leaving a deposit to assure they bring it back, getting a maintenance man to unlock the house, etc.
You might schedule an ‘open house’ in connection with the tape technique at which all qualified callers can inspect the property within a short period and complete an application with an application fee. This is typically $25 in my area. This way, you’ve gotten them all in one place at one time so they can perceive the level of competition for the property. This makes it easier to ‘close’ the best qualified tenant with a minimum of negotiation. We’ll discuss this more in future letters. It will take lots of applications and interviews, but in the end, all this preparation creates financial security over the long haul. If financial success is your goal, it’s worth it.
Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com. (888) 282-1882
Quotation not permitted. Material may not be reproduced in whole or part in any form whatsoever.
