February 1986
Vol 8 No 5
That's part of an old nursery rhyme someone used to read to me. Like most of those old sayings, it survived because it held a clue to several eternal truths. One of which is that even the man at the top must stay concerned with control of cash. The summing up of the fruits of toil is also pleasant work when a person has managed to achieve a measure of success, so it's not surprising that a King would be involved in this endeavor. Furthermore, without some sort of system to measure progress, he could find himself in financial difficulty in a hurry – especially if he were a leveraged investor in real estate. And, even when one is in position to delegate every possible activity to subordinates, he's still wise to take time out to audit the accounts to make certain that liquid funds aren't being drained away or siphoned off by others heedlessly.
That's what's been going on at our house over the past 60 days. We've been auditing the accounts. Part of the reason was for tax planning for next year and the year after. Without some sort of projection of future tax liabilities, serious errors could be made in timing the receipt and disbursement of funds which would measurably reduce after tax income. Each year this letter devotes several issues to changes in tax laws simply because true income must be spendable, after-tax income before it's added up as an indication of your financial worth. What you can save out of your tax bill can be the difference between failure and success. That's why knowledge of tax law is critical.
But it's a mistake to use taxes as the only reason for keeping accurate accounts. Probably the most important justification for a good record keeping system is to enable you to manage your affairs more efficiently. I like to think of each dollar I invest as an employee. That means that it has a job to do and it's important for me to know how well that job is being done. Anytime it fails to perform the way I expect it to, I need to make adjustments somewhere either in my planning or in the way I employ funds in the next venture. Otherwise I might just continue to make mistakes which waste resources.
As a landlord, records become even more critical. Why? Because I'm in the people business. When I make an error it doesn't always get filed away quietly out of sight and mind. It can backfire and cause a good tenant to move out – or cause a judge to decide that a bad tenant can stay a little longer. Or it could allow a hazardous condition to remain unrepaired in a property where injury and subsequent damage claims might ensue. Maintenance of tenant performance records is important when you're trying to decide whether or not to raise rents, or to do cosmetic repairs, or to allow someone to 'work out' a late rent or deposit problem over a period of time.
In a way, a Landlord is in the same position as a small loan company anytime the rent and/or deposit isn't received in cash at point of rent up or when due. Knowing who's reliable and who isn't is crucial. In other cases, tenants may use you as a credit reference. You need to be accurate when giving out credit information. Later on, you could be called on to prove any credit statement you might make. You'll need records. What about when a tenant departs and a dispute arises concerning tenant damages, or when appliances mysteriously disappear? Without appropriate inventory and inspection reports, the owner is on shaky ground. Especially when there's an argument over deposits. At this starting point of a new year, let's look at ways we can set up and maintain a simple record keeping system that will keep us out of trouble and on top our investments.
THE PLACE TO START IS AT THE BEGINNING . . .
Where else can you get that kind of logic at this price? What's the true beginning? Probably when you wrote down your goals to buy a certain number of a certain kind of investment property at a certain price and terms which you thought would be profitable over a certain number of years. Notice how many things you should establish as certainties when you set your goals? That's the start and that's what you should be using as a standard against which you'll be measuring your progress. What comes next?
Get a file folder and put the street address of the house you're buying on it. Into this put your purchase contract which contains the terms of your offer. Your offer should have language in it which sets forth price and terms AND PURPOSE of the purchase. One day you may have to prove that you originally intended a property as an investment rather than as INVENTORY in order to obtain favorable long term capital gains treatment of any resale profit you might make, or to be able to EXCHANGE it tax free under Section 1031 of the IRC, or to be able to DEPRECIATE it. So state that 'this property is being obtained for your investment account for future profit'. Write it on your contract.
When you go to the settlement/closing, you'll have to sign a closing statement and possibly some affidavits. There will be Notes, Mortgages, Deeds, Bills of Sale, Title policies, Termite Warranties, disclosure statements, pro-ration agreements. These should be placed into your file folder. After the originals of recorded documents have been returned, these should go in too along with insurance policies, tax bills, etc. You aim should he to have every fact concerning the property in a single, easy to find file folder for quick reference when you need it.
Why? Here's a practical reason. I was recently called by a tenant who asked to purchase his house. I had to make a decision while he was still eager to make a deal. I literally cradled the telephone on my shoulder while I leafed through my file to find how much I'd be willing to sell for and on what terms. In previous letters we've covered ways to structure wrap-arounds, how to handle 'paper' so it's the most marketable, etc. We've explained myriad ways in which to arrange a transaction for maximum benefit. But in order to calculate the best way to do business, I needed to know the current interest rate compared to the existing rate on my loan. So I needed a copy of my Note. I needed to know the current loan balance and remaining payments. I needed to know my tax basis. And the current condition of the property, installed appliances, projected costs. Also, the ability to make a quick decisions as to price and terms made the difference of either losing an easy, profitable sale or of keeping a property and possibly losing my tenant.
TENANT PERFORMANCE RECORDS ARE A POTENT TOOL . . .
Once upon a time I had a bad tenant. I mean a BAD tenant. One who had to be evicted forcibly. It took 5 carloads of police. Three months later a friend of mine had to go through the same agony with the same tenant. It happens all the time. We're so tickled to get rid of our losers that we don't make any effort to warn our peers about them. Bad tenants are like termites. We don't really eliminate them, we just chase them around the neighborhood. Now that's all changing. On a national scale, tenant credit rating agencies are springing up everywhere. And, judging from tenant complaints, they're starting to have an impact. One of their features is a data base in a computer into which is fed eviction records and landlord ratings. They have the capacity to link up with other computers and by mail to track bad tenants clear across the country.
Typically, when the owner uses the agency, he's asked to list tenants who've failed to live up to their agreements. These include those who leave early, damage the property, had to be evicted, or left owing money. All adults in the household are named, the term of residency, the address and the name of the landlord or agent. This file is entered into the data base. From that point on, the tenant is going to have a problem renting from anyone who uses the tenant rental credit service as a screening device.
Look back at the information required. How well could you respond with proof of your contentions without adequate records? So we've included in our rental contract for several years a tenant inspection sheet which not only lists appliances and the discrepancies in the property as reported by the tenant upon move in, but also condition of outside utility sheds, fences and shrubbery/lawns. In the tenant's own handwriting, this is a formidable record of any deterioration or damage to our property upon departure. From this point on, every repair is recorded along with its cost so that we're also able to evaluate each property on its own merits against each other property on an annual basis. And finally, we eliminate a lot of potential liability and/or claims of existing hazards on the property, because the inspection sheet is a 'sign off' by the tenant on any other conditions which are presumed to be satisfactory unless listed on the discrepancy report.
Let's talk payment records. I use a simple hand made form which shows the date and amount of rent paid by each tenant each month. I also maintain a file of 'late notices' and communication with the tenant. Too often, the owner relies on telephone calls and verbal transactions only to find out that the judge isn't sympathetic to his unsubstantiated claims. On minor matters there's no need to keep records, but where any potential disagreement could occur, a written memorandum of record can be dropped into the file following any telephone call or discussion, or a follow-up letter written with a file copy on more serious conversations.
The key to having a satisfactory tenant relationship is fairness. That's best achieved when each keeps his commitments. By jotting down any agreements which aren't part of the written rental agreement, you can both have a reminder of just what your agreement is. I've found this to be useful even with close friends – to maintain their friendship and to avoid disagreements which could damage an otherwise good relationship. This is especially important anytime a tenant is going to 'work out' rent or deposits by doing minor maintenance on the property. I like to write up a simple, one-page contract which specifies what work is to be done, when the job is to be finished, and the limits to the job. In other words, if a tenant is going to paint exterior trim, I'd specify the color and brand of paint, the preparation of the surface, the amount of rental credit he'd get for his job, COMPLETED TO MY SATISFACTION, when he'd start and when he'd he finished with it, and the fact that he's acting in the capacity of an INDEPENDENT CONTRACTOR who will be responsible for all payments for materials, labor, and liability in the event of any accidents. When I pay him, I stamp the check with a rubber stamp on which his status as a contractor and his liability for payment of his own taxes is also spelled out. This is another record that I want in my file in the event of a future claim.
You can never be too careful when it comes to hiring people to work on your house. Recently a tenant installed a new patio on my house. He did a good job and in return I gave him an Option to renew his rental contract without any increase. Later, I was notified that a lien had been placed on the house for the cost of the concrete.
My contract had specified that all materials would be paid for in cash by the contractor. When confronted with this, the matter got straightened out. Without the contract, it might still he in litigation – at my expense rather than at his. Another good idea is to staple a simple sheet of 13 column bookkeeping paper into the inside of your file folder. When rent comes in, you can post it to this form. Do the same for any bills you pay. Keep the bills and receipts in the file after making a note on each as to the date/source or application of any funds involved. Be specific. At the end of your accounting period, just take these into your bookkeeper and you can generate a simple profit and loss statement for each house and for all your properties. This pre-supposes that you can balance your checkbook and reconcile your accounts. If you can't, then it's better to get your bookkeeper's/accountant's input into your system.
COMPUTER RECORDS CAN BE LIKE THE LITTLE GIRL WHO HAD A LITTLE CURL . . .
When she was good, she was very, very good. When she was bad she was typical. In 1978 I bought a Radio Shack computer. After a couple of years I learned to use some of the software and spent about 3 days entering data into it to use in keeping accounts. Then I made a little mistake. I pushed a wrong button. I lost all my data plus about $300 in software. All for one little mistake. Later on, one of our subscribers designed a massive, all inclusive, sophisticated management system for computers. I paid about $1000 for the software and another $3000 for a computer. Then I found that it worked better on a different brand of computer. It was extremely slow on mine. I'd bought the wrong computer for it. I was learning.
Currently, we've got a simple program which runs on the Epson QX-10 (and apparently nothing else) which does a good job of writing checks and balancing checkbooks. We're still trying to get a bookkeeping system that will work consistently well enough to keep us from having anxiety attacks. I don't want to have all my files stored in an electronic memory that gets washed away in a hurricane. Our computer files went with us when we were evacuated during Elena last September, but we had to abandon the computer. But when you've got your system up and running it can be terrific.
It can make all your payments in minutes. We use window envelopes with our address pre-printed. The computer writes the loan number and amounts automatically. It has reduced a 3 day job to a fraction of the time. We also use a computer to list our houses by legal description, tenant, street address, loan balance, mortgage and rent payments. We can array them by gross and net cash flow each month or year. This helps me determine which I should keep or let go. Which I should increase rents on and which I should make a special effort on when rents are above market averages. As long as the King has to be in the counting house, he might just as well be having fun.
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