Getting Real

Steve Abramowitz

WHEN I STARTED OUT as a mom-and-pop property owner 40 years ago, I was burdened by both my naivete and the shibboleths promoted by the real estate industry.

In particular, I had to overcome two egregious misconceptions: that a well-written lease is the key to successful small-property investing and that aggressively raising rents is the surest way to maximize profits. Adopting an alternative management philosophy has saved me both money and heartache.

Character counts. Few things in life are as overrated as the Los Angeles Lakers, but the rental lease is one of them. Getting that lease is important, sometimes very much so when confronting tenant malfeasance. It sends a clear message: You are legally bound to this commitment. It’s your ace when that rare eviction becomes unavoidable due to excessive damage, flagrant misconduct or nonpayment of rent.

BlackRock, the multinational investment company that’s bought thousands of small income properties for its clients, has its own lawyers. But I’m not inclined to sumo-wrestle a renter over a few beer cans on the front lawn or an occasional late rent payment that would entail a $500-an-hour attorney’s fee.

Indeed, gauging a prospective renter’s character is far more valuable than getting the lease. Character assessment begins with an unbiased recent history of debt repayment, which the credit report provides. A credit score over 670 establishes that, regardless of personal hardship or broader economic downturns, a prospect has fulfilled her financial obligations. It’s eminently more telling than a large bank account or professional pedigree, both barometers of financial capacity rather than actual behavior.

Is the credit score all you look at? No. You have three other checks on character. First, you can ask for a tax return and judge if the figures support a prospective tenant’s self-reported financial wherewithal. Second, you can talk to her current landlord, not just about her payment record, but also about her personal suitability as a renter. Does she sound like a perfectionist who’d never be satisfied with a repair? If so, she’s history. You want a clean and tidy tenant, but not a finicky nuisance. Just make sure you aren’t talking to her Uncle Billy.

The third measure of character is tricky because it depends on confidence in your own social intelligence. Let’s say a rental candidate balks at the damage deposit. This person has unwittingly revealed to you that she may be a source of conflict. Is she presumptuous, and makes you feel like you’re the renter and she’s the landlord? Sayonara, my friend.

Here’s where the rubber meets the road. Who would you rather have as a renter—a lessee who discovers bathroom mold and threatens to sue you, or the fellow who calls you to amicably discuss the problem? I encountered this very situation, and I’m forever thankful that I had a tenant who was reasonable.

Taking it slow. That brings us to our second myth—the pervasive contention that pugnaciously raising rents is the Holy Grail of profitable real estate investing. My experience: Just as a person’s character usually trumps a lease, controlling discretionary expenses while methodically increasing rents is the key to profitability.

Many expenditures are out of a landlord’s control, like those involving safety or health, or fundamental life-quality issues like adequate heat and air conditioning. But others, like upgrading the landscaping or installing double-pane windows, are distinctly optional. You can’t ignore the $15,000 new roof, but you can certainly quash that wish for blond kitchen cabinets.

Invariably, the counter to this management philosophy is, “Well, you’ll get a higher rent.” Terrific. How much of a rent increase are you going to get from the next renter in return for kitchen cabinets that cost $3,600 but may not mean much to her? Maybe $50 a month. But let’s be generous and say $100. It’ll take three years to break even on your largesse.

Expenses swing wildly from month to month and year to year. You might be faced with a new heating system in May and removal of a fallen oak tree after a severe December storm. Many major problems, like a cracked sewer pipe, can’t be anticipated and require the owner to set aside a portion of each month’s rent as a maintenance and repair fund.

By contrast, a rental property’s insurance, taxes and utilities trend upward only gradually and, in the case of a fixed mortgage, not at all. The upshot: From month to month, your net income will largely fluctuate with your maintenance and repair costs, which is why you shouldn’t add to those unnecessarily.

Meanwhile, except perhaps in instances of tenant turnover, rents also grind slowly higher. And that’s what you want, because gradual rent increases don’t scare off existing tenants, thus triggering all the expenses involved with finding new occupants and making the property appealing to them.

Give me a choice between an aggressive landlord who authorizes extravagant improvements and demands big rent increases, and one who raises rents responsibly to hang on to good renters while carefully prioritizing repairs, and I’ll take the frugal manager any time.

Steve Abramowitz is a psychologist in Sacramento, California. Earlier in his career, Steve was a university professor, including serving as research director for the psychiatry department at the University of California, Davis. He also ran his own investment advisory firm. Check out Steve’s earlier articles.

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