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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Unfortunately there is no perfect process, and what is most important can vary by tenant. First, credit score. I am highly incensed by FICO scores since they reward high debt rather than prudent spending. (These same geniuses wouldn’t include SocSec income I was entitled to but hadn’t started on a mortgage @ <50% LtV; would I really not start it if I needed $ to not default? I also had plenty of other liquid assets and no debts and an 800+ credit score.) Second, the previous landlord might lie to get rid of a tenant, but certainly worth a call. Third, tax returns are great, since the chance of overstating taxable income is nil. However, there is no guaranty you are getting the real return they submitted. My conclusion is that all of your procedures are worth doing, but are not foolproof so should not be used by anyone to begin investing in rental real estate. There are lots of potholes, which fortunately have been filled by inflation.
I retired after a 40-year career in the property management industry in New York City. It provided a good life for me and my family but continuing on in that business is the last thing I want to do at this time in my life.
Bless you Steve!
Hi Steve, great article, I’ve enjoyed reading your articles. Have you ever had to evict tenants over loud music or put anything into your contracts to pre-empt that, i.e. loud music etc. We have had on occasion a problem with tenants & loud music since apartment next door changed to a rental when landlord moved, though it’s good now, I am wondering if you have ever encountered this & how you handled it? I am trying to counsel the landlord on how to address these issues but he’s Asian & very reticent or afraid.
I’m a (reluctant) landlord. I agree, good tenants are better than fine wine. I try to love them well and invite them to partner in the home. My friend’s best line, “My goal is to provide you with a great place to live. In exchange, I’m asking you to help me take good care of it.”
“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.”
Two of the best lines I have ever read in financial literature!
You are definitely a astute psychologist.
I’m with Dick. I read a book about getting rich as a landlord way back when, and my reaction was that I’d rather be poor than a landlord.
I’m also with Nate. If a prospective landlord asked me for a tax return she would have just lost a tenant. But I grew up in England, and I’ve noticed that I have a considerably higher regard for my privacy than the average American.
Yes, as I said to Nate, the tax return is always a last check on suitability. But remember, especially if you’re managing the property yourself, just one ornery renter—either because of nonpayment of rent or abuse of your investment—can make your private life miserable.
Which is yet another reason not to be a landlord. Still doesn’t give you the right to see my tax return.
The Right to show your tax return or not is up to you, just as it’s up to the landlord rent to you or not, depending on the answer.
When my daughter graduated from college, my husband and I had to act as guarantors on her lease. The best rental option did require us to provide our tax return. She needed the NYC apartment so we provided it. A friend, who specialized in Manhattan real estate, advised us that providing the return was quite common.
Providing a tax return was a request of multiple landlords who provided housing to our sons. I didn’t like it one bit!
It may be quite common, especially in a fierce market like NYC. It is also common in medical settings to ask for (a completely unnecessary) SSN which I always leave blank. (..and if told they “need one” I have a fake one that I use that belongs to no human being..which lists of can be easily found online.) It is estimated that around 50% of all medical records will eventually be subject to a hack of some sort due to the dismal security measures employed and I can’t imagine real estate rental data is protected at a much higher level.
Bingo!
I’m with you on the SSN. I leave it blank, or else N/A, and have yet to have medical services refused. I assume it’s a hangover from before we got different Medicare numbers.
I actually think it is so they can come after you for unpaid bills. (Through a collector.)
Excellent article and I am with Mr. Quinn: glad I am not a landlord.
One question: do you ever have anyone balk at providing tax returns? I always thought of myself as a good renter back in my renting days, by always paying on time and never really complaining about anything. After a 5 year rental, I even had the landlord say, “you were the best renter I ever had”. However, I would have felt uneasy about being asked for tax returns to rent. Given the data security issues surrounding disclosing such sensitive information (basically everything needed to steal an identity: SSN, birthday, full legal name, address, etc.), if I was searching for a rental and being asked for this from potential landlords, I think I might be apprehensive about the request. Maybe I am overthinking it though..
I agree that’s so much information I’d be reticent to just hand it out. If I found myself in such a situation, I’d probably suggest a compromise such as asking the landlord if they’d accept a redacted version with the sensitive information blacked out. Or maybe let them review it in my presence, but not retain either the document or the identity information on it.
I should have been explicit—yes, that’s the program.
You’re so right. Asking for a tax return is a sensitive last resort. But I’ve used it occasionally when I’ve really liked the renter but his credit and/or references raise a possible red flag. Nate, if you ever move to Sacramento, please rent one of my units!
Steve, that makes total sense.
Also, thanks for the offer! However, I am a happy homeowner now and don’t see myself ever renting again or moving to Sacramento but if I do, I’ll give you a call, my friend.
Every time a read one of your articles, I say to myself, glad I’m not a landlord.
I had word-for-word the exact same reaction.
Believe me, I know what you mean. It can be financially rewarding but, unless you’re a happy-go-lucky fixer with a lot of time, it’s a rough proposition. Not being hands-on, my repair expenses were always too high. I was nickel-and-dimed on the small stuff and—even more important—could never be sure I wasn’t being taken for a ride on big maintenance projects like a new roof (most cost-effective material? life span?). If you’re completely hands-off and can stomach a little less capital appreciation, you’re probably better off going with a real estate investment trust (REIT).
Where was this article when I was age 25, buying a 4 unit building. I made many of the mistakes you describe, especially raising the rent aggressively and loosing good tenants, and not relying on credit scores.
Ouch! But cut yourself some slack. You were just starting out—like I was when I self-destructed in the beginning.