When you are trying to reach your retirement goals using a long term real estate investing strategy, there is a multitude of factors can make the crucial difference between success and failure. To mention a few, the quality of the location and school district, the price to rent ratios in your portfolio and the terms of your financing are all factors that lead to underwhelming results when compromised.
But if I had to pick one factor that all successful long term real estate investors must get right, one ingredient that is necessary for your portfolio to achieve its full income potential, I’d have to go with the ability to find and keep great tenants. Without great tenants, your dream retirement unravels into a hassle laden, vicious circle of vacancies, evictions and problem calls that typically keep skeptical inventors from investing in real estate in the first place.
With that in mind, I’m convinced that one of the greatest services we provide for our clients on a daily basis is the procurement of great long term tenants. So today, I wanted to share with you some pointers on how to find and screen potential tenants to find the hidden gems that will pay rent on time for a long time and take care of your property like it’s their own.
Before I begin, I want to point out something of outmost importance. The investment properties you buy generally attract (and essentially pick) the type of tenant you will eventually have. If you buy a property in a bad location, with high crime rates and low quality schools your applicant pool will consist of tenants that would want to live in that property. There’s no magic wand that would allow you to find great tenants for a low quality property. So, what follows assumes that the property itself is an investment grade property in a good location that would attract a well qualified tenant.
Now that we got that out of the way, let’s say you just closed on a great investment property and are anxious to find a great tenant (as 100% of investors are). How do you go about finding and screening applicants in a methodical and proven way?
First let’s tackle the “finding part”. At the outset you have to let the market know that you have this great property available for occupancy. Painfully obvious, I know. But you’d be surprised how many investors fail at this stage in a futile quest to save a few hundred bucks. In order accomplish this, your property needs to be listed/advertised/posted where potential tenants look for rental properties. That means your property must be listed on:
- The MLS – A large percentage of the great tenant pool are relocations into the city where your property is located. These tenants are usually well qualified, have high paying stable jobs and they HAVE to move. So all the ingredients are there in a neatly wrapped package. Now the wide majority of these clients have agents who represent them that were assigned to them by the relocation company. Their agents aren’t going to drive by neighborhoods at random and see your red “For Rent” sign you bought at Lowe’s. If your property isn’t on the MLS, you essentially don’t exist for a large section of the very tenants you are hoping to attract.
- Every Real Estate Portal – Your listing needs to be on every real estate portal that accepts lease listings: Zillow, Trulia, Hotpads etc. Do all these work all the time? Not really. But you are trying to cast a wide net and see what brings in the haul. The good news is that most MLS these days automatically syndicate to these portals. Or in the event the one in your city doesn’t, there are websites you can use to upload the property once and propagate it to all portals (i.e Postlets)
- Craigslist – Finally, the godsend for landlords everywhere. After the MLS, Craigslist is the second largest source of tenants we have found. Your listing must be on Craigslist and it must be there as often as they will allow you to be there.
But the fact that your property is listed in these places, is as important as how it’s listed. In order for your property to stand out, you must have well lit, high quality pictures taken. If you don’t have a high quality camera and flash, hire a professional photographer. It will be the best Benjamin you ever spent. Pictures are crucial.
Last but not least, the ad for your rental property needs to resemble the ad for a job. Just like the employer paints a picture of the ideal candidate they would like to hire, so should you describe the exact tenant you are looking for in specific detail. Don’t be afraid to alienate the candidates that don’t meet your criteria (provided your criteria are reasonable and most importantly, legal). You’re not trying to generate interest for interest’s sake. You’re trying to generate targeted prospects that have a high probability of getting approved.
That brings us to the second part of the discussion: The screening process. Suppose that your marketing efforts have paid off and now you have lease applications from prospective tenants. What are the factors that will determine the eligibility of the tenant or lack thereof? In order of importance:
- Rental History
- Sufficiency of Income
- Employment History
- Background check
- Credit Check
The prior rental history of the applicant is a great indicator of how they are likely to perform during your lease term. So in most cases, serious problems in the applicant’s rental history lead to the rejection of the application. What you are looking for here is at least a two year history of leasing properties with no issues. Any prior evictions, collections from previous landlords, lease breaches etc tend to indicate problems that are likely to repeat themselves so we avoid them every time. Other aspects of the applicants’ rental history that matter are the typical length of their prior leases and the rent amount they’re “used to paying”. If the history reveals a tenant that moves every 3-6 months, that might not be the best fit if you’re looking for a long term tenant. And finally, you want to avoid the effects of rent increase shock. A tenant that has been paying about the same amount of rent over a period of time is less likely to be shocked than a tenant that’s used to paying half the rent you’re asking.
Sufficiency of income is paramount to avoid future defaults, evictions and vacancies. In fact, one of the principal reasons that lead to evictions is the investors’ own carelessness in placing a tenant in a property they can’t afford. This may sound like overkill but what you need to do to determine sufficiency of income is to run a down and dirty budget for your tenant. How much of their gross pay do they take home? How much “disposable income” is left over after they pay your rent, utilities, food, gas, and monthly payments? If the answer is “not much” you’re one car problem away from not getting your rent paid. Why would you do that to yourself on purpose? So, to insure there’s enough income there to support the lease, we require tenants to make 3.5 times the monthly rent in gross income. Essentially, we want the lease payment to be no more than 28.5% of their gross pay. Last but not least, their income has to be reliable (salaried or base, not variable commissions) and documentable through pay stubs or tax documents.
Employment history addresses the probability that the income we’re relying on is likely to continue during the lease term. Typically, we look for at least 2 years in the same line of work (they can be at different companies as long as its the same job and level of income). Of course there are exceptions – for instance a recently graduated college student with a solid job offer letter for a reputable company.
The background check is another go/no go criterion. It must be clean of any issues that show character flaws (theft, violence, fraud, drug related issues and other serious criminal offenses). We look at small misdemeanors on a case by case basis. If its an issue that happened 20 years ago and the tenant has no issues since, that’s looked at differently than something that happened last week.
The credit check is a tricky one because investors tend to simplify the matter down to a credit score. I don’t agree with that approach. More important than the score is the story. Some credit reports tell the story of an applicant that’s always late on all payments. Others, tell you about a rough patch the tenant may have been through a while back due to a job loss or medical issues but also speak of solid payment history since then. The funny thing is, both candidates may have the same exact credit score. And I’d lease to the second (provided all the aforementioned criteria is in order) but not the first.
Pets are another issue that requires a lot of care. If you just purchased a quality property in a great location you might be tempted to categorically disallow pets to prevent damage to your property. The problem is, a large percentage of the “great tenant” pool have pets so by excluding them you’d be missing out on some great candidates. Besides, pets require a lot of care and dedication so in a way, the fact that your tenant may have a pet is a sign of maturity and stability. But on the other hand, some pets can cause a lot of damage to properties. So, it’s important to get this right. Usually, we go with a case by case approach on this. We place weight limits (40lbs) and total number of pets limits (2) as well as exclude breeds considered dangerous to eliminate liability. We also charge non refundable pet deposits for each pet to mitigate the risk.
Finally, you want to make sure that the information on the lease application is true and correct and has not been “enhanced” by the tenant to fit what you’re looking for. You do this by checking references. Check county records to make sure the listed landlord truly owns the property they leased and isn’t a friendly uncle. Then, call all previous landlords listed and ask open questions (not yes/no questions). After you’ve verified the information as correct ask them if they’d lease to the tenant again if given the chance. Repeat the process with their managers at work.
There’s no possible way to avoid all defaults and problems as they’re part of life (even qualified tenants can be laid off) but if you follow the advice I’ve just given you to find and screen great tenants for your investment property, you’ll reduce their occurrence to a minimum.