Long Term Rental Properties

Regret > Loss

August 4, 2015 By Erion Shehaj Leave a Comment

The current strategy most Americans use to save and invest for retirement is fundamentally flawed. In order to evaluate the effectiveness of any strategy in an empirical way let’s look at the final results. Then let’s compare them to the results you employed the strategy to achieve.

We will go through that very process using two well known and often quoted studies.

First, a 2007 study performed by the Employee Benefit Research institute found that the average Baby Boomer had an average balance of $75,000 in their retirement account at retirement age. The same study performed recently, found that average balance has risen to $127,000 following the bull market of recent years.

Second, a 2009 study performed by the US Census found that the average college graduate (undergraduate) earns a little over $2M in their lifetime. Graduates with higher level degrees earned $2.5M (masters) and $3.5M (doctoral). But let’s stick with the undergraduate figure for the purposes of this article.

The math here is shocking and unforgiving! After 40+ years of working, earning, saving and investing the average “retiree” ends up with a little less than 2 years salary in their nest egg?! After four decades of tax-deferred 401K contributions, employer matches, double digit average market returns you arrive to find an account with 6% of your lifetime earnings?!

I know, I know. Yes, many boomers invested when the market was at the peak and pulled their money out at the bottom because they were fearful. Yes, they may have neglected to invest during the early years because they weren’t thinking about retirement then. Yes, their portfolios were probably not as diversified as they should have been. And finally, yes, they could have had much more money at retirement if they had the discipline of a robot and were completely unfazed by a 30-40% drop in the market.

All that considered, some pesky questions remain. Is this the outcome Baby Boomers signed up for when they invested their hard earned money? If given a do-over, would they do it again?

Of course not.

Sadly, for most retirement age folks in this predicament the only remaining option is to work much much longer than they had anticipated. But what about future retirees who are 15, 20, 30 years from retirement? After seeing the sad ending to this movie, do you follow the same path on purpose or do you shift strategy, direction and ultimately destination?

America has been called the “land of opportunity” and nowhere is this more evident than the above example. Unlike most countries around the world, an average college graduate earns a couple of million dollars in their lifetime. Think about that. Not the outstanding, exceptional college graduate – the average.

If this average graduate simply saved a dime out of every dollar she earned and never invested it at all, she would end up with 2-3 times more in their retirement account than the average retirement-age Boomers. How’s that for pathetic results?

When you first consider investing in real estate long term, fear of loss promptly ensues. After all, there are many unknown variables:

How do you know if it’s the right property?
What if the tenants are a major hassle?
What if it doesn’t rent quickly?
What if there’s a major repair?

I wrote this article to make one simple yet crucial point: Regret > Loss.

When you live in a country where the average college graduate makes over $2M in earnings in their lifetime, that’s a major opportunity. If you squander the opportunity to make something beautiful, to become financially independent and built wealth, the regret will be way more painful than any temporary fear of loss. If all you have to show for millions in earnings is 40 years of expenses, that will be a shame.

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References:

http://www.census.gov/prod/2002pubs/p23-210.pdf

http://www.usnews.com/education/best-colleges/articles/2011/08/05/how-higher-education-affects-lifetime-salary

http://www.fool.com/retirement/general/2015/01/10/the-typical-american-has-this-much-in-retirement-s.aspx

Case Study: Small multifamily investments in growing Texas market

May 22, 2014 By Erion Shehaj 5 Comments Tags: small multi family, texas duplexes

When market dynamics change, long term real estate investors have to adapt their approach to stay on track and accomplish their goals. Previously, I articulated the case for branching out into other growing markets and different property types when market conditions restrict supply to the extent that it threatens the investor’s acquisition needs. Today, we are going to get deeper into the nuts and bolts of purchasing new construction, luxury small multi family properties (duplexes) in a growing Texas market with a detailed case study.

Income and Expenses

Annual Rental Income: $31,800 ($1325/side/month)
Operating, Management, Vacancy and Leasing Costs: $11,534* (36%)
Net Operating Income: $20,266

Purchase Price: $279,000
Down Payment: $69,750 (25%)
Loan Amount: $209,265 (4.75% 30 Yr Fixed Conventional)

Debt Service: $13,099.50 ($1091.63/mo)

Positive Cashflow: $7,166.50 ($597.21/mo)

*Breakdown of Operating/Management/Leasing/Vacancy

Vacancy: $1590
Property Taxes: $5400
Insurance: $800
HOA: $200
Management : $2544
Leasing fees: $1000

Total: $11,534.00

Investment Scenarios

Let’s begin with a basic example and build from there. Suppose you acquire one duplex that performs as outlined above. Next, you follow our advice and decide to grow your capital base first so you can maximize cashflow at retirement. Therefore, you utilize current positive cashflow to aggressively pay off the debt on the property. If you just use the property’s own cashflow without any additional investment from your job income, the mortgage will be paid off in 170 months or (14.2 years) at which point, if rents haven’t risen a penny in that decade and a half (chances of August snow in Houston are higher), your property would produce a pre-tax income of just over $20,000 per year. That’s in addition to your capital base growing four fold from the $70k initially invested to $280,000 of paid off real estate (if we assume zero appreciation). Suppose you need to get this done in 10 years vs 14 – how much would you need to contribute monthly from your job income? Roughly $500 per month! That’s lower than most people’s monthly Starbucks “contribution”.

Now what if your income needs far exceed the $20k/year produced by one duplex. Let’s look at a scenario where you acquire 3 such small multi family properties. It’s commonsensical that if you are able to pay off one duplex using its own positive cashflow in 14.2 years, you will be able to pay off 3 in the same amount of time since you’d be working on all three simultaneously. But what may not be as self evident is that if instead of using each duplex’s own income to pay off its own mortgage, you use the combined income to pay them off one at a time, you will start seeing results sooner. More specifically, the first duplex would be paid off in roughly 7 years, the second in just over 4 years and the last in just under 3. So, while the total time to pay off all three is the exact same, the investor that has one duplex completely paid off after 7 years has a lot more options on her menu than the investor who has the same mortgage balance spread over three properties but none paid off. And more options lead to victory. Similarly, if you want to shorten the time in which they’re paid off, a small contribution from your monthly job income could shave about 30% of the time to get to retirement. In this scenario, the investor would end up with pre-tax income of $60,000 per year and a paid off portfolio of real estate worth just shy of $1M if rents and values don’t go up one penny.

Concluding thoughts

In these case studies, I intentionally omit to consider any rent or price appreciation as part of the analysis due to my conservative nature. But you don’t have to be a real estate expert to know that over long enough periods of time both prices and rents go up (excluding markets where prices are artificially inflated by bubble conditions and rents are controlled). Even under the most conservative of appreciation assumptions (I.e inflation rate), the investor that controls the highest asset value (3 duplex scenario above) reaps the largest benefits on both the income and net worth front.

Finally, any investment performance must be judged relative to other available alternatives. So in that sense, I want to end this with this question:

When we take up the case of investing $70k to purchase one small multifamily (or $210k to purchase three), can you think of any other investment alternatives that in 14 years would turn your capital into $280k (or $840k for 3) AND produce $20k (or $60k for 3) per year respectively?

Or let’s make it a bit more fair. Can you think of an alternative that can do HALF as well?

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In the next post, I will discuss the Top 5 qualities that make this property type and it’s growing market a solid investment for a long term real estate investor. So please stay tuned.

If you would like a detailed cashflow analysis of the numbers discussed above, please email me or if you’re reading this from your email just hit reply.

Branching out to solve the Biggest Challenge: Small multifamily properties

May 16, 2014 By Erion Shehaj 2 Comments Tags: small multifamily, texas duplexes

In an article I wrote at the beginning of the year, I summarized the biggest challenge of 2014 for long term real estate investors in a single word: Supply. Now that the second quarter of the year is almost coming to a close, that prediction has become reality. And as we go into the summer months, supply historically shrinks even further as demand rises. In the meantime, your financial goals are still there, calling for acquisitions to be made to build income streams that lead to financial freedom. On one side of the coin, you don’t want to acquire assets that don’t make sense from an investment standpoint simply for the sake of acquiring them. But on the other, you don’t have the luxury of simply taking a year or two off in an environment where prices and (eventually) interest rates are expected to rise further. So how should you navigate under these circumstances?

Market “gravity”

In life and investing alike, there are issues that are rightfully up for debate and then there’s “gravity” – a law that applies equally across the board regardless of our beliefs about it. In long term real estate investing, a gravity-type law says that you take what the market gives you and build your strategy around it. Many a fortune have been squandered by investors on a mission to disprove that simple law. While in midair, many such investors actually think they have outsmarted the law – on the way to the eventual pavement.

However, one major distinction is that, unlike physics gravity, which is constant and applies to all equally, the real estate investing market is an ever changing landscape. Today’s market “gives” investors a much different set of circumstances than say it’s 2008 counterpart. So while the law always applies, there’s a variable dimension to it and you must be able to adapt your investing strategies to reach your goals. That’s not to say that you switch strategies as the wind blows – the principles must remain the same. But you shift your investing approach while abiding by those principles.

Principles to assets

Investing principles come first and assets follow. I know it sounds like a Captain Obvious proclamation but you would be surprised to know that the majority of long term investors get that important order completely backwards. Without first devising an overarching strategy and distilling from it investing principles to live by, they make an arbitrary decision on the type of real estate assets they will pursue. They buy “cheap single families and rent them out” or “small apartment complexes at $X per door” or “small condos with a max price of $X”. And all the while there’s no rhyme or reason to it. And most crucially, there’s zero consideration of the fact that the market “gravity” may have changed the landscape to extinguish the opportunities in the asset type they’ve arbitrarily chosen.

The alternative approach: Start with the end in mind (goals), devise a plan to achieve them (Blueprint), come up with clear criteria the asset must fulfill (principles) then look at the market and the asset types it offers that are the best suited vehicles to get you across that finish line.

Asset principles of the Blueprint Strategy

Our Blueprint strategy’s approach to determine investing principles for the type of asset to acquire is very simple. Our investors reach their goals when they own the right size portfolio of real estate leased to great tenants. Great tenants lead to low vacancies, low turnover and profit maximization. In our experience, great tenants look for properties located in good school districts in great, safe neighborhoods with easy access to employment centers through highways and great amenities and low hassle. Constant repairs in a property represent a great hassle to a great tenant (and the corresponding investor which has to foot the bill to boot) and they’re a direct result of the age of the property. It’s better to purchase an older property in a great location than a new one in a bad location but it’s so much better to purchase a newer property in a great location. Real estate investors should be concerned with two types of returns: returns on investment and returns of investment. The way to protect your invested capital and make it grow through appreciation over time is to purchase a property that can be sold for top dollar should the investor decide to exit. No one pays top dollar for average, run of the mill properties so investors should be looking for a property that will have appeal to the eventual buyer to whom they will sell the property eventually. And last but not least, the property has to have a good price to rent ratio as to provide an adequate return on investment.

So, to sum up, long term investors following the Blueprint strategy look for newer, quality properties in top locations with good price/rent ratios to provide an adequate return on investment.

Asset types

Notice how in the above summary, there’s no mention of specific property types. No “single family homes”, “small multi-family”, “condos” etc. That’s an omission of crucial significance because different markets “give” investors different asset types that can accomplish the goal. For example, in North Carolina, new (or new-ish) attached townhomes offer everything the asset principles above call for at a more favorable price/rent ratio than single families. In Texas, single families substantially outperform townhomes. In some cities, there are newer small multi-family opportunities in great locations while in Houston they’re virtually non-existent – they’re either older properties in good locations or newer ones in bad locations.

That’s the reason most of my case study articles that discuss investing in the Houston market involve single family homes. It is not because, that’s the type of asset we favor but because in this particular market, that’s the best asset type the market gives us to help investors accomplish their goals.

Solving the Biggest Challenge

Let’s come full circle to the initial premise of the article: Rising prices and increased competition for single family homes in the Houston market have reduced the supply of opportunities for long term investors. But if your Blueprint still calls for further acquisitions in a climate of reduced options, what are we to do? We need to look for additional options elsewhere – in markets that have most of the same strengths that perhaps “give” investors access to property types that just aren’t available here at this moment. That’s what we’ve been diligently working on since the second half of last year and I’m excited to say that what we’ve found abides by the asset principles above and gives us some additional benefits to boot.

I plan to present a specific case study with hard numbers in a subsequent article but I’d like to end today’s post with a summary of strengths that this new opportunity offers:

New construction, luxury small multi-family (duplexes) zoned to great schools
A growing Texas market with a population growth rate 9 times the national average
Quality property management company in place providing a true turnkey investment
Maximization of asset value per conventional loan
Low property taxes, hazard insurance, HOA dues
Attractive price/rent ratio and low days on market/vacancy rate
Luxury low maintenance finishes (brick exterior, granite counters, 11-12ft ceilings, oil rubbed bronze fixtures, no carpet anywhere)
Builder warranties (1 year wall to wall, 2 year HVAC/electrical/plumbing, 10 year structural)

Next time, I will present the hard numbers and show you how you can weave these small multi-family properties in your Blueprint strategy and utilize some of the strengths above to propel you towards your goals. Until then, take good care of yourselves for me.

The principal reason you won’t become wealthy investing in real estate

February 28, 2014 By Erion Shehaj 1 Comment

The majority of my writing here covers real estate investment strategies and mindsets you can use to become wealthy with long term real estate investing. In various case studies, I have shown you how to create a six figure income and how to retire in seven years etc. by making smart real estate investments tied by the common thread of a solid Blueprint strategy.

And that’s all well and good. We all can benefit from a little more “big picture” insight to help us design and take charge of our own financial future. But when you get down to the dirty details, the execution of such plans usually ends up being a lot messier than those projections. It’s one thing to look at and intellectually understand the mathematical implications of a strategy that assumes flawless execution. It’s another to actually execute. Think about all the things you have to contend with when making an important financial decision. We all want to avoid risk where possible (risk aversion) which leads to uncertainty (indecision) about whether this is the right move (wanting the best deal possible) which leads to procrastination and paralysis by analysis (inaction).

Sometimes knowledge of the path that leads the opposite way can illuminate the path that leads to what we want to become.

In the context of building wealth through a disciplined approach over long periods of time this is not only true – it’s eyeopening.

You see there’s this massive myth in the realm of real estate investing that has been propagated by multiple books and has been accepted as truth by most. It claims that in real estate investing you live and die by your rate of return. You might have heard it put a different way in “you make your money when you buy the property” or “if your incoming rent is not at least X% of the purchase price, don’t buy the property”. They’re all different shades of the same idea:

Myth: Your ultimate success or failure in becoming wealthy investing in real estate is a direct result of your rate of return. Therefore, you should have a set return number in mind and use it as an acid test. Anything yielding a lower return is a nay, anything higher a yay.

Sounds sensible enough, right?

Let’s add on another layer of context to this discussion. In a free capitalist society the only constant you can count on is change. Case and point: The real estate market over the last 9-12 months has been experiencing rapid change from a sleepy sideways market to a “write your full price offer before you leave the property or you don’t stand a chance” Seller’s market. Obviously this has caused prices to rise and inventories to shrink substantially in most markets which leads to downward pressure on rates of return investors are able to obtain. Last week, I had a conference call with a client that had purchased several properties in 2007-09 and was mortified by the unrecognizable landscape.

With that in mind, you can see how “the number” you have in your mind for an acceptable return can change based upon your previous experiences (a new investor with no past frame of reference would view today’s market very differently than an investor that acquired property at the most distressed point of the 08 recession) and therefore influence your action (or inaction) going forward.

But none of that matters.

The idea that your wealth building efforts will succeed or fail based upon your ability to secure a certain rate of return is just untrue. Here’s an example that dispels that myth: Suppose you have two real estate investors A and B. Investor A puts together a portfolio of 9 high quality properties yielding 15% annual returns and Investor B purchases similar quality properties (9) that only yield 10% returns. Both investors employ a Blueprint strategy to aggressively pay off their properties over the next decade and end up with the same income at retirement. All else being equal, Investor A will get to retirement much faster due to the higher return on his investments but in the end both investors end up with a similar net worth and income. In other words, both end up wealthy. So the 30% difference in returns impacted the speed of success but not the ultimate result.

Of course, all else is rarely equal in real life.

Take the same example above and add the layer of context of a changing market I described above. During the acquisition phase their plans, the market shifts and now 15% return properties dwindle in numbers and Investor A only acquires 5 out of the 9 properties he was planning to acquire. Meanwhile, Investor B completes all nine purchases since his 10% rate of return is more readily available. Who do you suppose fares better in the end? Investor B portfolio crushes Investor A’s and his coveted 15% because he acquired and paid off a larger asset value becoming significantly wealthier in the process.

It’s not the rate of return that determines your success or failure on the road to becoming wealthy. It’s action. If you’re disciplined and have a solid plan, you will pay off and own whatever you acquire. But it’s the acquisition that sets everything in motion. Without it, you lack the target to hit and with it the structure you need to be able to execute.

Remember this: Far more wealth is lost by inaction than ever was lost by accepting a lower return. Don’t let an arbitrary number in your head back you into the corner of inaction. That’s the principal reason one fails at becoming wealthy.

The biggest challenge of 2014 for long term real estate investors

February 3, 2014 By Erion Shehaj Leave a Comment

Sometime around the summer of 2013, the investing landscape in Houston began to change at a rapid pace. Demand soared, inventories shrunk to record levels and the Houston real estate market lit up like a wildfire.

Bank owned foreclosures, the perennial sweethearts of investors everywhere that had accounted for one in four sales just a year ago, now barely contributed six or seven percent. The few properties that banks were bringing to market were either inaccessible to investors (in favor of owner-occupants) or priced at market prices despite the need for repairs.

Meanwhile, builders started ramping up construction to complete subdivisions that had been developing at a snail pace and break ground on new communities. But as one builder told me, “after five years of increasing construction costs and stagnant prices the market was finally allowing them to raise prices”. And raise prices they did. Same subdivision, same property that had been selling in the high $140s, first went to the mid $150s then mid $160s in six months’ time. Fortunately, rents kept on rising right alongside prices so it made sense up to a point. Then prices rose out of reach.

Finally, the owners of existing homes with plans to sell started setting their pricing sights ever higher boosted by anecdotal evidence of neighbors’ homes selling in a matter of days at full price and multiple bids.

As a result of this combination of higher demand and tighter supply, we ended up with record numbers in sales, prices and inventory for 2013:

So what does this mean for investors in 2014?

After that synthesis of the second half of 2013, the knee-jerk conclusion that some investors might draw is that the “train has left the station” and the prudent course of action would be to sit tight and wait for prices to come back down to the good old 2010-2012 levels. While I understand the impulse to draw that conclusion, I think it’s misguided on several levels.

First, the idea that if we just wait it out, prices will come down in short order is based on the assumption that we are currently in a bubble that will burst soon. That couldn’t be further from the truth and here’s why. From 2008 till the end of 2012, home prices in the Houston area were pretty much flat. They didn’t go down much (like California, Nevada, Florida and the like) but they didn’t go up either. That was during the 2008 recession. In 2013, prices went up 10% for a single year after five sideways years. If that constitutes a bubble, I’m Irish. In a real estate recovery, what do you suppose prices should do? Not only are prices not going to come down shortly, but they are likely to go up some more. In fact, Forbes (among others) predicts that prices in the Houston-Sugar Land-Baytown metroplex will grow about 24% over the next 3-4 years. So waiting on the sidelines will not help but rather hurt your efforts as an investor.

Second, if you are an all cash investor that does not utilize financing, the price you pay for a piece of property is the single determining factor in how that property will perform as an investment. But for the overwhelming majority of long term real estate investors, that’s not the case. They will put down a large down payment (20-25%) but will finance the rest. For that overwhelming majority, prices tell only part of the story. The terms of their financing tell the rest.

Here’s what I mean: Suppose there is a property that you can purchase for $150k today (and finance $120k of it at 5.25%) or you could wait a year and buy the same property for $127,200 (and finance 101,750 of it at 6.75%). Do you know that for cash flow purposes, the cost of both properties is exactly the same? And here’s the kicker – the scenario where interest rates rise 1.5% over the next 12 months is a lot more plausible than the possibility of prices dropping by 15% in the same timeframe!

Third, it’s very important to understand what happens to an investment’s returns in an environment of rising prices. There are two dynamics at play – On one hand, paying more for the same stream of income puts downward pressure on cashflow returns. If before you could get 12-16% cash on cash returns, now you’d be looking at 9-10%. But, on the other hand, suppose you acquire a property for $150k in January 2014 investing $35k out of pocket in the process. If by the end of the year prices rise a modest 5%, your return on investment from that appreciation for the year is over 20%! How? Well, when you purchase the property with 20% down, you invest only 20% of the amount out-of-pocket but reap 100% of the price appreciation. Therefore, that $7,500 increase in asset value (5% of 150k) represents a return of over 20% on your invested cash of $35k in addition to the cashflow return you realized. So, the same factor that compressed your cashflow returns is the same factor that caused your appreciation returns. To be fair, cashflow returns are different in the sense that they are reaped every year whereas appreciation returns require the sale of the asset to be reaped. But the goal of a long term real estate investor is maximum cashflow at retirement facilitated by capital growth until that point. In that context, this new environment of slightly lower cashflow returns and higher appreciation returns accomplishes the same goal via a different path.

The Biggest Challenge

That brings us to the crucial point of this article – the biggest challenge of 2014 for long term real estate investors. One Word: Supply. From where I stand, the ability to find and acquire assets to assemble your portfolio will continue to be the principal challenge for long term real estate investors this year. Over the last six months or so, my principal focus has been to find solutions for this challenge. And I am happy to report that I will be sharing some of those solutions with you in the coming posts. So stay tuned – it will be worth it.

Note:

After an avalanche of a fourth quarter and a major life event (we had a healthy baby boy in December), I have been absent around these parts for quite some time. I really appreciate that many readers have reached out and missed the regular writing. I can’t begin to tell you how much I miss it myself. Although mildly sleep deprived (sleep is overrated, anyway), I’m back on the saddle and I look forward to the discussions on the blog. Thanks for sticking around –

Investing Architect

How to find and screen tenants for your investment property

May 31, 2013 By Erion Shehaj Leave a Comment Tags: Tenant screening

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
Pets
References

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.

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