The Investment Scientist

Being a Landlord is not a Piece of Cake

Posted on: July 27, 2012

Lease agreement

I wrote about our rental property investment six months ago. We purchased the property for $180k, and we are earning a monthly rent of $1,750. That’s a great investment, with cash-on-cash return of 8% after taxes and HOA fees.

All was hunky dory until recently when we got a call from our tenant, who told us he lost his job and he was only able to scrape together $875 to pay for half of the rent.

We told him we appreciated his effort, and we hoped he would get another job soon. Deep down, we are really not sure how long our rental property will be nonperforming.

Our tenant is by all measure a pretty good tenant.

I have a friend who owns multiple investment properties. One of her tenants sued her for unsafe living conditions. It turned out her property had traces of asbestos, a substance that was commonly used in construction in the 70s and can cause health problems if inhaled. My friend couldn’t have known that, but her tenant was able to hire a good lawyer who forced her to settle. In the settlement, she paid $60k to her tenant for unspecified health damages.

I just can imagine other smart and devious tenants who are using this tactic to extort money out of unknowing landlords.

One of the myths about being a landlord is that you earn passive income – all you do is sit there sipping coffee and the income just rolls in. It is anything but that.

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2 Responses to "Being a Landlord is not a Piece of Cake"

Most horror stories in the Landlord/RE Investor business come from accidental landlords. Divorces with unsold/settled properties or other situations that have no margin in the deal for profit. You don’t have that issue.

We don’t invest in condo/townhomes because the HOA fees absorb profit. But, they also reduce exterior maintainence costs. You could argue either way, our choice was to go single family. If you go with condos you have to structure the debt/equity with enough margin to have profit. It seems you’re good, as long as the rent come in.

We have had 2 move out situations in 3 years on 9 properties. Here is how we resolved them.

The first was an over the road truck driver. He had great income, paid his rent on time, in full. Then the fuel prices skyrocketed. I take blame for leasing to this tenant. I saw his verified income qualified him to rent a home twice as expensive as ours and it was irresistable. When the fuel prices went up he started making partial rent payments. Here’s $500, I’ll catch you next week with some more. You can go like that, but the bookkeepping is more difficult. In Ohio, you cannot evict when you are excepting partial rent payments. The way the law looks at it, you have re-negotiated the terms by your action of taking partial payment. By this time, Jeff had 3 months left on his lease. We managed him to keep him within the current month, then notified him we would not renew the lease. This allowed us to find a better qualified family for that property, with out attorney and eviction court costs and fees. We lost 1 month rent.

The second was a senior citizen. She walked away from her home of 28 years because she had re-financed it several times to get the cash out, then lost her job in a downsizing. By renting she was saving $600/mo.
The trouble is, she loved the home shopping network. In a year and a half she had releveraged the $600/mo savings by using her credit cards to buy stuff. When she complained about how hard it was to live in a house I was sensative to what she was really saying. I told her a lease is an easy contract to break, all the landlord really wants is monthly rent. She let me put our sign out front, gather leads, and show the property. In her case, I paid for the movers to mover her to a senior apartment community. It cost me about $1,000. Court, attorney, Sherrif’s deputy, and a put out would have been about $4000. She moved out on Friday, on the weekend my painters freshed up the paint. Monday morning “the Maids” did the kitchen, baths, windows, and blinds. Monday afternoon the new tenant paid her deposit, rent, and made plans to move in.

Years ago a good friend that was a CEO of a company gave me an axiom. He said, “If you don’t solve today’s problem, you will never get the chance to solve tomorrow’s problem.” Your tenant has a problem. Your job as landlord is to keep his problem from becoming your problem. He has lost some of his income and he needs a more affordable place to live. The longer you allow this to not resolve the more expensive and the more litigous it becomes. In this situation I would work toward marketing the property and finding a more qualified tenant so you can be generous and let him out of the lease without sueing him, getting a judgement, and setting his stuff out in the street.

To mitigate this issue in the future, I established a vacancy fund. By tracking my experiences I noted how much a vacancy costs and put away that amount for this situation. Then when it happens, we still get our draw checks, mortgages still get paid, and I still have cash to freshen up the place and market for that new tenant.

When I ran my little barber shop years ago, I used comparison and exception as an accounting tool. I set targets and worked at meeting them. Then measured the difference. I discovered when the exception becomes the rule, you need a new model. So in the rental business as soon as vacancy warped the model I started budgeting for that reality.

I’m not the know all/end all in this. I’ve only been at it three years. It’s been very rewarding and even in this banged up economy it’s been a winner for our family. I think the reason is local control. If a unit is broken, I can see about fixing it. If it’s vacant I can rent it and restore it’s earning power. In 2008 those were things my investment manager could not do.

Ron,

Thanks for sharing your story. You are a good planner, you are disciplined and handy. People who do not have your traits may not find being a landlord their cup of tea.

Michael

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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