Wednesday, August 17, 2005

Painting a Target on Yourself?

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Want To Be A Landlord?
Understand The Risks Housing Boom Makes Investments Appealing, But Potential Pitfalls Abound
August 16, 2005 By JAMES R. HAGERTY, Wall Street Journal

Determined to profit from the housing boom, many Americans are acquiring rental properties. But some of them may be underestimating the risks and complications that come with being a landlord.

"We get a lot of inquiries from naive people," said Mike Phillips, who owns Century 21 All-Pro, a real estate brokerage in Kansas City, Mo. He gets calls from people in California, Florida and New York who think that property in Kansas City must be a steal.

Phillips tells inexperienced investors that they need to examine such factors as the health of the local economy and the supply and demand for rental housing. In much of the country, the fundamentals look bleak for landlords. Low interest rates have allowed many former renters to buy houses in recent years, removing some of the most reliable tenants from the mix.

According to the Census Bureau, the vacancy rate for rental housing in this year's first quarter was 10.1 percent; that rate has been gradually rising since the late 1970s, when it was about 5 percent.Investors also need to ask whether they can cope with the hassles of dealing with tenants.

"What if the renter's kid shoves G.I. Joe in the toilet?" Phillips asked.

"You have to have a game plan because they're going to call you."

Yet Americans' faith in real estate is remarkably strong. During this year's first four months, investors accounted for nearly 10 percent of new mortgage loans used to buy homes in the United States, up from 6 percent in 2001, according to LoanPerformance, a unit of First American Corp.

For those willing to put up with the ordeals of owning rental property, here are some tips from seasoned landlords.

Figure out your total costs. Unless you take into account all of your costs, you won't know whether you're making money.

"Most people underestimate their expenses dramatically," said Jonas Lee, a managing partner at Redbrick Partners LP, a New York firm that invests in single-family rental housing in Baltimore, Philadelphia and other Northeastern cities.

The costs include obvious things, such as insurance, maintenance and property taxes. But they also include items that some landlords overlook, such as periods of vacancy, bad debts, the occasional need to replace expensive items, such as roofs or furnaces, and time spent managing the properties, Lee said.

All of these costs can easily eat up half of the expected rental income, Lee said. And that's before you consider financing costs, which may absorb the rest of your rental income, or more.

Screen potential tenants. Many landlords use a variety of Internet services to check on applicants' credit histories, as well as any past evictions or criminal troubles.

"My theory is that if they don't pay Citibank, they're not going to pay me," said Jean Yevick, president of the Western Pennsylvania Real Estate Investors Association.

Some landlords also consider such things as whether the applicant shows up on time for an appointment and can communicate clearly. Neatness helps.

"If they have a car that's full of junk and is disgusting-looking, the likelihood is that they're going to keep a dirty house," Yevick said.

Don Werner, a Denver landlord who is chairman of a committee of independent rental owners who belong to the National Apartment Association in Alexandria, Va., requires his tenants to have monthly income of at least three times the rent.

Understand the Fair Housing Act. Among other things, this 1968 law prohibits discrimination in the renting of housing based on race, color, national origin, religion, gender, family status or disability.

That does not mean you have to rent to anyone who comes along. But you should strictly follow written policies about your criteria for selecting tenants so you can't be accused of bias. It is lawful, for instance, to refuse to rent to convicted criminals. But you could be vulnerable to complaints of discrimination if you applied that rule only to certain applicants. If you want to run criminal checks on some applicants, run them on all.

React quickly when tenants cause trouble or don't pay.

"There are a lot of people who have convincing stories" about why they haven't paid the rent, said Chris Ballard, who owns rental houses in the Atlanta area, as well as Century 21 Gold Medal Realty in Atlanta. But "you have to stick to your standards," he added.

"You learn over time to be polite, but firm and direct."

After 30 days, he starts the eviction process. Some landlords start even sooner.

Many rely on the courts to evict deadbeat renters. But Rich Sommer, a landlord in Stevens Point, Wis., said he can usually work out problems informally by visiting tenants.

"Most often a five-day notice will encourage them to leave," he said.

If tenants violate Sommer's rules, which include a ban on kegs of beer, he urges them to find another home more suitable for their lifestyle choices. To show his good faith, he sometimes shows up with a check refunding part of the deposit and promises to pay the rest if the tenant leaves within a few days without causing damage.

Inspect the property regularly. Ballard, in Atlanta, makes sure to inspect each unit once every six months. In the past, he was less disciplined about inspecting. He then discovered that one tenant had let more people move into the house without Ballard's knowledge. That eventually caused a septic tank to overflow and leak into the backyard. Be ready for problems. Sommer has had a suicide in one of his apartments and a drug raid in another.

Expenses can come in big lumps. Mike Weston, a financial planner in Highlands Ranch, Colo., said sewer lines broke in two of his rental units within a month.

"I'm assuming it was a total coincidence," he said.

The cost totaled more than $10,000. Other tenants called him in to unclog toilets or shoo away bees from the backyard. Eventually, he decided the headaches were too frequent and sold his properties. Make sure you are properly insured. Ted Webersinn, a commercial property appraiser in Surry, Maine, and his wife, Susan Sokol, owned rental rowhouses in Baltimore in the 1980s. They initially expected the neighborhood where they invested to improve, but the crime and blight only grew worse. The property manager they hired carried a gun while collecting rents. Eventually, the couple sold four of the houses and gave one to the city.

More than a decade later, a former tenant sued them, alleging that the tenant's children had suffered from exposure to lead paint. The case rumbled on for years before being settled out of court. The couple's insurer paid for the settlement and legal fees. As soon as that suit was settled, a second tenant filed a similar one. Altogether, Webersinn and his wife endured about a decade of litigation. Without insurance, Webersinn said, they probably would have had to file for bankruptcy.

Don't count on rapid appreciation."People are real high on appreciation right now," said Sommer, the Wisconsin landlord.

"They think they're just going to make gajillions."

But house prices are unlikely to keep rising indefinitely at the rapid clip of the past few years. That means some investors may find themselves remaining in the landlord phase longer than they expected while waiting for a good opportunity to sell.

Landlord Rights and Free Speech

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