VSM Real Estate
The secret to a successful rental property is finding the right tenant! - Learn the secrets to make it a reality!
Secrets to Rent Your Home the
Right Way Everything you need to know about successful property management for the Do-It-Yourselfer or Investor.
Confessions of a property manager and real estate investor!
The Secrets to Renting Your Home the Right Way
Prologue: Getting the right tenant is easier said than done. This book is written to give you a step by step process of making renting a profitable and stress free investment. Whether you own a house that is upside down or you are savvy enough to know that now is the time to invest in real estate, the principles are the same. About the Author: Ryan Schroder is the owner and CEO of VSM Real Estate, a real estate company specializing in leasing and property management in Saint Paul, Minnesota. With more than 10 years of diverse real estate experience including selling small businesses and hotels throughout the Midwest region, Ryan also owns and operates dozens of rental properties in his home market. For more information on the author and his company, please visit www.VSMRealEstate.com Ryan was born and raised in the Twin Cities area of MN. He graduated from Metropolitan State University with a degree in Management. He is a serial entrepreneur that is involved in a number of businesses ranging from real estate to online products. From his early days he always loved all things real estate. Ryan lives in Woodbury, MN with his wife and family. Introduction Thank you so much for choosing my book. My approach to â€œThe Secrets to Renting Your Home the Right Wayâ€? is a culmination of the experiences I have had as both an investor and property manager for others. While it is true that there is more than one right way to rent your home, there are some very good principles in this book that you should give strong consideration to. This book is intended to be a step by step guide to finding a great tenant and making money over the long term. In my experience, there are no short cuts when operating a successful real estate investment. When considering renting your home you should try to remember that in order to get the best tenants and to expect them to do things the right way, you will need to be prepared to do the same. My theory on the tenant-landlord relationship is reciprocal respect and honest, forthright communication. Having managed several hundred properties for owners in a situation probably very similar to your own, I have learned a lot about what works and what doesnâ€™t. There were times when I was a lot more flexible in what I thought was an acceptable way of renting homes. Over a longer period of time and with a larger sample size, certain facts became very evident. The underlying message of this book is that the best expect the best. Given that the right tenant makes all the difference, this book is about attracting, keeping, and holding the tenant accountable.
TABLE OF CONTENTS
There are 15 Secrets to Renting Your Home, and a chapter dedicated to each. 1. 2. 3. 4. 5. 6. 7.
Rent Ready Condition – winning the beauty contest and finding a tenant The Right Price – limiting vacancy and getting the most out of your property Professional or Self Manage – do you need a management company? Marketing – where can you attract prospective tenants? Maintenance – how do you manage to stay on top of the work load? Background Check – how to determine that you’ve found the right tenant? Move In Condition Report – assuring the new tenant understands their responsibility to your property 8. The Lease – the details of your binding agreement 9. The Addendum – where you customize your agreement 10. The Move In – the transfer of possession and utilities 11. Rent Collection – expectations with timing and late fees 12. Tenant Issues – if there are tenant related problems and how to handle them 13. The Move Out – comparing the move in to move out 14. Tax Implications – the benefits of a real estate investment 15. Liability – protect what is yours
Chapter 1 - Rent Ready Condition To know what the right improvements are is to understand the tenant mindset. There are certain improvements known to give you the most bang for your buck. Tenants are not responsible for the cost of the repairs to the furnace or the roof. They don’t find value in your new windows and retaining wall. They care about the way the house looks and this is something that you won’t change once they are your renter. Kitchen, bathrooms, and living areas are what sell your home. Even if your house is old, it can still look its best with the right improvements. The three ways to get the best return on investment for your rental are: 1. Cleanliness – Your property should truly be sparkling clean. The best prospects have discerning standards. This has a dual effect of setting expectations high with the tenant and showing them just how you do business! Setting the standard early will help you later down the road. 2. Paint / Walls – There shouldn’t be wallpaper or vinyl, unless it’s very modern looking. Walls should be patched and sanded prior to painting. Paint colors should be neutral and professionally painted for the highest quality. Don’t try to save money on paint, it will cost you more in the long run. High quality paint is one of the best investments you can make in your property because it covers in one coat and holds up over time. 3. Flooring / Carpet – The floors should be at least relatively modern or desirable. Outdated or ugly carpet, vinyl flooring, and other types of flooring can drastically reduce the desirability of a rental. Taking into account that these improvements go a long way and are less costly than others, flooring makes the cut for best return on investment. Cleanliness falls into the category of Rent Ready Condition. All rental properties should be both shown and delivered hotel clean. All appliances should be pulled out and cleaned inside, outside, and underneath. All floors should be cleaned. Carpets should be professionally cleaned if not in excellent condition already. For your reference, we have added this simplified checklist. CLEANING CHECKLIST Living Room • Clean all blinds • Wash all windows, sills, and screens • Dust all baseboards and electrical plates • Wipe down baseboard heaters or boilers • Vacuum carpet and any cobwebs • Wipe down closet shelf, if applicable • Clean air conditioner filter, if applicable Kitchen • Clean all blinds • Wash all windows, sills, and screens • Dust all baseboards and electrical plates 4|Page
• Wipe down baseboard heaters • Wash ceiling fan, counter top, and any debris on walls • Clean dishwasher inside and out • Clean refrigerator and freezer, inside, outside, and floor underneath. Turn it off and leave the doors propped open. (Defrost with hair dryer if necessary.) • Clean oven, top of range, under burners, hood, and broiler pans. • Wipe out all cupboards and drawers inside and out • Vacuum any dust off ceiling from fan • Scrub floor, even under appliances, leave appliances pulled out • Wipe down closet shelf, if applicable • Replace any burned out light bulbs (refrigerator, vent hood, oven, and fan) Bathroom • Dust all baseboards and electrical plates • Wipe down baseboard heaters • Scrub the bathtub, toilet, and sink inside and out • Clean medicine chest and shelves and closet and/ or cupboards • Scrub floor • Clean ceiling exhaust fan, light fixtures, and replace any burned out light bulbs • Wipe down washer and dryer inside and out, if applicable Bedroom • Clean all blinds • Wash windows, sills, and screens • Dust all baseboards and electrical plates • Wipe down baseboard heaters • Wipe down closet shelves • Wash ceiling fans (if applicable), blades, and globes-replace any burned out light bulbs • Vacuum carpet and any cobwebs Storage and Garage Areas • Sweep out or vacuum any garage / storage areas Cleanliness helps to not only set the expectations of how you treat your property and expect them to treat it, but it also makes the property considerably more desirable. Be sure to keep the appliances in line with the house. If you have a high end house, high end appliances are expected. If your home is on the lower side of the spectrum, you will not achieve a commensurate return on investment if you over spend on appliances. Generally speaking your updates should be in line with the value of the house. I have seen property owners spend 25k plus on a kitchen remodel for a home that is in a blue collar neighborhood where the value of the homes are less than $150,000 on average. These owners were not able to achieve any additional rent for these improvements because the home and the area greatly limited the upside. 5|Page
Exterior – Make sure the lawns and landscaping are well kept. The exterior of the house is clean and free from debris. Be sure to make sure the exterior does not have obvious defects or work that needs to be done. Curb appeal remains a primary factor in any rental property. From the moment they park and walk up to the front door, their first impression is already being made. If the outside of the home is not well kept, any improvements you made on the inside are quickly diminished. Where not to spend your money: Furnace / AC – Believe it or not, it’s hardly a selling point to a tenant. Some will be energy conservationists that value such improvements, but most will be indifferent. Windows – If your windows need to be replaced, by all means make this improvement. Upgrading to premium windows when sufficient windows exist is not recommended. Specialty Exterior Features – Some people build elaborate ponds, streams, fountains, landscaping and other exterior upgrades. More often than not a tenant is looking for a simple living experience and isn’t interested in an unnecessary upgrade. Specialty Interior Features – Pool tables, workout rooms, built-in bars and other specialty items will certainly be of importance to some individuals. However, not everyone shares the same interests. It’s often more valuable to offer flexibility for prospective tenants with open spaces for them to envision it as their own. For example, someone who doesn’t work out would find your workout room to be wasted space and probably not rent from you. Whereas if it was an open room they could use the space as a workout room, office, kids play area, or other use that they personally find value in. Pools & Hot Tubs – These are not typically recommended in a rental property. They can create additional liability for your insurance. They are also maintenance intensive and as the owner, you would likely prefer to have it professionally managed because of a personal interest in assuring that the equipment will not be damaged. Pool and hot tubs may help you get a place rented, but in my experience they don’t provide enough additional rental income to cover the cost. When considering the risk and cost they are truly not a beneficial asset to a single family home. I am not recommending that you pave over a pool, just that you don’t build one for your single family rental. With property types such as an apartment building, condo or townhome association, they generally are major benefits. As an owner you can offer this benefit and share the cost and liability. These pools generally have professional maintenance and clearly posted rules and regulations, thus eliminating the concerns stated above. If you have a hot tub that can be removed, get it out. The annual operating costs could be negotiated into a lease as the tenant’s responsibility, but they are expensive to maintain and use a lot of energy. You are better off moving or selling it.
When considering that the goal is to appeal to as many high end tenants as possible, be sure to make tasteful and neutral upgrades. Make enough improvements to showcase that the property is well kept. This will let the tenants know that you are not only a good landlord, but one they want to rent from. Most niche properties will still eventually find a tenant, but be aware that cookie cutter houses in desirable areas often rent faster. You will be less likely to have to compromise on rent and terms if you have multiple interested parties. Remember, finding the right tenant is to win the beauty contest. Spend your money where they can see it. Tenants on average will spend less than 15 minutes touring a home and make their decision. Bear in mind that most tenants do not focus on the mechanicals, but rather the way the home looks, the neighborhood , and the way they picture themselves using the space. Chapter 2 -The Right Price Before we even go into a discussion about price, itâ€™s important that we first consider the cost of vacancy. In any given year there are 12 months to rent a property. Whether you are counting a year from when you begin to market the property or from the start of a calendar year, missing a month of rent will dramatically affect the profitability of your investment. The biggest mistake that I see home owners make is allowing their pride or mortgage payment dictate what they think is the rental value of their home. In an effort to make your property more competitive in the market place and find a great renter, generally speaking, losing even a single month of rent to vacancy will be more costly than a minor rent reduction. Use the following formula to determine the cost of one month of vacancy versus a rent reduction (Rent Reduction Amount $) x 12 Example: $50 a month reduction x 12 = $600 This determines your cost of a rent reduction over 12 months. The next step is to determine the cost of one monthâ€™s vacancy. Compare the cost of the rent you are looking to achieve and see how it compares with the cost of lowering the rent. Oftentimes, I see people with a monthly mortgage payment that is higher than the house will rent for. Usually these people bought a property or refinanced at the peak of market value. They simply cannot afford to sell and they cannot cover the cost of their mortgage. In this situation it is critical that you be cognizant of the fact that your mortgage does in no way dictate the rental market for your home. Any emotional or financial hesitance you may have to renting for a loss are misplaced and could hurt you more in the long run. You should also price your property at the high end of market value and never higher. Properties that are overpriced will sit without interest from prospective tenants. Effective marketing, that we will discuss later will get you in 7|Page
front of tenant prospects. If you are not receiving calls, it’s generally for no other reason than the price. Price is the most important variable you can control in creating a market for your rental property! Pricing Indication: 1 or less inquiries a week – Overpriced 2-6 inquiries a week – Appropriately Priced 7 or more inquiries in a week – Under Priced If you see 5 or more inquiries in the very first day, do not respond to any of them and remove the advertisement. The next day, repost the advertisement at a 10% increase from what it was first listed at. Some may find doing so unscrupulous, but the only thing you were guilty of is undervaluing your property originally. You do not have an obligation to the prospects interested in your property below your home’s market value. Chapter 3 - Professional or Self Manage? There are many things in life that a person could do but they choose not to because of limited skills, constraints of their time and/or money, or a multitude of other reasons. Renting your home is usually considered a job for the professional, unless you are willing to make the necessary sacrifices and put forth the right effort to get the job done. Much like anything in life there is an easy way and a right way. There are a number of important considerations when deciding if you should rent your home out yourself and handle everything or hire a professional management company. Questions you should ask yourself include, but are not limited to: Time: Do you have the time to answer or respond to all of the phone calls and emails during the marketing period? Will you have the flexibility to show the property at a time that works for the prospective tenant? When there is a maintenance issue (which can come up at any time) are you around and available to take the call and come up with the solution? When you leave out of town, do you have a back up in place to handle your affairs? If you can answer yes to all of these questions then you both have the time and are adequately prepared to consider self managing. Most of the work is done at the beginning. Your improvements, marketing, showings, etcetera are all done at the outset. The time requirements will become less after the first 8|Page
month of occupancy. Most repairs are also done at the beginning; things that you may have been able to live with the tenant may ask to get fixed early in their tenancy. Contacts: If you choose to manage the property yourself, you will need a good handyperson who is fast, responsive, and can take care of a wide variety of issues that could arise. Do you know this person; if not how will you find them? If your primary handyperson cannot handle these functions, you need to have a plan in place for finding someone. You should also have a backup for this person in case they are too busy, unreachable, or found to be unreliable. Try before you buy! Ask the handyperson to do some work for you before you commit to this being your go to person. They should prove that they are responsive, do good work, and are fairly priced. This is the area that is most likely to trip up a do it yourselfer! Problems: Problems with renters are almost inevitable. Usually they are small matters that can be handled over the phone amicably. Sometimes they are issues that require a bit more finesse and occasionally a firm hand. Do you have it in you to demand payment of rent? What if the tenant is in violation of the terms of your lease, will you confront them? What if they think a repair should be made and you donâ€™t agree, how will you resolve it? Imagine your tenant tells you that they have lost their job and have no place to go. How will you handle your conflicted feelings? If you are unsure, then managing yourself is not a good option. Renting your home the right way is treating it like a business transaction. There are a number of issues that come up on a daily basis for those in the property management business. One of the exciting factors of being in the business is the constant change and new challenges that emerge regularly. The question should be, do you have it in you to show the right amount of assertiveness? If you come off as too nice and accommodating, you could be taken for weak and have issues with rent being paid on time. If you come off as too stern, you will detract tenants who have concerns about working with a control freak. To be a property manager, professionally or otherwise, you need to strike a balance of care and precision. You should exude strong customer service in the initial period, while setting the framework for what will be a strong, legal document you intend to enforce. Be careful to not take a threatening tone and to avoid going over the eviction and penalty parts of the lease. A lease is a legal document, but that doesnâ€™t mean you should just have them sign it. Itâ€™s a valuable exercise for both you and the tenant to go over the entire document, line by line. This is a non-confrontational way for you as the landlord to specifically discuss expectations of you both. It will make you more confident 9|Page
in your responsibilities and it will show the tenant that not only do you understand the contract, but that you are expecting them to fully grasp it prior to their signing and agreeing to it. If you end up in court, it certainly wouldn’t hurt to be able to demonstrate that you went through the lease with them line by line, rather than admitting that they may have not actually read what they signed. We are all big boys and girls in this game, but I think it is always wise to be as explicit as you can on all terms. We have consistently found that a combination of both verbal and written agreement is the best recipe for consistent adherence. Know and study the document you plan to use before you meet the tenant. If there are items you want to alter within the lease, complete those and understand the entire agreement before you provide it to the tenant. Legal: There are also a number of important legal considerations when being a property manager or landlord. You should be sure to check how the laws in your home state function in relation to this entire book, but especially this section. Generally speaking there are some over arching national laws with regards to real estate, but the majority of the governance is done at the state level. You should be aware that there are a number of protected classes that you are prohibited from refusing to rent to based on their inclusion in a particular class. This includes, but is not limited to: race, nationality, religion, color, disability, and sexual orientation. Many states proceed further to include familial status . In these states you can’t refuse to rent to someone for being a divorced person or having children. You should be consistent in the questions that you ask, your tone, and level of accommodation when you speak to prospective tenants. There are tenant advocacy groups that exist to ensure this compliance. It is imperative to be very aware of the laws in your home state before you start. Mistakes here could find you in a court on the wrong side of a court room, know your local laws. Use common sense folks. Treat people the right way and don’t let any preconceived notions dictate who should be your renter or what the neighbors will think should not guide your decision making process. Legal issues also include the actual documents that you will use. Many states have a statutory form that you are required to use in a lease. They have found that this type of regulation ensures that tenants won’t fall victim to a slumlord. The lease also ensures that owners will have the proper recourse in the event of a bad tenant situation. When such a form exists you are usually heavily recommended or required to use it. Our management company has found that the statutory form is light on a few important issues. We decided that it was necessary to add an addendum to cover things more clearly and to represent our owners more thoroughly. There will be a chance for you to see our lease addendum in the forms section. Always use an addendum if your state requires a statutory form. The statutory forms are meant to be fair and balanced, but you want an agreement that covers your interests. 10 | P a g e
You may not be able to alter the meaning of the original lease, but you can clarify or address unmentioned terms from the lease in an addendum. Another important legal consideration is the rental license. Most states do this at a city level because of the need for an inspection. Your city may or may not require a rental license, but if you go at it on your own you will want to make sure that you know the proper compliance. This is customarily an issue in which a property manager would provide guidance on state and city specific requirements as well as how to contact the appropriate government office to receive information on inspection and licensing. I usually recommend that homeowners do a Google search for “(Name of City) rental license” which will take them to the appropriate site where they can find information and start the process. Another very important legal consideration is your potential liability. More specifically, how does one limit their liability? The simplest way is to hold your property investment in an LLC. LLC stands for “limited liability company”. There are a slew of options when considering incorporating. Most people do choose an LLC because of its flexibility and because it’s considered a pass through entity for tax purposes. Pass through meaning there is no taxation at the corporate level, rather it passes through to the personal income tax returns of the owner. We have an entire chapter dedicated to the LLC, its uses, and why we always recommend having one. Whether you manage the property yourself or have a property manager, the owner is first in line to be sued for things that go wrong in a property investment. Protect yourself! If you ever get sued you will be happy you did. Chapter 4 - Marketing If there is one place in this book that we are going to really give away trade secrets, it’s this chapter. The way that tenants search for homes to rent has changed over the years and we fully expect that it will continue to evolve in the future. For right now, the majority of qualified tenant prospects are found online. The beauty of the internet is that there are a number of ways to advertise your property at no cost and still reach a tremendous number of tenant prospects. Recall that renting is a beauty contest. You should think of the ad as the start of the competition. There will be a number of other homes and property managers out there competing for the same eyes. Your ads should be professional and attention grabbing. Like all businesses the competition is stiff, so you have to be ready to step up to their level. Thankfully, there are free tools to help you with that and will make you look like any other company. PHOTOS:
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Start by making sure that you have the right photos. A nice shot of the exterior of the home taken in such an angle so as to make the home look large and welcoming is key. This is going to be the main picture of your ad in most instances. Unless your home looks much better inside than outside, you should plan on an exterior photo being the first picture that a prospective sees. If possible, take the photo in quality daylight and in the most beautiful season. In areas with snowy climates, it’s always best to try to avoid using a photo with snow on the home because it doesn’t look as inviting. We recommend a bright and sunny shot of the home after the exterior has been specifically cleaned up for the photo. Be sure that the home is the focus of the photo by removing any superfluous distractions that may in any way detract from the shot. This exterior shot is the curb appeal of your home and generally the shot that will either make a good or bad first impression with a prospective tenant. The photos are a good place to enlist the help of friend or family member with a high quality camera or photo taking skills to help. Photos can be used again in the future, so make them good ones. I have great photos of my properties in the summer with full bloom that make it stand out in the winter time. Other photos of interest to prospective tenants are the kitchen, living room, master bedroom, and any other areas that illustrate the home’s beauty (landscaping, updated areas, etcetera). The rest should be pictures that represent the actual condition of the house. Be careful when taking pictures and try not to only take good photos, but accurate photos. If you have an area of the house that is heavily updated the rest is outdated, don’t take photos of only that part. If you take photos that show the house very well, but are not realistic, you will get many showings. However, the objective is not the number of showings, but rather finding the right tenant. You will end up being extraordinarily busy doing showings and not getting a commitment if you do not represent your property accurately. Certainly you want to show it in its best form, but be sure to be realistic and not misleading. It will be a waste of time for all involved. If the outside of the home is not up to par with the inside, it may be tempting to only take photos of the inside. In the past when we have done this, tenant prospects have called me to tell me that they saw the outside and just kept driving. This was a waste of my time and a valuable lesson about accurate representation. What should you leave in the home? Attached or customary items like washers, dryers, microwaves, and built-in shelves are usually left behind. It’s critical that anything that is in your photos and in the home when you show it be included in the lease or otherwise specifically excluded in writing. It’s not appropriate to remove those items prior the tenant moving in unless they know that they will be responsible for providing their own in advance. It is not necessary for you to go overboard on the size and quality of your photos. All websites that you will be advertising on will have file size limitations. As impressive as your 12 megapixel camera is, the files are going to be less than 300kb per photo or approximately 640 12 | P a g e
pixels. This is about 1/60 of the size that your camera is capable of producing. For this reason, it’s good to remember that not all of the details will show up when tenants are looking at the ads on a tablet or phone. Additionally, for the sake of not scaring someone away with a lengthy load time, we customarily size our photos to less than 200kb so that they come up quickly. There is a free website called www.postlets.com in which anyone can create an account and use their tools to create an html advertisement. In simple terms, an html ad has a consistent format and photos that present themselves much better than simple text options. Creating a rich html ad not only makes your ad look better, but it makes it seem like you know what you are doing. The novice homeowner or property manager that doesn’t have an engaging and beautiful ad will often get pushed aside from the more eye-catching ads. Remember that the text portion of you ad should not only be accurate, but very descriptive. It is important to note that the photos are usually all viewed prior to the text being read. A property must pass the initial test of a prospective tenant (the photos) before they continue on to read about it. For this reason it makes sense for your text portion to follow along with the photos. For instance, if the first photo is of the exterior, your description could start out with “Find yourself at home in this elegant, 4 bed home with a beautifully fenced in yard.” From there describe the property in the way that a tenant would view it. The first rooms they walk into should be described first. The key highlights of the property should be in BOLD so that they stand out on the page. Studies have been done that confirm that too much capitalizing can be perceived as shouting, and be difficult to read. Be sure to use your “bold” and “all caps” sparingly so that they are hard hitting when used and not washed out or offensive. Once you have used Postlets or a similar tool to create your appealing ad, the next step is getting it out to where tenants look. The top free site where tenants look is by far www.Craigslist.org. There are a number of stories of bad things that have happened while transacting on this site, but we have been extremely successful in using the site and have a very favorable opinion of it. It’s important to note that you will want to mask your email address and phone number when advertising here because unfortunately there are a number of scams still derived from this site. Tenant prospects should either be contacting you by a masked email address or by calling your “second” phone number. A quick and free way to obtain a second number to call to your phone is to use Google Voice. It’s snap to set up at www.google.com/voice and it sends phone calls to your phone without using your actual number. In the event that you get uncomfortable with the calls or the volume of calls, you can simply discontinue usage of that number. Meanwhile, the number that your friends and family know remains intact. I believe the service works with all mobile carriers. Other top sites that get a lot of activity are www.Zillow.com and www.Trulia.com. It’s important to note that the Postlets product is owned by www.Zillow.com and www.Yahoo.com. 13 | P a g e
They offer syndication of your ad to a number of sites. They also will help you post it on www.Facebook.com and www.Twitter.com. It saves time and effort and ensures that your ad is consistent among all the sites. Furthermore, when and if you make updates to your ads, it simplifies the process. There are a few sites that are not free, but do offer value as far as finding prospective tenants. They offer another avenue for producing leads from popular search engines. If you are not getting enough or don’t feel like dealing with www.Craigslist.org, this is a viable option for you. Truth be told, we have been very successful at renting properties without using the pay sites. In the times that we have used them we found them to be about in line with the number of leads that we received from their free counterparts. www.Rent.com, The free sites are usually sufficient for finding a tenant. www.Rentals.com and www.RentalHomesPlus.com are all good sites for generating more traffic. They do carry a cost, but they justify their value by ranking high on search engines that your tenants would likely be using to search for their next home. Professional management companies will also advertise on their own websites. They will want to draw prospective tenants to see not only your listing, but others as well. Most management companies have robust websites that showcase your property very well and contain concise well written ads. There are a number of traditional marketing methods used in finding tenant prospects that we consider to be increasingly less valuable and costly. A small sign staked in the front yard stating “For Rent” with a phone number is useful if your property is in a highly trafficked and desirable part of town. Unfortunately, these signs will lead to a lot of phone calls from people who are not truly interested candidates. Those who respond to a sign in the yard haven’t seen what it looks like on the inside. Similarly, they won’t know the rent amount, the number of beds, or when it is available. For this reason we find that these calls can be longer and they are more often not the right fit. Our company was founded in the age of technology; therefore we have never found it useful to advertise in written media. Information in print is not in real time and takes much more time to get in front of your prospects. The cost associated with print is also dramatically higher than other methods of advertising. We simply don’t find this type of advertisement to be of value in today’s ever advancing technological age. You are more likely to have someone view your ad from a tablet device than in a newspaper. Chapter 5 - Maintenance Most leases specifically spell out whether the landlord, association, or tenant is responsible for maintenance. Traditionally, the property owner is responsible for the regular upkeep of the home. Things like plumbing, heating and cooling, exterior, and appliances are the responsibility 14 | P a g e
of the property owner. If you are sure to include routine maintenance items in the lease, you can customarily pass off the responsibility of things like light bulbs, smoke detector batteries, furnace filters, water softener salt, and other simple maintenance. These items are rarely included in a lease and should be part of an addendum. Leases will also typically spell out that the tenant is responsible for neglectful or willful damage to the property. It is critical that you check your lease to be sure that language similar to this is a part of it; if not, add it to your lease. Tenants need to know that if they accidentally break a window, it is not the owner’s responsibility to pay for it. Tenants also need to know that they are responsible for the neglect of your home and you should be clear to them both verbally and in writing that you need to be notified immediately of any issues. Most problems become bigger once left unsolved. It is in your interest to resolve the issues ASAP. If you are managing the property yourself, you should be sure to have met your handyperson at the property prior to your tenant moving in. It is good for that person to become familiar with the property before the first call. Important considerations include, does the tenant call you with a maintenance request or the handyperson directly? It is usually preferable for the tenants to call you so that you can manage the process and be sure of what is being fixed. Personally taking tenant’s phone calls allows you as an owner to act like a filter and prevent repairs that may be at the tenant’s cost from being your responsibility. It also prevents your repair person from turning your property into a profit center for themselves. It is prudent to stay involved in this part of the process. The average cost of repairs varies greatly. Obvious factors such as the size of the home, age, and condition will play a large role. On average about 25% of homes won’t have a single repair or maintenance issue arise in one year. Most homeowners can expect two to three maintenance issues to arise in any given year. Typical repairs include: garbage disposal, appliance difficulty (broken not but replaced), leaky faucet, and clogged drain. Older homes tend to cost more to keep up, as do larger homes. Although the amounts can vary greatly, we tend to see maintenance expenses average between $500-$750 annually. Be sure to set aside a sufficient replacement reserve for repairs that can come up. You should know the age and cost of repairing and/or replacing the more expensive items in your home. It is wise to know approximately how much life is left on an AC unit or furnace. The roof and exterior can also be costly repairs as well. It is important to do regular maintenance in an attempt to extend their useful life and to help predict when they may need to be replaced. Chapter 6 – Background Check The background check is a critical step to knowing who you are really about to rent your property to. There are several things that you should always obtain (listed below), which along with your intuition will tell you if a person is worthy of being entrusted in your home. In most instances the cost associated with the background check is the responsibility of the tenant 15 | P a g e
prospect. Be sure to specify in your marketing who will pay for the criminal and credit checks and what fee will be assessed. We strongly recommend that you go with a professional background check service. There are a number of reputable sites out there including www.mysmartmove.com,which is done by a credit reporting agency, TransUnion. Trust your gut! If the prospect is late to the appointment you have, it’s a bad sign. If they don’t act with some class and respect for you, your time, and your property they probably won’t make a good tenant. As long as you are consistent in the way you treat people with regards to protected classes, you can surely avoid renting to them. Items that you should include in the assessment of a prospective tenant: Copy of the Driver’s License – so that you know who you are really dealing with. A copy of the front and back should be kept for your permanent records. Credit Application – It’s important to know if a person pays their bills or doesn’t. If you see nothing but charge offs, collections, and/or judgments on a person’s credit report be sure to consider them high risk. Often a much larger deposit is the only way to consider renting to a person with a high credit risk. We have consistently found that tenants who have more charge-offs, collections, liens and judgments than credit lines that are paid on time and in good standing make the worst tenants. They tend to be late, fall behind in rent, and create additional work and stress for you. Don’t be tempted to succumb to renting to a subpar tenant because of missing a month of rent. Your small problem could become a bigger one. Criminal Background Check – Is this a dangerous person, have they committed fraud, or have they been evicted in the past? All things you would like to know, right? The most pertinent info in the credit and criminal background checks can be obtained simultaneously through a single application if you go with the right service. Income Verification - You should get a copy of their most recent paystub and be sure that the income stated in the application process coincides. The very minimum in household income that you should accept is three times the net income. Net income is their take home pay, after taxes, retirement accounts, health insurance, and other deductions that have been taken from the check. Example: Rent Amount - $1500 Minimum Income Requirement (3) x Rent Amount or 3 x $1500 = $4500 or greater If the household does not make at least three times the monthly rent amount, it is likely that they will be unable to pay on time consistently. Much like a bank would have its requirements for 16 | P a g e
how much a person has to make to be extended a mortgage; you too should know the limits of what a tenant can reasonably afford. It is not wise for the owner or the tenant to get into a situation where they are stretched too thin just to pay the bills. Some additional tips for knowing if the tenant is right for you: Ask them to confirm the appointment 30 minutes before the time it is set up. Did they confirm? This shows how they follow directions and their level of organization. Did they show up on time to the appointment? We find that people that are late to appointments are often late on rent. Circumstances can cause a person to be late, but how do they treat their lateness? Ask, can I see where you live now? If a tenant prospect is unwilling to show you where they live now, why is that? If they take you to their current home to sign the lease, you can see how they live currently and learn a lot about whether you would rent to them. This is not often feasible, but a great way of knowing more about them. Are they looking to move ASAP? Sometimes a break up or relocation can cause a person to be looking for a place to live immediately. Some folks are just procrastinators. Oftentimeâ€™s people that are looking for a place to live very soon are not in a good situation where they are at currently. They could be getting kicked out, evicted, not on a lease, or in a number of other situations. It is good to ask them why they have not found a place yet; the answer will shed light on this person and their circumstances. Ask what do you do for a living? People love to talk about themselves and you will learn a lot about them by asking this simple question. You will hear about what they actually do, but also you may pick up things like the length of employment, whether they enjoy the work or not, and how they feel about and treat their coworkers. You can cross reference this with the income and employment verification section of the background check. NOTE: Be sure to stay within the laws of your home city and/or state when deciding whether you are going to rent to this person. There are surely rules and regulations that may limit you from asking certain questions to a prospective tenant. Because the laws vary from state to state, you should do your research first and compile a list of questions that you will ask of every potential applicant. Consistency is the key in order to demonstrate that there was no bias in your decision. After you know the laws on what you can and cannot ask in your area, compile a list of questions. Print multiple copies of this questionnaire and keep them handy for each call / email you get on the listing. This type of good record keeping will show that you have been consistent with all prospects.
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Chapter 7 – Move in Condition Report This may be the single most important document that you have if you ever end up in court over damages to the property. The spirit of the move in condition report (see the forms section for a sample) is to demonstrate the condition of the property at the time that the tenants take possession. It is also used to establish expectations of having the property returned in the same condition. A move in condition report should include detailed photos of the property. These photos should be taken immediately prior to the tenant taking possession. An excess of 100 photos of the property should be taken for even the smallest of properties. Photos should be taken of everything. The flooring, walls, and ceilings throughout should be well documented. Inside, outside, and tops of all appliances should be included as well. Special note should be taken to demonstrate the make and model of the appliances. This will protect you in the rare instance that an appliance you left the tenants with at move in is not the one that you find at move out. Photos should also be taken of the insides of closets, cabinets, sinks and bathtubs, and even toilets. The photos should demonstrate that the property is in immaculate condition throughout. The photos should also document a professionally cleaned property that is rent ready as discussed in Chapter 2. The move in photos should not be compressed. If you need them for court, the details will be important. Find a secure hard drive or cloud based solution for you to store your photos. In the move in condition report the tenant is agreeing that the condition of the property is accurately depicted in the photographs and that they were taken just prior to the tenant’s possession. In the event that there is damage to the unit at the end of the lease, you now have the necessary documentation to withhold a security deposit or sue for more than the deposit. In most cases, if you can provide a tenant a photo of the “before” in perfect condition, “after” of it how they left it, and the bill from your handyperson for the repair, they will not contest it. In the event that they do, you will have the necessary photo evidence to try it in court. Your second objective in the Move in Condition Report is to get the tenants to agree that they are responsible for bringing the property back to the condition in which it was delivered. Many states and cities will allow for “reasonable wear and tear” but it is my opinion that if you deliver an immaculate property that you should be allowed to ask that it be returned in the same condition. Your move in condition report and lease addendum should clearly spell out that this property was professionally cleaned and painted and that the tenants agree to return it in the same condition. Ambiguous terms like “normal wear and tear” leave an out for them and I would not recommend using the language.
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Tenants should also be allowed to provide additional photos or written evidence of the condition on their own as well. Let them know that anything that they wish to provide as evidence of the condition should be submitted via email or standard mail within 72 hours of their taking possession. There should be a short time period to submit this information. Otherwise it can be come convoluted and difficult to figure out when the damage really occurred. I prefer to receive it only via email, so there is a time stamp and proof. Chapter 8 – The Lease The lease agreement is the document that is designed to spell out all the specific terms of your agreement. It will cover the basics like property address, tenant name, lease duration, rent amount, special terms, and a great deal more. It will also cover a lot of lesser known, but equally important items such as who’s responsible for each utility, lawn and snow care, and a tenant’s responsibility in instances of willful damage to the property. Many states will have a required statutory form for leases. Please be sure to check if this requirement exists in your state. In addition to using the statutory form, feel free to use your own addendum as well. If you live in a state that does require a statutory form you can expect that it was designed to be fair and balanced to both sides so that predatory type landlords cannot victimize the tenant. Sometimes these fair and balanced leases do not go far enough to explicitly protect property owners all the time. This is why we use a lease addendum in our home state of Minnesota. Lease addendums will be discussed in greater length in the next chapter. Important Considerations when signing a lease: Always collect the first month’s rent and security deposit at the time of lease signing. Payments should be in the form of a money order, cashier’s check, or other certified funds. The last thing you want is to get someone moved in without money in your hand. This requirement will weed out tenants that don’t intend to pay or carry out their obligations. I’ve had tenants bounce a personal check for the first month rent and security deposit paid immediately prior to move in. Don’t let anyone move in with less than the first month rent and deposit in certified funds. Imagine having to evict without ever receiving a dollar! Leases should always be written formal documents, never verbal. It would become incredibly difficult to enforce a lease with no written terms. Even though a verbal lease is considered enforceable in most areas, we highly recommend that you never consider one. It is not recommended to rent to friends and family members period. In the event that you do, it is still prudent to have a lease
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Most of the horror stories I have heard from property owners are related to renting to friends and family. Stick to someone you don’t know as it won’t cloud your judgment if there are issues. You need to remember this is a business transaction and you won’t be able to kick your sister or childhood friend out without ruining the relationship. Both the tenant and the landlord should have a copy of the lease and the lease addendum. Be sure that if they are signing originals that they get either a copy or a second set of originals. Keep this document safe in case you need to refer back to it later. A good tip is to scan the original and email it to them. That way you have proof that you have delivered the documents to them. Read the lease to them line by line before they sign it. This has the dual purpose of making sure that the tenant understands the document they are signing as well as setting the expectation that you are a very thorough landlord that anticipates that the lease will be followed down to the last letter. A lease will discuss the responsibilities of both sides, so there is a definite benefit to making sure that you understand your obligations in this agreement as well. If there are necessary changes to be made to the lease so that they don’t contradict your interest in the property you should do those changes prior to the tenant ever seeing the document. It is more difficult to explain to them why you insist on this change, and to get them to agree, than it is to have never let them know it existed. Chapter 9 – The Addendum As discussed in the previous chapter sometimes a lease isn’t enough. A lease may not be specific enough to cover minor details which can protect an owner. This is why we recommend a lease addendum to provide the teeth needed to go beyond what a standard lease expects by stating terms of your agreement in a more explicit manner. Important lease addendum considerations include, but are not limited to: Lawn and Snow care: Who is responsible? Are you providing the tools? What about upkeep of these items if they break? Renter’s Insurance: Do they know your insurance doesn’t cover their property? If you require they have this insurance, it will assist you if the tenant causes major damage to the property by accident. Utilities: Between homeowners, associations, and tenants, who is responsible for what utilities? Utilities in the tenant’s name should be set up in their name ASAP. What is the recourse if the tenant does not do this? Lease Violations: What if they break the law, smoke, have unauthorized tenants staying the property? What is your recourse and what fines will be assessed? 20 | P a g e
Lease Termination: If they want out early, what will it cost them? How much notice is required? Routine Maintenance: Who changes light bulbs, air filters, smoke detectors, batteries, etcetera? Lockbox: Are you keeping a key on site for the maintenance professional? You can make the tenants aware, but do not provide the code. Move Out: How much notice do you require? What if they hold over? At lease termination, how and when will return of keys and possession occur? How many keys and garage openers were delivered originally should be returned and what is the penalty if not returned? What about outstanding late fees or other balances? We ask that the tenants initial next to each item in the lease addendum, as well as sign at the bottom to provide maximum assurance that the document will stand up in the court of law. Chapter 10 â€“ The Move In After all the forms have been signed and money has been received the move in process is initiated. As the owner you or your property manager should go to the property and take very detailed photos of the property. These should be as detailed as in the move in condition report section. Careful note should be placed on making sure the number of keys and garage door openers are recorded. The tenant should provide evidence that the utilities are set up in their name prior to taking possession to ensure that it is done. When you show the tenant around for the move in it is in your best interest to give them a detailed tutorial on the home. Show them where the furnace filters are and how they should be replaced. If there is a water softener, show them how to fill and use it. Any unique appliances that require care and maintenance should be explicitly explained to the tenant verbally as well as given to them in writing so they can look back at it. The tools used for lawn and snow care can be shown to the tenant along with some light training. If the home has any quirks that are important for the homeâ€™s upkeep and enjoyment, now is the time to share that information. It is in your best interest as the homeowner to make sure that the tenants know and understand the workings of the home. This will help to ensure that you can rest more easily knowing that those items are being properly cared for. We ask homeowners to provide a tutorial on living in their home. A laminated sheet of paper that goes over the important items and stays in the property ensures that the necessary information is at their fingertips. Chapter 11 â€“ Rent Collection The amount of rent and the due date are spelled out in the lease agreement. A good tenant will make their rent payments to you on time and in the manner of your choosing. Unfortunately, not all tenants will be on time, so there needs to be recourse if this happens. The most common way 21 | P a g e
of incentivizing a tenant to pay their rent on time is to penalize them if itâ€™s late. Many states will have a limit on how much you can charge for a late fee. I usually recommend that you go right to this limit and include that in the lease. If you let it be known from the beginning that you expect to be paid on time and the consequences of not paying on time are severe, you can be confident that the less qualified tenants out there wonâ€™t choose to rent with you. It may sound harsh to seek the maximum late penalty, but when you realize the additional work and stress it causes you as the owner, you will realize even that is not enough! We offer tenants the ability to pay their rent online. This is likely a service that your property management company would offer. If you are self managing, there are ACH companies out there that can help you set this up. An example is www.erentpayment.com, if you do a Google search you will find many that offer this service. Your tenant likely has some form of online bill pay with their bank, if they prefer to set it up that way. They can send a personal check in the mail or a cashier check. Whatever you prefer, be sure to state it explicitly to the tenant. Give them a nice magnet or some kind of friendly reminder of where to send rent in order to avoid any confusion. It is not uncommon for even a good tenant to be late on their rent once in a while. Sometimes itâ€™s a vacation or the Holidays and they forget. An unexpected expense may come up and paying rent at the scheduled time may be impossible. My policy has always been if the tenant has enough respect to inform you that their rent will be late prior to it actually being late and can also provide a firm, acceptable date for when it will be paid, I will waive the late fee one time. This is simply an act of good faith between you and the tenant. It also shows that you respect one another. I recommend an entirely different approach to late rent when the tenant is not proactive and upfront, forcing you to chase them down. These types of tenants generally need to be shown that this is a serious business transaction and that you will enforce your contract. It is critical that you follow through with the lease, charge the late fee on the day that it is to be charged, and that you take the next steps as required. Our late rent process is as follows: 1. Rent is due on the 1st of each month and is late if not received by the 5th. 2. On the 6th day a late fee is charged (8% max allowed in Minnesota). At this time an automated email is sent and a phone call is made. This will inform them and remind them that they are late and a late fee has been assessed. If the tenant responds to your email or phone call with a satisfactory plan, be sure to record the details of the plan in your calendar and check back to make sure they have followed through. If you cannot live with the terms that they have suggested, provide terms of your own. If you simply cannot come to agreeable terms, revert back to the lease.
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3. If the tenants do not respond or do not comply with the terms of their lease, send a letter via certified mail. The letter should state that the tenant is in violation of their lease and should clearly spell out the amount owed, including any fees that have been assessed because of their late, returned payment (NSF), or nonpayment of rent. The letter should state something to the effect of, “Notice to Pay Rent in 5 days or Eviction will be filed.” It is a matter of personal preference if you send the letter above or proceed directly to the eviction process. In my experience if they know you are serious and they care to stay, they will make up for the past due rent and get things back on track without having to evict. 4. File for Eviction. This is generally done at the county level. I recommend that either a lawyer is contacted to assist you with the forms or that you perform an online search for the eviction process in your area. There are generally forms that you are required to file along with the lease documents. A court date will then be set and you will be set to stand in front a judge to enforce your contract. A fee will be assessed when the paperwork is filed for eviction. This is why I first opt to use the letter above. Once again honest and forthright communication is the key to solving problems. If everyone is working in good faith it is very possible to avoid the eviction process. Reserve this last resort option for the habitually bad tenant who you don’t see ever getting back on track. Chapter 12 – Tenant Issues Tenants are people and people have problems from time to time. These problems can range from job loss, health problems, death, or the need to relocate immediately. Whatever issues may arise, the key to resolution is good communication and good faith efforts from sides to resolve it. If a tenant has a legitimate reason to break the lease early and you wisely have placed in your lease addendum a fee and process for this, you should be able to work it out with them. It is critical here that the process does not get personal. Remember, this is a business and should be treated as such. This means don’t be overly sympathetic and too willing to be on the losing end. It also means that you should realize that a lawsuit is something that doesn’t benefit you or the tenants. Try your best to be diplomatic and work it out between the parties. When you go to court you risk being completely unsatisfied with the judgment. Even if you win, there is still a long and tedious process to collect. For this reason, we highly recommend coming to an agreement between the parties that is put into writing in lieu of waiting for the court’s judgment. Most issues can be worked out through dialogue. If it gets to the point where you can no longer handle or solve the problem, ask a trusted friend to step in on your behalf. Sometimes a new person thrown into the mix can result in a different conclusion. If this fails too, there is always 23 | P a g e
the legal system as your final recourse. Attempt to avoid this at all costs. It will drain you mentally and cost you more time and money before you can ever hope to recover a cent. Even if you go to court and win, the process to collect what is yours takes at least 6 months or longer. Itâ€™s to your benefit to try to settle matters when ever possible. Chapter 13 â€“ The Move out The move out process is all contingent upon how well you handled the move in process. The more thorough photo evidence and written proof that you have of the condition of the property at move-in, the better prepared you will be if there is any damage. Prior to the lease ending, you should contact the tenant roughly 75 days before the end of the lease. Your lease should call for a 60 day notice to vacate. Hence why you give the tenants sufficient time (75 days) to consider whether they will be renewing their lease or vacating the premises. If they do indicate that they will be vacating at the end of the lease term, you need to get your plan in order for the move out process. Start by sending them a move out checklist. This checklist will name all of the rooms in the house and the different elements within that room. For example, the bathroom would list the floors, walls, toilet, sink, tub, vanity, etcetera. This room checklist, followed by your expectations that each of these items be cleaned and delivered in the same rent ready condition the property was received in, ensures that you expect that the tenant will return the property to you in this same condition. Approximately 2 weeks before the end of the lease, contact the tenant to arrange a time to do a quick walkthrough of the property. During this walk through take note of what, if any, paint work, carpet cleaning, or any damage that will need to be fixed at the time of move out. Donâ€™t wait for the end of the lease to bring these items to their attention. Let them know right then that these items are things that you expect them to take care of. It is in your best interest to have them willingly correct these problems prior to vacating than to take it from their deposit and do it yourself. That way if there are more expenses than you expected, unpaid rent or bills, you still have sufficient funds. If they seem confrontational or have their reservations about these items being their responsibility, you should begin to plan how you are going to get the property back to rent ready condition for the next tenants. The purpose of this pre move out inspection is truly to know what you should be expecting at the time of the move out in order to plan accordingly. Time lost on coordination efforts will cost you rent. Spare yourself the trouble and know with eyes wide open what you will have to do. Initially your focus should be on getting it ready for the next tenant. Spend the money that you have to spend to get it ready. Worry about collecting from the first tenant after. 24 | P a g e
You can’t go after the first tenant for lost rent after the expiration of their lease, so don’t compound the matter by waiting for them to accept responsibility. If there are deviations at the time of move out, take even more photos than what were taken at the time of move-in to document and use as evidence. You will want to provide as much photo evidence as you can of these differences to the tenant when you send them the bill. Once you feel you have sufficient evidence, commence bringing in your team to restore the property to rent ready condition. Keep the actual invoices for the work performed and copies of the checks; you will need these later. It is important to note that some states will not allow owners to arrive at a value for their work and will not consider an invoice for expenses that have not been hired out. This is to say, if you make $100 an hour at your job (or this is how you otherwise value your time) the courts may not allow the expense to be considered for reimbursement if you paid the bill to yourself. Check your local laws. In the event that you cannot pay yourself for the work, you will want to be sure to hire a professional company for the work. Time is money! If you think you are saving money by taking two weeks to paint yourself and save $600, but you lose $1200 in rent for the whole month, your attempts to save money have actually cost you money. After the rehab of the property is complete, it is time to send an itemized list to the tenants of the items that are being fixed at their expense. Start with the actual invoice and copies of the checks paid to get it restored. Neatly situate all receipts, invoices, documents, and photos of both the before and after of the areas that required work and email the tenant. This level of detail is usually enough to deter the tenants from arguing with you or denying the damage. Be sure that anything you are striving to be compensated for is legitimate and can be proven in a court of law if you are asked to defend your claims. It is much better to be conservative rather than to ask for too much in this process. For example, if the carpet was already ten years old and the tenants stained it beyond repair, you would want to ask for a pro-rated portion of the cost of replacement. If you feel the carpet still had half of its life left in it, ask the tenant to pay for half of the cost of replacement, but not the entire expense. However, if the carpet was brand new at the time of move in and it’s currently trashed, you can most certainly ask them to pay for the whole amount. Let the amount of evidence and the level of proof you have dictate how much of the deposit you should retain. This will also help to determine how well you will fare in court if the tenant chooses to contest the accusations made against them. Don’t ask for anything that you can’t prove. Don’t be overly greedy and try to remodel your home on their deposit. Most states have tenant advocacy groups that help tenants from being victims by predatory landlords. Not only is it wrong the wrong thing to do, but it could land you in big trouble or cost you even more money if the judge believes your accusations against the tenants have been made in bad faith.
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Chapter 14 – Tax Implications Disclaimer: I am not a tax attorney or CPA, this is meant to be general advice. Be sure to consult a tax professional before proceeding. The most substantial items that become tax deductions are: • • • • • •
Mortgage Interest Property Taxes Depreciation Home Improvements Repairs and Maintenance Other
There is talk in Congress of eliminating the mortgage interest deduction as a way to balance the budget. Until that happens, investors continue to get the awesome benefit of tax deductible interest on their investment properties just as they would on their residence. At the end of the year the bank that holds your mortgage, if you have one, will send you a form detailing the amount of interest you have paid on your loan for that year. Generally speaking, that entire amount is tax deductible. The same can be said for the property taxes that you pay. Most of the time taxes paid to one jurisdiction are deductible in others. When you decide to turn your property into an investment, the way that improvements are handled changes. Repairs and maintenance are generally considered an “expense” which is tax deductible, in full, in the year in which it occurred. An example of this would be hiring an appliance repair person to fix your washing machine. Improvements to the home like purchasing all new appliances are generally considered to be a depreciable expense. The government expects these improvements to last longer than one year, and they ask that you spread the cost of these improvements over a 5 year period. There will be more on depreciation, but in general if it’s something that is an investment into the property that will be lasting, it has to be depreciated versus expensed. This is an important tax consideration you will want to discuss with your tax person. Depreciation is the way in which most investors can show a paper loss for tax purposes, but not actually have lost money on their investment. What the IRS is saying is that there is a finite period in which the personal property and building will be useful. Therefore, investors should be allowed to depreciate those assets over the time of ownership. There are three general groups in which the property is divided into: Land – Not considered to be depreciable
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Building – Considered to have a life of 27.5 years for residential (longer for commercial investments) Personal Property – Considered to have a useful life of 5 years Land is very straightforward. It’s the piece of earth that your property sits on. The government thinks that land won’t go down in value and doesn’t need to be depreciated. Building is the structure itself, the home in this case. It is generally considered “immovable property”. Personal Property is considered “movable property”, i.e. appliances, light fixtures, furniture. When you buy a house for an investment you are tasked with assigning a value to each of these three groups. As a raw example, if you buy the house for $200,000 you will assign values to each of the three categories. Land - $32,500 Building - $137,500 Personal Property - $30,000 In the example above the land portion, which is not depreciable, will not gain you any depreciation deduction. The building, which is depreciable over 27.5 years, will gain you a deduction of $137,500 / 27.5 = $5000 for 27.5 years. The personal property which is depreciable over 5 years, will gain you a deduction of $30,000 / 5 = $6,000 a year for five years. Based on this example your property would give a depreciation deduction in years 1-5 of $11,000. From years 6 – 27.5 your deduction would be just $5,000. You may be asking yourself why would the government give you such a fantastic phantom deduction? You would be wise to have considered this too good to be true without some sort of take back. The way that the government recaptures this otherwise lost revenue is through what is called depreciation recapture tax. Using the example above, let’s say that the property was held for exactly five years. You took a depreciation deduction of $11,000 for 5 years (totaling $55,000). Now you sell the property for $240,000. Your first instinct is to say that you have a gain of only $40,000.00 ($240,000.00 sale price - $200,000 purchase price) but you would be wrong. 27 | P a g e
The government says that the amount that you took in depreciation lowers your basis cost of the investment. In this case the actual purchase price of $200,000 â€“ $55,000 = $145,000. So when you sell it for $240,000, your true gain is $240,000 - $145,000 = $95,000. In this particular instance the $40,000 it was sold for over your cost is considered a capital gain. The $55,000 is considered depreciation recapture. You will want to discuss your tax liability with your tax professional since capital gains are currently taxed different than depreciation recapture. Currently, January 2013, capital gains are taxed a max rate of 15% and the depreciation recapture is taxed at a minimum rate of 25%. It is important to note that if you are considering not taking the depreciation deduction to not complicate your tax matters or to avoid this recapture tax, that you would be hurting yourself. The IRS will tax you on the depreciation recapture based on the allowable amount, whether or not you actually took the deduction. Also important to note, you can avoid paying the recapture tax and capital gains tax if you do what is called a like kind exchange or a 1031 Exchange. This is another government loophole for real estate investors. To do this you will need to work with a qualified intermediary to hold the gains from your first sale in escrow while you purchase the next property. This person will help you navigate all the tricky rules and laws surrounding this tax deferred exchange. There are a number of highly technical rules and regulations on this subject matter that would be worthy of another book. Prior to selling your property, if you plan to do a tax free exchange into another property, be sure to proactively seek out guidance on this subject so that you can be sure to do it the right way. Mistakes in this type of exchange can void your ability to make a tax free exchange. Chapter 15 - Liability Disclaimer: I am not an attorney and this is not intended to be legal advice. I am a licensed real estate broker and property investor offering only general advice. For specific help for your personal investment strategy, please seek the guidance of an attorney in your area. Every property investorâ€™s nightmare situation is getting sued. For some, the potential of getting sued is enough of a reason to not get involved. Like all great endeavors worth taking on, there will be risk. Thankfully there are ways to protect yourself and to mitigate such risk. Proper liability protection measures can keep you from having to reach into your pockets if something unfortunate should arise. The first and most common form of liability protection is something that everyone is already familiar with, insurance. You have insurance on your home now if you currently reside there. Itâ€™s used to protect both the asset itself and to protect you if there should be an accident on your property. The concept is very similar in an investment property only that you will seek slightly 28 | P a g e
different insurance. The type of insurance that you have on a rental property differs in that it does not cover the personal property of the tenants. It will continue to cover the building, any property of yours that remains inside like appliances, cabinets, and other parts of the home not considered the building itself. It will also provide you with medical coverage protection should there be an accident. Rental income will also be covered as you would normally receive if there should be a catastrophe at the property. Be sure to specifically tell your insurance agent that you are now using the home as a rental property prior to the tenants moving in so that they can adjust your insurance to properly protect you. You will not be fine to just keep what you have. There are generally loopholes and ways to exclude you from coverage if a claim arises later and the occupancy is not quoted as a part of the policy. The second step to protecting yourself is to incorporate. Most investors consider a Limited Liability Company (LLC) to be the best way to hold your investment property. There are a number of other options such as an S-corp, C-corp, limited partnership, and more. The reason that most people prefer an LLC is for tax purposes. It is considered a pass through entity for a single owner LLC. This means you are not required to do a business tax return, but rather pass the income and expenses to your personal return on a Schedule E. This will save you on tax preparation fees and simplify matters. The other advantage of an LLC is that it does not have the board meeting requirements of a corporation and offers the ultimate in flexibility for set up. You can have more than one owner and can choose how the income and expenses are shared with great flexibility. Whereas in a corporation, shares are issued and all things must be divided by the number of shares one owns. Also, it is important to note for tax purposes that generally a married couple is considered one person in an LLC. This also indicates that there is no need for a partnership agreement or lengthy member control agreements. The essence of any corporation or LLC is to separate yourself personally from the investment property. In other words, if you get sued at the property, your personal assets are safe from reach. The inverse is true as well and if you are sued personally your business assets are generally considered safe. This protection is sometimes referred to as the corporate veil which functions as a means of protecting you. There are ways to pierce the corporate veil, so you should be aware of what actions could crumble this protection. The first and most obvious way that it can be pierced is if you commit a crime and try to hide behind your LLC or corporation. If this were a way to protect yourself from liability arising from the actions of your LLC or corporation, the government would have little strength in enforcing the laws. So for the purposes of this book, just note that this will not protect if you commit a crime in the name of the business. Your corporate veil could also be pierced if you are not truly acting as a business. Filing for and having an LLC is not enough for you to demonstrate that you are acting as a business. Additional steps should be taken to prove that you are in fact a business. Examples include, but are not limited to: â€˘
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o XYZ Property Investment, LLC by “Your name” its Owner Open a bank account in the name of the LLC. o Have your rent checks go here and pay expenses through this account If possible, transfer the title of the property to the name of the LLC Conduct business as the owner of the LLC and not as an individual
Taking the right steps when incorporating your business and acting as a business will help to show that you and the business are not one in the same for liability purposes. With the right insurance and approach to business dealings, you can reduce your risk to nearly nonexistent. WRAP UP These are the secrets to renting your home the right way. By following these steps and trusting your instincts you can avoid many of the pitfalls that a new landlord may encounter. If you are still unsure about renting your property or buying an investment property my advice for you is this. Don’t let fear rule your decision on whether to invest in real estate or not. Most of the millionaires in this country made their wealth in real estate. There will always be people out there who want to rain on your parade. You should have nothing to fear if you take the right steps to protect yourself and conduct business in a respectable manner. Don’t let one person’s fear hold you back. If you are reading this book and have made it this far, you can do it in real life! Best of luck to you in your endeavors and remember that Henry Ford once said, “Whether you think you can, or think you can’t – you’re right.” Thank you very much for choosing my book. I hope that you found valuable insight into the world of being a Landlord. We sincerely appreciate your business and welcome your comments, suggestions, and feedback on the book. Please send an email to the author at firstname.lastname@example.org
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