Sunday, January 21, 2007

So you want to be a Landlord

A lot of homeowners can’t sell for what they perceive as a fair price and are starting to resort to “plan B.” Rent the place out. It sounds easy doesn’t it?

The best route to take is having it professionally managed. Management fees are about 15% of the monthly rental amount plus a fee for getting the new renter. The prospective renter will be screened by the rental company and they will be able to give the owner a ball park figure on what it will rent for (it might not be a figure they want to hear).

Since the owner is already negative, the management fee is probably out. Imagine what happens next. Let’s figure it isn’t going to get too bad, maybe just a couple of dogs and cats and 2 or 3 kids with crayons. Maybe a couple of college kids who like to party.

In Southern California coming up with a first and last months rent (deposit) can be a real obstacle. On a $2,000 dollar rental, the tenant needs $4,000 up front to move in. So there is a definite issue here with the quality of renters, a lot of whom are living from paycheck to paycheck.

Is the rent going to be on time? Will the check bounce? Why are there 10 cars in front of the house after they move in? Is it being sublet?

If the owner is diligent, it can work out OK. Budget about one month’s rent for yearly repairs, water heater, sprinkler system, air conditioning, etc. But if the owner is having money problems already, this could be the beginning of the end.

The biggest item that has to be considered is the owner’s vulnerability. If the renter is of poor quality and the owner has a negative cash flow on the property, the hole is being dug deeper. It’s not a crime to stiff the landlord on the rent, in some states it can take 3 months to evict the tenant. There isn’t much recourse to the landlord other than chalk it up to experience.

I have had good success with rentals. From my experience, if the purchase price is 100 times the monthly rental rate, you have a real money maker. I don’t see that happening here in California any time soon. But some areas of the country are getting temptingly close to that ratio. A $100,000 house purchased with 20% down would provide a nice retirement supplement when the mortgage was paid off in say 20 years. Not to mention the inflation protection and tax deductions it would offer. I suggest that you wait a tad. If housing prices drop in some of these distressed areas, rents may drop even further and that messes with the “100 X multiplier rule.”

Remember one thing about rentals from the landlord perspective. It doesn't matter what the rent being charge is, it matters on how many months out of the year it is vacant. You divide total rent received by 12 months to determine the actual rental rate. The actual rental rate for a house advertised at $2,000 per month that is vacant 4 months is actually $1,333 per month. The landlord does not determine the rental rate, he only determines the months of vacancy.

I wish any future landlords the best of luck, its not easy, but well worth the time, if you purchase the rental at a decent price.

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