Tuesday, June 9, 2009

Screening Tenants: Keys to Success


To many people, being a landlord seems daunting. Of all the factors that deter people from investing in real estate, tenants, or the obligation to work with them, is the largest.

I hear people tell me all the time "I just don't want to deal with tenants" or "I had a really bad experience once, I just don't like tenants".

Its important to understand that landlording is part art but mostly science. Its definitely not something that you do shooting from the hip. That type of behavior will hasten your exit from the real estate business. So, lets take a look at the fundamentals of landlording and see if we can lay a solid foundation for everyone.

There are three things you are concerned about as a landlord:

1. Timely payments of rent
2. Preservation of the condition of your asset
3. Neighborly behavior of your tenant

The application is the means we use to determine the likelihood that these three things will happen. By taking an application AND verifying the information on it, you will eliminate most of your problems up front and be on your way to running a successful business.

The next question is: How do you know your tenant fits these three criteria?

Disclamer: What I am about to share is how my business model works. Depending on your model (i.e. slumlord model, resort property model, absentee owner model) you will handle things a bit differently.

First, you will have your tenant fill out the application. The Utah Apartment Association is an excellent resource for landlord documents. You will find out if your tenant has a job. If he does, how long has he been there? Does he bounce around from job to job? What does he do between jobs? Is his income steady? You want steady income from rents so income needs to be steady for your tenant. If not, a higher deposit is in order to compensate for the risk. Also, how much does your tenant make? Is it twice as much as rent? If so, beware. How will he pay rent if his car breaks down? How will he pay rent if he has to pay a speeding ticket? The safety zone for income-to-rent is usually three times rent. In a few of my rentals I require income to be four times rent. Again, if the tenant doesn't fit in this mold, I increase the deposit to compensate for the risk.

Note: Per Fair Housing law, you cannot discriminate WHERE income comes from. For instance, if your tenant is on disability income or receives all their rent from a church, you cannot discriminate against them for that. However, you can screen them for not making enough money based on your written renting criteria. That is a legitimate reason to decline an application. Just be sure you apply the rules equally to everyone who is applying. If you are "playing favorites" with applications, you run a serious risk of getting fined for violating the law.

Looking at your clients credit report is going to tell you a lot about your tenants track record paying his obligations. Is he late on his car payment? Did he stiff his last landlord? Or the one before that? It will show up on his report.

Now lets talk about protecting our asset. The first thing I do is make sure my tenants pass the smell test. If I can smell them (i.e. body odor, cat urine, smoke, alcohol, ect.) its an instant DQ. If they smell like that, what do you think their living environment smells like? Bad smells translate into repainting and re-carpeting when a tenant leaves. That mean you will spend a lot of money fixing the problem. Of course, most folks who don't take good care of thier hygiene typically don't take good care of thier credit either. There is a tight correlation there.

Pets are a touchy subject. You need to read Perils of Landlording: Canine Catastrophes to see how destructive pets are. I no longer allow dogs in any of my properties. I am 1 for 2 on dogs. I have had two trashed houses. Thats two too many. If you want to guarantee a property returned in good shape, avoid pets in general.

Smoking is another interesting and sometimes sensitive subject. Many tenants smoke. The risk associated with smokers is when they smoke inside or chain smoke. If they smoke inside, plan on stainblocking, re-painting, and re-carpeting when they leave. Smoke will ruin a house the same way that a house fire causes "smoke damage". For this reason, I am trending away from renting to smokers. They also happen to be higher risk for late rent as well. Smoking represses the immune system and so smokers are sick more often and therefore work less and earn less. Since they are tired most of the time, they usually do not do normal cleanup around the property. I have had a couple exceptions to this but not many.

Finally, its important, especially in larger complexes and in multi-unit situations, that your tenants behave neighborly. I had two tenants in one of my buildings who were at each others throat all the time. They both suffered from maturity issues and they each called me constantly to tattle on the other. It was a big headache. Unfortunately, there wasn't any one specific thing on the application or my conversations with them that would have clued me in to this type of behavior.

MAKING SURE GOOD THINGS HAPPEN

You need to be compensated for taking risks with tenants. Tenants need to compensate you for taking a risk on them. How does a tenant compensate you? They give you collateral.

If they have good credit, that credit and a small deposit is offered to compensate you in case of damages. If they trash your home, you trash their credit via a judgement and collections. A trashed credit report makes life much more expensive for that tenant in the future, plus you can collect from them via the courts if they have a job.

If they have bad credit to start with, a large deposit stands by their name. If they trash your home you keep their deposit. Most tenants I know want their deposit back so it acts as a huge incentive to behave well while in the property. So far, yet unfortunately, I have only had to keep one tenant's entire deposit.

Hopefully this is a good refresher for some of you and a good start for others. Practice makes perfect. Keep the three criteria in mind and balance risk with appropriate deposits and you will headed down the right path.

3 comments:

Regency said...

Amen! Amen! Great article. I couldn't agree more.

Sonny said...

Have you checked out NoPayTenants.com?

Here's the link http://nopaytenants.com/

john said...

Nice job Jeremy.
Can't wait to talk about some of these experiences and how they'll apply in the future.