This is the last tip in a 10-part series on purchasing residential rental properties based on my experience.
10. Utilities can use you up, so be careful.
Utilities can be a major issue for landlords if not set up properly. If you supply utilities to your tenants, you are generally not permitted to terminate these for nonpayment or other issues, and penalties can be severe.
Want to keep the bills in your name but have the tenants pay their portion to you? The law does not generally allow you to collect if they default on these sums, so you may risk losing out if the tenant stops paying their portion of the utility. Plus, you are still required to furnish them with these utilities, even if they fail to pay. Unless you can incorporate a flat fee into the monthly rent figure which covers your expenses even as costs continue to rise, it is best to insist that tenants pay utilities directly, under their own name. Then, in the event of default, you are not responsible.
This means that properties containing 2 or more rental units need to have split utilities; separate furnace, hot water heater, meters, etc. It is much easier and cheaper to purchase an already-split property than to try to do this yourself, so this is an important factor when you are looking at multiple-unit properties. Duplicate systems will mean more maintenance costs over time, however.
In addition, you should look into whether a property has gas heat , electric heat or oil heat and understand the issues involved. Electric heating systems can be very expensive, and therefore undesirable for tenants. Oil heat, while better-priced, can involve more system maintenance, since if the oil runs out, the system needs to be bled by a technician before the new oil will enter the system and begin heating. Based on technician availability, this can mean a few days without heat if the tank runs out and you don’t schedule ahead to ensure a seamless transition. Gas heating is generally the simplest to maintain from a landlord perspective, since if the gas company ceases to be paid, they cut off the gas supply, but can quickly reinstate service once payment is received.
This is the ninth tip in a 10-part series on purchasing residential rental properties based on my experience.
9. Bigger is not always better.
As your property size and square footage help to determine your tax rate, an acre or more of land really isn’t necessary. You’ll mow it (or pay to mow it) and pay extra taxes for it, but beyond increasing overall property value, it won’t do much as far as rental income goes unless you have plans to build an addition or another rentable structure on the lot.
Neither will room size. As long as you meet the minimum bedroom requirements required by the township or city, more square footage per room doesn’t necessarily help. 4 small- to medium-sized bedrooms may actually produce better income than 3 large bedrooms.
Common interior space (living rooms, dining rooms, family rooms, etc.) is great in moderation, but too much can become a problem. Although this space is factored into your property taxes, it can be difficult to actually produce income from this extra space. Plus, if you give your tenants the perfect party house, your property may see a lot more traffic and wear and tear than you intended, and repair and maintenance costs will go up accordingly.
One of our rental properties featured a lovely but immense bar in its finished basement, which we immediately earmarked for removal. The small extra initial cost has paid off in the long run, especially when we decided to rent to college students. If our goal was to flip the house, we might have left it, but for our intended use it was more of a liability.
The optimal rental property for tax purposes is a solid structure on a relatively small lot with adequate distance from the neighboring properties to diminish noise. It features a number of small- to medium-sized bedrooms, and has enough space for the tenants to comfortably congregate without substantial excess.
This is the eighth tip in a 10-part series on purchasing residential rental properties based on my experience.
8. Stay close to home.
In my experience, absentee landlords tend to find out about and resolve problems less quickly, which in turn can make them bigger, more expensive problems. For this and other reasons, municipalities are none too fond of absentee landlords, which can also lead to bigger, more expensive problems, like fines and even citations. It may sound lovely to own a rental house in the Outer Banks of North Carolina when you live in Michigan, but you may be in for a nasty surprise when you next visit. Plus, you’re not there to help batten down the hatches when the next storm rolls in.
Twenty minutes or less is an ideal distance; it allows you to appear involved and available to your tenants and local officials, be a visible part of the community, and respond rapidly when help is needed.
One unfortunate landlord I know attempted to hold down a busy job in Manhattan and found a startup company while managing several properties over an hour away in New Jersey. He invested a chunk of money to fix up his properties, and everything seemed fine until a minor plumbing problem occurred in one of the houses. A cleanout cap popped off the waste line sewer pipe. It was an easy fix involving a five dollar part, but this landlord was late to respond. He didn’t have much luck with the local plumbers he reached out to, and more time passed. One day a plumber finally called back after visiting the house and angrily exclaimed that he patently refused to work under those conditions.
What conditions, you ask? In a house of eight tenants, raw sewage had been pouring into the basement for over two months. The muck was knee-deep, the stench was abominable, and yet the tenants, college students, had never said a word. The house was in foreclosure within the year.
One of my own tenants phoned me one day several years ago to let me know that water was gushing into the backyard from beneath the outdoor spigot and she was unable to stop it. In twenty minutes, I was there to address the issue, shutting off the entire pipe until it could be fixed. Proximity saved me a flooded yard and basement as well as a hefty water bill.
If you cannot be local to your investment property, it is important that you find someone you can trust who is able to serve as primary contact for emergency maintenance needs. This will become part of your ongoing cost of ownership. Even then, you need to ensure that lines of communication are such that problems are not allowed to fester before they are addressed.
So you understand the construction of the home you are looking to purchase, including its foundation. The next step is to analyze the property from a liability standpoint, assessing potential safety concerns and budgeting to fix them as part of your initial investment.
7. Look out for safety issues.
For anyone looking to purchase a rental property, I always recommend a home inspector. An excellent value for the money, a licensed home inspector can help to identify potential safety and maintenance issues and even provide ballpark estimates for correcting these. I would personally never purchase an investment property without consulting one, as too many potential dangers lurk within and behind the walls which can turn your House Beautiful into The Money Pit.
Radon, lead paint, asbestos and mold are four primary concerns, as they pose significant health risks and can be expensive problems, requiring specialists to remediate. My insurance company will not even insure a property which it believes to have lead paint, and I’ve been hearing reports lately about local code officials doing tests which penetrate the top layers of paint to reveal any presence of lead below. It’s no longer sufficient to paint over lead paint — it must be removed in its entirety. Houses built before 1978 are likely to contain lead paint, so pay special attention to these. You can get more information from the EPA website.
And while you may have the choice to live in a residential property with one or more of these issues, rental properties are a different story. Your local municipality may refuse to allow you to rent a property without correcting these issues.
As a landlord, there are certain things you need to pay special attention to in order to prevent potential lawsuits. These include:
* Exterior stairways without handrails or where ice/snow/rain may cause a slip hazard
* Steep steps
* CO and smoke detectors (fire hazard)
* Obstructed doorways or exits (fire hazard)
* Broken windows/glass
* Cracks or unevenness in sidewalks, driveways, or walkways (trip hazard)
* Open electrical circuits, outlets or wires (electrocution hazard)
* Unfenced swimming pools (drowning hazard)
* Lack of GFI outlets near kitchen/bathroom water facilities (electrocution hazard)
Most issues will need to be corrected prior to tenants moving in. However, for conditions which become hazardous as a result of inclement weather, you will need to either install material to increase traction or develop an action plan so that ice and snow are not allowed to build up in these areas.
As a rental property owner, you have an increased risk of lawsuits overall, so safety is a primary concern, but accidents still happen. Owners often choose to limit their personal liability risk by establishing each property as its own LLC. It is advisable to consult a lawyer to ensure that your other assets will be protected in the event of a lawsuit.
Simplicity, accessibility, and replaceability are important aspects of rental property construction, but at the foundation of your investment is the foundation itself. This week, a caution:
6. Beware of houses built on a cement slab.
Not having a basement can cost you much more than storage space.
In some places, like parts of Florida and Texas, all houses are slab construction, so real estate investors have no other options. Even then, it’s important to understand the issues with this type of construction, as it can have major financial impact over time.
Generally, in such structures, ductwork, heating pipes, plumbing and electric lines can all be buried in or beneath the slab. If your plumbing pipes are set beneath the cement, to fix a simple leak you may end up jackhammering out the floor. Basements or even reasonably-sized crawlspaces provide access to critical systems within the home, systems that may break either on their own or with your tenant’s help. A simple job can end up costing many times more in such a home.
Moisture and drainage issues are exacerbated in structures which are built on a slab. If a moisture barrier was either not installed or improperly installed at the time of construction, moisture from the ground can leach upward and cause mold problems beneath flooring or cause floor tiles to pop off. I’ve seen a number of slab homes which are set low to the ground, making flooding more possible and more damaging in areas without proper grading and drainage.
Termites love below- or at- grade homes, since they have easier access to the wooden beams of the structure. If you have a low-lying home and moist conditions, watch out. In slab homes, it can be much more difficult to detect and remediate damage from termites or other wood-boring insects.
And any time you have a slab home, you’re looking at less living space because you may lose a room to utilities such as the furnace and water heater. It’s a safety violation to house these items within the bedrooms, so they’ll need a room or walled space all their own.
Lastly, there’s the issue of the washer and dryer. I must caution that laundry facilities located on the main level or above are more likely to cause severe damage when they flood, destroying interior finishes. This concern pertains especially to landlords because tenants may be unaware of loosening hoses, may fail to report leaks or, in the case of a rupture, be ill-equipped to stop the deluge in time. Having these facilities in a basement can limit the potential for damage.
Besides alleviating the concerns listed above, basements can be beneficial in terms of rental property value if the potential exists to finish them in the future.
So you’ve found a property at the right price, in the right neighborhood, and in compliance with local rental and parking regulations. But what about the structure of the building itself, its surrounding property? My next tip addresses just that.
5. Look for simple construction, with systems accessible and materials simple to replace.
That Victorian home you’ve been ogling may feature lovely leaded glass windows, but you’ll never find a suitable replacement at the local home improvement store. A slate roof is a beautiful thing to behold, but can be terribly expensive to repair. And if the roof’s very steep, costs could go up even further.
Maintenance and repairs are critical to the success of your rental investment, but need to be done promptly and at a reasonable cost. A house which has simple, solid construction, where everything’s easy to access and uses relatively standard materials, is generally the easiest and most inexpensive to maintain.
As some building contractors will tell you, the shape of your structure provides a general measure of its complexity. Count the corners of your building. 4-corner buildings are often simplest to maintain and add on to, and it goes up from there. There’s simply more to go wrong with the structure of more elaborate buildings, more chance that something wasn’t constructed quite right. Pipes and wires may have been routed unusually to accommodate the layout, or there may be areas vulnerable to leaks where differing roof lines meet. For this reason, a home inspector is especially valuable when you’re looking to purchase a more complicated structure.
When examining a potential investment property, consider ease of access to the heating, cooling, plumbing, and electrical systems. A panel or wall behind the shower allows quick access to plumbing in case of a problem, whereas if that shower backs up to another bathroom, you might be looking at removing a whole tiled wall.
Certain upgrades, like granite countertops or ceramic tile, are worthwhile because of their durability. Things like carpeting and paint jobs tend to be much shorter-lived in rentals, so expect that these will need to be updated and replaced over time.
Complicated landscaping may be expensive to maintain as well; I look for properties with a simple, small lawn, nice manageable planting bed, and ideally a large rock garden or patio. Less maintenance for your tenants and for you.
As you might have noticed from my rental articles to date, I believe that landlording is a serious responsibility, not to be undertaken lightly. You can realize serious benefits from a rental property, but also serious repercussions.
Because of this, I read today’s CNN Money article on so-called “accidental landlords” with great interest.
In the article, Kate Ashford relates the story of a Maryland couple who, after purchasing a new home for themselves, decided to wait out the weakening market and rent out their former home in the hopes of benefiting from future appreciation.
While they never planned to become real estate investors, they suddenly became landlords.
The rationalization offered is indeed compelling:
The inventory of homes for sale is twice as big as it was three years ago, which could mean a longer wait to sell – and a longer time to shoulder two mortgages if you buy your next home first. And with home prices flat – or worse – in many markets, you may not clear enough to cover broker fees once you do sell.
The rental market, on the other hand, is robust. Rents were up 4.1 percent in 2006, according to the National Association of Realtors.
While there are a number of costs to consider, including insurance, legal fees, and maintenance, the single-biggest watchout for this type of situation concerns capital gains tax. If a couple ends up renting their former home for three years or more, their capital gains tax exemption on the first $250,000 in profits ($500,000 for a married couple) is lost. That can significantly affect their resale profits.
Renting for a few years to wait out the market can be a savvy move, but beyond that three-year mark, the profit model alters. At that point, it might make sense to hold onto the property for the long term, enjoying the rental income for as long as possible. Of course, all of this is based on the property having a positive cash flow throughout its rental years. Without that, the risks may outweigh the rewards.
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In my last entry in this series, I discussed local rental regulations, “invisible” factors which can have a huge impact on your rental experience. One type of regulation which can particularly impactful concerns parking.
4. Ensure proper parking is available.
In one local township, parking requirements for rental and residential real estate differ substantially. While almost anything goes for residential homes, for rentals, one paved off-street parking space is required for all tenants old enough to hold a driver’s license, whether or not they actually have a license or own a car. A house rented to a family of two fiftysomething adults, an 18 year old son and 20 year old daughter would require 4 parking spaces.
Other jurisdictions may institute a flat, per-property parking space requirement or even a sliding scale based on square footage, such as the city of Mankato, Minnesota:
2. One and Two-Family Dwellings in R-3, R-4, and Office Residential Districts. For rental properties licensed after the effective date of this ordinance, off-street parking spaces shall be provided for each dwelling unit based on the following ratio of square footage of sleeping rooms to required parking stalls:
| Square Footage: |
Parking Stalls |
| 70 to 119 |
1 |
| 120 to 169 |
2 |
| 170 to 219 |
3 |
| 220 to 269 |
4 |
| 270 and greater |
5 |
More and more municipalities are passing such regulations, which are often conditions for licensure. Landlords are being forced to either retrofit their properties to meet the new requirements or throw in the towel and sell, as some lots lack the space to provide sufficient paved parking. These city codes often list a maximum percentage of the lot which may be paved, as permeable ground must also remain in order to prevent flooding.
Besides meeting existing regulations, off-street parking is desirable for landlords seeking quality tenants in areas where cars are de rigeur. People who care about their cars don’t like to park them on the street, so offering a protected parking spot can help you to attract better tenants.
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