Craig Kamman — A Short Guide to Investing in Rental Properties

Have you ever considered buying rental properties? Then this article is for you. I am going to attempt to cram my knowledge into a short article. If you have questions come up as you read, please feel free to jot them down and send them to me. I will get back as quickly as possible.

Rental Properties allow you to leverage into an asset and have someone else cover the payments on the debt until you own the property free and clear or decide to sell.

I will attempt to give you a Quick Overview of the Rental Property Investment. This is not an investment for everyone, it is a very good investment but takes some participation to make It pay off. I will try to address some of that as well as get into analyzing the ROI, ROA and Cap Rates of properties.

Managing the Rental Property:

This is the area that you should give deep consideration to. This is the biggest drawback to investing into rental properties and where investors get hurt as a result. The management itself is not all that difficult but it can be trying at times especially if you don’t have the time. If you have more money than time you may want to consider contracting this portion of the business out to a professional management company, or at minimum have the management fee built into your investment analysis so you can opt for professional management if you decide later it is not something you enjoy or excel at.

As a Property Manager your duties will include:

Attracting Renters
Leasing the property
Maintenance of the property
Collecting Rents
Evictions
Compliance

These are not complex things, but there are times where it gets to be a pain in the neck. For example, Thanksgiving Day 2009, I sat down with the family to begin the Thanksgiving Day meal when my cell phone rang. It was one of my renters, they had flushed the toilet and it had backed up and made a mess. I choose to do a lot of these repairs and maintenance myself as opposed to calling a plumber for something like this. So I missed the family meal to clean up the mess and unplug a toilet. These are the sorts of things that happen when you own rental property that you need to prepare for, whether you take them on yourself or hire it all out.

Attracting Renters:

The age of the internet has really simplified this process. I recommend advertising for free on Craigslist.com. The price is right and it has a very high success rate. Other options might include the local paper or yard sign, I don’t personally use those techniques though – I advertise on craigslist. To get an idea of what the place would rent for, search craigslist.com. Other resources for rents are: www.zipskinny.com , www.rentometer.com , www.fastrent.com

Section 8 rent subsidies. There are property owners that utilize Section 8 housing program. I have not worked with this program so I recommend starting at HousingLink’s resource page for you to learn more about this program.

http://www.housinglink.org/List.aspx

Leasing the Property:

Now that you have an interested prospect in renting your place, there are a few things I recommend. The first is to have an application they fill out agreeing to a background check including: credit score, income to debt ratio, forcible evictions, and criminal background. You will be better off if you fight to get a good renter in than fight to get a bad renter out. Some Tenant-screening companies you could use:

You will want to set a guideline on what is acceptable to you for credit score, income/debt ratio, forcible evictions, and criminal history; this will serve as a way for you to keep things fair for everyone including yourself. REMEMBER: You can NOT turn a renter down based on: Race, Religion, Color, Sex, National Origin, Familial Status, Disability, Marital Status, Status with regard to Public Assistance or Sexual Orientation – if this statement makes you nervous, you may want to stay out of the rental business. They monitor this stuff very closely and are always on the lookout to make an example of someone. The most recent one I heard was in LaCrosse, WI where property owner was hit with a $10,000 or $15,000 fine for turning down a single mom because the owner felt there was too much snow removal for her to handle.

Special Requirements for Handicapped Tenants. The ADA covers:

psychiatric disability
mental retardation, dementia, or other mental problems.
Alcoholism or history of abusing alcohol
Aids or HIV-positive
History of using illegal drugs, but does not use them now.

As a landlord you must consider requests for reasonable accommodations that would enable a person with disabilities to enjoy the same rights as a person without disabilities. There are exceptions: 1) if the accommodation puts an undo financial or administrative burden on the property. i.e. adding an elevator to a home built in the 1920’s. 2) If the accommodation substantially alters the purpose f the property or its program. Now this changes a bit if the disabled person requests to pay for reasonable modification of the existing property. My opinion is if you find yourself in this situation; consult an attorney to make sure you are following the laws. These rules may change from the time I write this to when you may be reading this.

Under Minnesota law, landlords are required to notify tenants of the availability of the Landlords and Tenants Rights and Responsibilities handbook from the Attorney General’s office: 651-296-3353 or www.ag.state.mn.us/consumer/housing/lt

Also, check again with the local municipality for additional requirements.

You should disclose all non-operational elements, for example if there is a fireplace but doesn’t function – don’t let a renter move in thinking they are going to be able to enjoy sitting by a nice fire if they won’t be able to. The same is true for the little things, like appliances, windows, etc.

If the property was built prior to 1978, you must provide a copy of the Protect Your Family from Lead in Your Home booklet from the Environmental Protection Agency (EPA.) Download a copy here: www.epa.gov/lead/pubs/leadprot.htm

The Lease. The lease should be written in plain language that the average person can understand. I don’t recommend buying leases online or from office supply stores, you may find one that is just fine but there are a lot of them that would not be enforceable in Minnesota. If you are getting into the rental property business and will be managing your own properties, I recommend you contact the Minnesota Multi Housing Association and become a member. They will provide you with the resources and updates of the ever-changing rules. They are also a great resource for Lease agreements. www.mmha.com

You can also call me to lease your properties out for you and I will provide the Lease, advertise the place for rent, obtain the rental application and submit it to the Tenant Screening. If they are acceptable to you I will collect the Security Deposit and 1^st months rent and deliver it to you. My fees are negotiable and depends on the property.

Maintenance of the Property:

If you currently own a home now, you are aware of the constant maintenance that needs to be done. The normal things like snow removal, lawn care is easy to plan for on rental properties. Some properties you can have the renter take care of those, other properties you can’t. It is the little things like a broken window, a leaky faucet, an appliance goes out, a pipe breaks, pest control. If you are managing the property you will be dealing with these things. If you are hiring a property management company, you will be paying for these things plus a management fee. There are also big-ticket items that you need to consider in the investment such as roof replacement, furnace replacement, water heater, appliances. These items have life spans ranging from 10 years to 30 years, but at some point eventually need replacing. When you budget them out over the life of property, they are not that expensive on a monthly basis – if you are saving up for them.

Collecting Rents:

This is the fun part! Hopefully if you ran your screening process properly, this area won’t give you too much trouble. I recommend setting up an automatic payment from their checking account to yours. This simplifies the renters life and yours, and more and more renters are preferring that method. I have had very little trouble in this area. But when this goes bad, it can go really bad.

Forcible Evictions:

Hopefully you will never make it to this point. But if you do, there are specific procedures in the State of Minnesota that you must follow to remove a renter. It is referred to as Eviction by general terms, but when you are in the Court system it is referred to as “Unlawful Detainer”. If you are in need of filing an Unlawful Detainer, you can do that yourself – however I highly recommend seeking legal counsel on this matter because there are pitfalls you can fall into making an unpleasant situation much worse. Some property managers will file for Unlawful Detainer right away after the rent is late, because the clock starts to tick. For more information about filing an Unlawful Detainer in Minnesota go to: http://www.mncourts.gov/district/2/?page=1000

Gut Check Time:

Are you scared yet? If you have made it this far and still not afraid of being a landlord, then your personality is probably a fit for this kind of investment. If you use common sense and practice fair business, you will be just fine. The horror stories everyone hears don’t happen all that often, especially if you do your homework as outlined here. If you get into trouble, reach out for help from a trade organization and/or legal counsel before you make matters worse. If you don’t want to deal with all this stuff above but still want to invest into property rentals, then contract these services out to professional Property Management company. There are a lot of great Property Management companies in the Twin Cities.

How to Select a Rental Property

Go back to the first 3 rules of Real Estate: Location, Location, Location. I am sure you have heard that saying a million times. The same rules hold true for Rental Properties. The objective on the rental property investment is to have the renter pay the mortgage for you, so you end up with all the equity. Where do you want that equity at? What areas do you want to have your asset for re-sale and appreciation? Then there is the reality side of it to, what price range can you afford to enter the investment at?

Since Real Estate is longer term investment strategy, I recommend you choose your location wisely. I recommend you be in close proximity to the property to be able to handle issues when they come up. There may be some great investment opportunities in locations far away from you, but if you are not in the business of rentals, my personal opinion is to avoid that trap. Try to pick something within a reasonable drive time for you, I like to stay within about 20 – 30 minutes from me.

Once you select an area or areas you would like to own in, check with the municipality on rental licensing requirements. This will let you know how much you need to budget for licensing; it may also tell you that you don’t want to own rental properties in that municipality. You may also want to check on the Property Taxes when they go non-homestead and Property Insurance rates.

The next step is to Contact Me to begin the property search. Ideally you are looking for a property that needs no repair, you can charge really high rents and can be purchased for $1. Well, that isn’t going to happen, so you need to go through some properties with me and begin to learn that market well. While we are looking continue to input various scenarios into my spreadsheet to project the potential Return on Investment. In rental properties you are looking for the location, condition, and ROI, this spreadsheet will help you determine your ROI. I have a lot of experience in real estate and own and manage rentals myself, I will be there to assist you through this process.

The first page of the Rental Property Analysis Excel Spreadsheet allows you to enter your scenarios.

This will include your purchase price, down payment, mortgage loan, rents, and expenses. These are all fairly self-explanatory. The trickier part gets into a little economics by allowing you to run projections based on inflation and appreciation. I like to use 3% for inflation and 3% for appreciation, over time this has been fairly consistent and property values had historically paced inflation until we came into the housing bubble. This spreadsheet will allow you to run various scenarios so you can determine if the investment makes sense for you.

This scenario shows a 2.68% ROA (Return on Asset), 20.23% ROI (Return on Investment), and Cap Rate of 5.7%. (cash on cash). I have been seeing these trade recently around 10% Cap Rate, so this example is a little low.