Rental property ownership can be one of the most financially rewarding investments you will ever make. As with any investment, there are risks that accompany the rewards. Rental property investment has plenty of potential risks but with proper education and planning, the risks can be minimized.
Whether you are new to rental property investing or an experienced investor, here is a list of the most common pitfalls of rental property investors:
#10 – Overpriced rent
The investor who is anxious to maximize their return on investment may fall into the trap of thinking their property is worth more than the market will pay which can lead to a longer time on the market which equals vacancy. A vacancy is a killer on your investment return, so correct market pricing is critical to a successful investment. Rental prices are typically established through open market competition. “Market rent” is determined by what residents are paying for comparable properties. Rents will vary by property type, amenities, neighborhood, and overall property condition. The apartment industry often tracks, and reports rent based on a square foot basis. For example, a 1000 square foot apartment that rents for $1000 is renting at $1.00 per square foot. This method makes for a systematic way of planning and pricing rents for an apartment community. Single-family rental home pricing is similar but takes a little extra effort since homes can vary widely by condition, location layout, and amenities. Begin by shopping the immediate market and compare. Find out what other houses in the neighborhood are renting for and how long they were on the market. You will begin to assess what a good current local rent should be for your property. Keep in mind that market rents fluctuate based on multiple external factors such as local employment, seasonal or weather influences, and school districts to name a few. For this reason, it is important to do this same process on a regular basis to make sure your rents are current with the market. Remember, the market establishes your rent…not you.
#9 – Not increasing rents
Landlords often make the mistake of thinking that since they have a “good resident” who is taking care of the property and paying their rent on time they don’t want to upset the resident by giving them a rent increase at the end of their lease. Rents will typically follow inflation. By not raising rents to at least keep up with inflation means you are not only leaving money on the table but you may be digging a hole for yourself and your investment. As we all know, costs of goods and services typically increase. This means that the cost to maintain the property is also increasing. Prior to the end of each lease term, a market evaluation should be done to determine the current market rent for your property. An adjustment for inflation should be considered at a minimum. In some cases, demand for available rental property may exceed supply. In that case, you may find that your rent can increase even more. There are rare occasions where a downward adjustment is required due to external market factors such as loss of major employment, but these instances are rare these days. Making upward adjustments in your rent at the end of each lease period is smart business but does require attention to maintenance and other critical processes which will be mentioned later.
#8 – Believing that low rent will attract better renters
As discussed in the previous two paragraphs, rents are established by the supply and demand of available rental property. The idea, therefore, of lowering rents to attract the best residents is short-sighted and you will be unnecessarily reducing the return on your rental property investment. Quality residents are best determined by a thorough screening process. Objective background screening that is compliant with federal, state, and local laws should include, credit, criminal, previous landlord, employment, and income and is critical to successfully placing a qualified resident. A property that is well marketed at fair market rent will attract prospective residents. Consistent application of your screening criteria will then allow you to identify a qualified resident without having reduced your rent.
#7 – Allowing Security Deposit to be paid in installments
This is a really bad idea! Once a lease has been signed and the resident has moved in the only recourse for unpaid security deposit balance is to file a complaint about monies owed or possession (eviction) in the local magistrate court. It is always best to require a full security deposit paid at the time the lease is signed and prior to move-in.
#6 – Allowing discounted rent in exchange for work on the property
In most cases, this is not a good idea. Although this can be an effective and inexpensive (and tempting) way to make a needed repair or upgrade, the process is often mismanaged causing greater damage to the resident relationship, the property or creates risk exposure to the property owner. It is best to respond to maintenance, repair, or upgrade need by hiring a fully insured, qualified vendor. If the resident is qualified to complete needed work, proper documentation is critical. Proper documentation will include: clearly specified work to be completed; specify materials; time frame; required inspection of the work (before, during, and after completion); photo documentation; define the compensation. Perhaps most importantly, check with your insurance carrier to make sure you have coverage in the event the resident is injured, or property is damaged as a result of the work. You may also want to have your lawyer draft a contract document.
#5 – Not knowing the law
There are well-established local, state, and federal laws governing residential rental housing. Not knowing these laws can be expensive and have a devastating effect on your rental investment. Local governments often adopt a housing standard and, in some cases, require a business license, property inspection, and certificate of occupancy for a rental home. At the state level, rental homes are governed by a statute that provides legal guidelines for the landlord/tenant relationship. At the federal level both HUD and EPA regulate certain aspects of the rental property. Every landlord needs to be familiar with these regulatory agencies and their requirements to avoid expensive mistakes or omissions.
#4 – Poor documentation
Let’s face it, we all want the resident to move in, pay their rent on time, report legitimate maintenance needs, clean and care for the property and move out in accordance with their lease with the property looking better than when they moved in. However, we need to document not only property conditions but virtually all transactions and communications in case there is any variation from the perfect scenario. Periodic property condition reports (including move-in and move-out) that include photographs or video and notes will not only document the condition of the property at that time but can also help identify unreported maintenance needs. Resident rent payments should be documented on a resident ledger showing when rents are paid each month along with corresponding charges such as late fees, NSF charges or other lease-related payments. All correspondence with the resident should be documented including application screening and decision criteria, phone calls, email and snail mail communications. Maintenance records showing when work was requested, what work was done and when work was completed. Maintaining good records and documentation will enable the rental investor to navigate through challenges that may occur.
#3 – Poorly written lease agreement
A poorly written lease can leave the property owner exposed to unnecessary risks. As mentioned above, documentation is critical to a successful outcome when challenges arise. Documentation starts with a quality lease agreement that incorporates applicable (and enforceable) landlord/tenant laws, rights, and responsibilities. Rental owners often use a template lease form which should be thoroughly reviewed by both the property owner and a qualified attorney to ensure that the lease is compliant with local, state, and federal laws. If things go well, then a poorly written lease may never be noticed but if things don’t go well a well-written lease will help protect the owner of investment property from unnecessary risk exposure.
#2 – Short-sighted maintenance
Rental property owners often see maintenance as a dreaded expense instead of an opportunity for value enhancement. The resulting poorly executed maintenance response can be devastating to a rental investment return. To be understood thoroughly we must remember two things:
1. A rental property is a naturally depreciating asset that must be maintained properly. Without regular and proper maintenance, a property owner will lose value resulting from a decay of the property. Proper and regular repair of the roof, walls, grounds, utility systems, interior finishes, and appliances all create real market value for the rental property. Since the property is going to naturally decay or depreciate through use and from environmental factors we must maintain the property on a regular basis to stop or slow this process.
- A rental investment property is going to produce greater revenue if maintenance is handled effectively. Apartment industry surveys reveal that nearly 25% of residents who choose not to renew their lease make their decision based on poor quality maintenance repair and responsiveness. A lease that is not renewed results in turnover and vacancy expenses which increase operating costs. It is a far better investment strategy to respond to legitimate maintenance requests with quality and timely maintenance services.
#1 – Becoming emotionally involved in the rental investment
The residential rental property includes three key components: people, money, and housing – each component is potentially charged with emotion. However, by definition, an investment is the action or process of investing money for profit or material result. There is no part of that definition that includes deference to one’s emotional wellbeing other than the part about “profit” of “material result.” To put it simply, an investor in rental property must view their investment as a business and act that way. A business exists to produce profit and provide opportunity. Rental property investment is no different. The investment must generate revenue and thereby an opportunity for both the investor (landlord) and the resident (customer). It is important to take a step back and look at the commercial transaction that takes place between and landlord and a tenant. The landlord provides a quality product (housing) for the marketplace (customers). Customers (residents seeking housing) need a quality product. Customers will always respond positively to a well-priced, quality product. Housing is no different. So, when a rental investor places that well-priced, quality product into the market it will attract customers needing that product. Now that the customer has purchased the product (signed a lease, paid rent, and moved in) it is up to the business owner to ensure the customer is happy with the product through professional, courteous, timely services. The key to success starts with an emphasis on professionalism and all the responsibilities and implications that go with being a professional. Separating one’s emotion from the contractual, business relationship is an important skill for any professional and is important for the rental investor to learn if they are to be successful.