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Tenant Selection Criteria – What to Use?

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Use the right criteria to say no!

Tenant selection is perhaps the most important thing a landlord can do.  You have heard the saying “One bad apple spoils the bunch.”  Well one bad tenant spoils a landlord’s life.  Bad tenants will not pay you, will destroy your property and will generally be a thorn in your side and to your other tenants.

So you want to weed those bad tenants out before they get into your property.  But, you must be careful with your selection in order to avoid a potential discriminatory claim.  To do that you need to establish a set of criteria that you use to rank all applicants.  You want to find tenants who can pay, who will pay and who will take care of your property.

What are those criteria?  Let’s first discuss what they cannot be.  You cannot base your tenant selection on the eight federally protected classes.  These are: race, color, national origin, religion, sex, disability, familial status.  That means you cannot disqualify someone because they are black, or Jewish or female or because there is a child involved.  These criteria in no way affect anyone’s ability to be a potential renter, so do not even think of using these criteria.  It is just wrong and it will get you in some serious trouble.

So, back to the question, what criteria can you use to select your tenants?  Frankly, it could be almost anything except those criteria listed above.  But here are some of the more common items used:

  • Enough income to cover rent, utilities and living expenses.  Many will use a standard of a monthly income equal to three times the amount of rent.
  • A steady work history with good references.
  • Decent references from past landlords.
  • A decent credit score.
  • A history of prompt bill payment.
  • No recent bankruptcy or evictions (last 5 to 7 years).
  • Criminal or arrest history.

Using the above criteria, you should be able to determine fairly well if an applicant can pay the rent, will pay the rent and if they will take care of your property.  Is it 100% effective?  No, nothing is when dealing with people but it does work pretty well.

Some will include other criteria based upon their own personal experiences.  I know of landlords who will not rent to lawyers.  Lawyers like to sue.  They are not a protected class and you can discriminate against lawyers as long as you are consistent.  I know another who will not rent to people with motorcycles.  Their experience has been that the motorcycle will end up in the living room dripping oil come winter.

You will most likely need to tailor your criteria to your particular circumstances.  Depending on your location, your tenant pool may not have decent credit scores, or bankruptcy may be very common.  Whatever criteria you do decide upon, be sure to write them down and be sure to evaluate everyone against those written criteria.  Keep a record of your evaluation process.  If someone ever does come back on your screaming discrimination, you will have records showing otherwise.

 

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What’s In Your Rental Application?

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The rental application is one of the most important documents that a landlord uses.  It is the tool that is used to verify everything that a potential tenant has told us.  The application should give you the authority to check an applicant’s credit, criminal, work and housing history.  A good application for should do three things:

  • Positively identify the applicant (yes, some do lie here.).
  • Determine if the applicant can afford the rental unit.
  • Provide enough information so you can rank the applicant according to your application standards.

You application form needs to be clear, easy to read, and easy to complete.  At a minimum it should ask for the following:

  • Legal Name
  • Current Address
  • Social Security Number
  • Phone and E-mail
  • Addresses for previous 5 years
  • Employment Information
  • Income Information
  • If the applicant has ever been evicted
  • If the applicant has ever been convicted of a crime
  • If the applicant has ever filed bankruptcy
  • If the applicant has pets
  • Who will be living with applicant (adults and children)
  • Where they bank
  • Credit references
  • Emergency Contacts
  • A space for comments and explanations
  • Authorization to check references, call employers and pull a credit report.
  • A place for their signature.

All of this information should be enough for you to determine if the prospective tenant can afford the property, meet your rental criteria and will be a decent tenant.

Keep it simple and straightforward.  Also be sure to keep your application form neutral in regards to the 8 federally protected classes, which are race, religion, color, national origin, age, sex, disability and familial status.  Determining your applicant’s ability based on any of these criteria is just plain wrong and will land you in hot water.

Next time I will take a look at some criteria you can use to rank your applicants.   Untill then, have a happy new year!

100% Occupied May Not Be What It Seems

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100% occupied.  Sounds great right?  That is just what we want to hear when we are looking to purchase a multi-family building to add to our portfolio.  However, not everything is always as it seems.

Trying to sell a building is easier if you can tell perspective buyers that the building is 100% occupied.  The buyer thinks that there will be less work involved in taking over the building when the sale closes.  They will not have to advertise, they will not have to do showings, they will not have to spend money rehabbing the apartment to make it rent ready.  There will be a smooth and easy transition.

But, as I said, not everything is as it seems.  Sure the building may be 100% occupied.  But, what if the current owner rented the last few apartments to anyone who could fog a mirror just so they could say the building was 100% occupied?  What if the people they placed in the building had been evicted from their previous residence just a few months before?

Don’t think the above happens?  It happened to me when I bought a four-plex several years ago.  Yes, I did my due diligence and reviewed all of the leases and the income and expense statements.  Everything looked fine.  But if I had bothered to check a simple and free database I would have noticed that one tenant had just been evicted and had a drug arrest as well.  No one in their right mind would have rented to this guy, unless you were trying to say 100% occupied.

So what happened?  You guessed it.  As soon as we closed, he stopped paying.  Four rent free months later, after going through the expensive and lengthy eviction process I had a dirty and damaged rental unit back in my possession.

On the bright side, I learned a valuable lesson.  Check out the current tenants as best you can before you close.  The court and criminal databases are free here as they are in many jurisdictions.  It is as simple as typing in a name.  If you do find something odd, go back to the seller and discuss and if you need to, renegotiate.  It would not have been so bad kicking the guy out if I had gotten a little bit better price.

Cash for Keys

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Tenant screening is one of the most important things that a landlord can do.  You want to make sure that you selected people to live in your properties that can pay, will pay, will pay on time and will not tear up the place and cause trouble.  However, no matter how well you screen your tenants, every once in a while you will have a tenant that cannot pay.

Perhaps the tenant lost their job, or had some other unfortunate circumstance happen.  Whatever the reason, when you have a non-paying tenant you want to get them moved out and a good paying tenant moved in as soon as possible.  It is not that you are a mean person, but you have to eat as well and the bank really does not care that the tenant has stopped paying you, the mortgage payment is still due.

The first thing that most people think of when they have a non-paying tenant is the eviction process.  Yes, you can go that route, but it can be expensive, time consuming and just downright nasty.  It creates ill feelings on both sides.  Plus, crafty lawyers will be sending your tenants advertisements telling them how they can stop that eviction with a bankruptcy (and they can for several months!)

Rather than eviction, I prefer to use the cash for keys method.  What is cash for keys?  It is simple really.  You pay the tenant to move out and hand you the keys.

Why would anyone do that?  Shouldn’t the tenant be paying you the back rent?  After all, they owe you money.  Yes, that is correct, but by the time they get to the point where they cannot pay the rent they have likely exhausted their resources.  They may want to move, but do not have the money to do so.

So it seems to me that it is better to pay them a little bit of money, maybe even as little as $50 or even as much as $300 to get them to move their stuff out and give you the keys.  By using the cash for keys process you have control of the incentives.  You can even get the tenant to clean the place before they leave so they can get their money.  Evictions use the threat of the courts and we all know cash today is much more effective than the threat of a judge sometime down the road.

Plus, when using the eviction process you are going to have to pay a lawyer.  How much will that cost?  $300, $400?  Did you figure in the filing fees, process server fees, writ fees and set out crew fees as well?  Now which one makes more sense?

I know it can be hard to swallow giving money to someone who may owe you a substantial sum.  But the best thing for everyone is for the tenant to move on and for you to get possession of your property back so you can get it re-rented as quickly as possible.

One last thing, before you had them the cash for their keys, be sure to get them to sign a release to the rights of possession.  Otherwise you could be in for more headaches down the road.

Presenting Yourself Financially

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One of the great things about real estate investing is that you get to leverage OPM, that is other people’s money.  Rarely do you use your own funds to purchase investment property (although if you can, that is a great way to go), rather you use the bank’s or some other investors funds to purchase your investment properties.  No matter where you are getting the funds, a smarter real estate investor learns how to present themselves financially.

Presenting yourself financially begins with you.  You have to show any investor, be it a local bank or a wealthy friend, that you are a good risk.  You need to demonstrate that if they choose to invest with you the chances of the investor loosing their money are very slim.  One of the best ways to do that is to put together a packet or “bank book” that explains who you are, what you do and how you plan to pay the money back.  Such a book makes you look professional and on top of your game.

Your bank book should first contain information on who you are.  Include resumes of yourself and any business partners.  Draft a short overview explaining how you got into the real estate business, how long you have been doing it and your goals for the future (you have thought about your goals right?).  Include any articles or blog posts you may have written that are relevant.  Perhaps you were interviewed by the local paper about your investments or about some charity work you have done, include that as well.  You want your investor to see that you are a solid and ethical person and thus worth the risk.

Next you need to include all of your financial information.  At least two years of tax returns will be required although more is better.  You should also prepare and sign a personal financial statement that outlines all of your assets and liabilities.  I also include information pages on the properties I own and manage that describe the workings of those properties, debts, expenses, cash flow, etc. in detail.  Include pictures.  If you rehab properties, show some before and after shots.  Remember a good picture is worth a thousand words.

I also like to add information about my team.  I list the names and telephone numbers of my attorneys, accountant and the various contractors I use.  I let my investor know they are free to contact anyone on my team with questions (let your team know first).  This information helps show folks that I seek competent advice when necessary and that I have a competent team to back me up.

Let me close with a tip.  In years past I would actually print out all of this material and put it together in a book form, over 100 pages!  No more.  Today it is all scanned and placed on a jump drive.  This cuts down my paper expense and helps my lender do their job because they are just going to scan everything into electronic format anyway.  Make their job easier and do it for them, they will like you for that and it may just give you an edge.

To help you get started, you can find the table of contents to my bankers book (or list of files for my jump drive) on my Smarter Resources Page.  Until next time, work smarter not harder.

Do Not Disturb (The Tenants)

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Many new real estate investors have bought at least one piece of real estate, their own home.  They have been through the real estate purchasing process at least once and this process is their frame of reference for future purchases.  The process for purchasing investment real estate is very similar.  You negotiate with the owner, agree on a price, draw up a contract, fulfill the terms of that contract and close the deal.  One key way that the process is different however revolves around existing tenants.

Investment properties like duplexes, quad-plexes, apartments and even single family homes that are on the market often have tenants in them.  Tenants make showing the property difficult.  The current owner is simply not going to invade his tenant’s privacy every time someone thinks they may want to buy the property.  You as a buyer have to realize that you will often have to make an offer on a property without seeing the entire property beforehand.  This is generally not a problem as we shall see below.

Tenants also require a certain level of discretion on the part of any prospective buyer because many times the owner has not told the tenants the property is for sale.  Often there will not even be a “for sale” sign on the property because the owner does not want the tenants to know that the property is on the market.  Why not?  People hate change.  A sale of the property means change and many tenants will simply move rather than deal with change in ownership (Yes, I know moving involves change as well but that is just the way tenants are.).

So when looking at an investment property with existing tenants, NEVER disturb the tenants in any way shape or form.  Always inform the listing broker or owner before you go on the property.  The agent or owner will most likely want to meet you at the property to show you a vacant unit (or possibly an occupied one) and prevent awkward encounters with the tenants.  You can always do a drive by for a look, but do not do much more.   If you do, you may just anger the owner enough that you will loose the deal.

As you can see, you will almost never see all parts of an investment property before you make your offer.  So how do you protect yourself?  You put a clause in your contract stating that the contract is “contingent upon the inspection and approval of the condition of all dwelling units.”  Once the seller and his agent are confident that you are a qualified buyer who can close and intends to truly buy the property, the owner will arrange for your inspection of all dwelling units and most likely let his tenants know that the property is going to be sold.  If, upon inspection they are in a condition that you anticipated then move forward and close.  If not however, it is time to return to the negotiation table.

 

Subscribe to Smarterlandlording and receive a Free Report: 21 Tenant Screening Red Flags

The “Getting Your Deposit Back” Form

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Tenant turnover is one of the costliest aspects of this business.  You have to advertise and re-rent the property.  Most likely you will also have to do some clean up and repairs after the tenant moves out.  One of our most important goals in this business is to get our properties back from tenants in a clean and nearly rent ready condition.

Getting your properties back in a clean and rent ready condition is not impossible.  To do it you need to do three things.  First, collect a security deposit for the property.  Then provide your tenants with a “Receive Your Deposit Back” form upon their move in.  Lastly, provide the same form again when the tenant gives notice that they are going to move out.

The “Receive Your Deposit Back” form states very clearly what the tenant must do to get their deposit back upon move out by listing the costs to clean and repair various items that were clean and working upon move in.  For example, if the tenant does not replace a burned out light bulb, it is going to cost him $15.  If they do not clean out the stove, that will cost them $75.  If they did not feel like vacuuming or sweeping up, that will be $50.  If they leave a bunch of junk, it will cost them $75 per hour to clean it up.  These costs are not made up; they are based upon actual labor and materials charges.

The goal here is not to make money with this form.  I can make more money if I can quickly re-rent my property so I want it returned to me pretty much the way it was when it was rented and I want to give the tenant their deposit back.  By using this form you create the incentive for your tenants to give the property back in a clean and working condition.  Tenants now know that it will cost them if they decide not to clean the stove when they leave for example.  We do allow for “normal wear and tear” such as small nail holes from pictures, scuffed up paint and very minor issues that come from someone living in the property.

This strategy has worked pretty well.  Plus, as an added bonus there are less disputes regarding deposits after move out.  The tenant was provided a list.  They signed the list and they made their choice upon move out, clean or not clean.

You should use such a form to help you get your properties back in a nearly rent ready condition.  To help you get started, you can download a copy of the form I use here.

Do Friends & Family Mix With Your Rentals?

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The other day on the radio with Holly Swogger and Jo Garner we were discussing some landlording basics.  One of the topics of discussion touched on renting to friends and family members.  Here is the main point and conclusion of that discussion.  Do not rent to friends or family members!

Renting to friends or family members seems like a good idea at first.  You know them.  You do not have to do a background check on them.  You know where and if the work.  You “know” they will make a good tenant.  And just possibly, they might.

But, what if they loose their job?  What if they just stop paying the rent?  Are you prepared to kick them out?  Are you prepared to take them down to eviction court and then set their stuff on the street?  If so, what do you think will happen to the relationship between you and your friends and family?   Who will end up being the bad guy in this situation?  You will.

The best way to avoid the above situation is to simply not get into it in the first place.  Do not mix your friends and family with your real estate business.  It can lead to some real disasters.  My fellow radio hosts and I have all talked with people who own rental properties they want to sell.  When we ask what they are getting in rent the answer is often $0 because the tenant is their son, daughter, niece, whatever and they can’t bring themselves to kick them out.

Is that a position you ever want to be in?  I don’t think so.  So avoid it on the front end.  Be a smarter landlord and avoid renting to friends or family.

Podcast – Landlording 101

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Check out my latest podcast where myself, Jo Garner and Holly Swogger, President of the Memphis Investors Group, discuss landlording basics such as leases, screening tenants, security deposits and more.  We also discuss how you can increase your cash flow by using some of the many mortgage options available to landlords for their rental properties.  We have never seen rates this low.  If you can refinance now is the time to do it.  Put some more cash in your pocket today! 

 

 

 

 

 

 

 

 

 

Get Off the Wall

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I attended my local REIA meeting the other night and was glad to see several first time visitors there wanting to get into real estate.  As I have written before, joining a local REIA group is a great way to get into real estate and now is a good time to get into real estate.  Being an officer of MIG and one of the more experienced members, several first time visitors caught up with me during the meeting.  They always ask the same thing, “What do I need to do to get into real estate?”  Here is what I tell them.

First, I tell them they need to study all they can about real estate.  There are many different aspects to real estate and I do not know what you want to do and frankly, neither do you.  Check out every book from the library, buy a few books, listen to pod casts, peruse the internet.  You need to get familiar with the basic terms and concepts used in real estate like wholesaling, mortgage, writ of possession, trust deed, etc and you need to become familiar with the methods to invest in real estate.  There is no right way to invest but not every way is right for everyone.

Secondly, you need to get to know some people in real estate.  You need to meet people who do different things in real estate such as landlording, or rehabbing or retailing.  While all deal with real estate they are very different and utilize very different skill sets.  You need to determine which investing activity best suits your skills.  There is no better place to do this than at your local REIA group by talking with other experienced investors.

I know this can be hard.  I was a newbie once too.  I went to meetings and stood along the wall and I see many first time visitors doing the same thing.  I know what they are thinking.  They are afraid you will sound dumb.  They are afraid you will not make a good impression.

But none of that is true.  The more experienced folks remember when they were first timers and how hard it was to take those first steps.  We will not think you are dumb.  We will be impressed that you have taken that first step!  So take that first step.  Get off that wall and up out of your seat.  Ask what people do, how they got into investing and ask for a business card.

Here is another idea for you first timers, offer to take a few of the people you meet out to lunch.  You need to eat lunch.  They need to eat lunch too.  Use your lunch time to your advantage.  There is nothing like an hour over a good meal to pick someone’s brain.

So get to a local REIA meeting if you really want to get into real estate.  Get off the wall and introduce yourself, talk to folks and find out what they do.  Over time, they will help you become a successful investor and soon you will be handing out cards to the first timers.