“Single Family Houses are hard to beat when it comes to investment vehicles. There is, however, one small problem called Tenants. While most Tenants are good, it only takes one bad apple to completely disrupt your life. From plunging toilets to eviction court, there has to be a better way. And there is… read on!”
I've been playing the tenant game for a long time now. And to be perfectly honest with you, I've never liked it. In fact, there are days that I'm ready to get out of the landlord business completely.
Of course… those days pass and I'm always glad I didn't quit. But there are still those days. If you own any rental property, you know what I mean.
It's those dad-blasted tenants. I know… I know… these are the people who provide me with a positive cash flow and pay for my houses. If I can just hang on mentally… they'll make me rich.
Honestly, I've had some excellent tenants. People who have stayed with me for years and years and never called or complained about anything. These people are a real pleasure to deal with. They actually enhanced the value of my property.
And then there was Karla…
“Come On Down To The Club Sometime!”
Of course, Karla isn't her real name. But here's the true story. I own this nice brick 3 bedroom 2 bath home with central heat and air located in a nice neighborhood here in Jackson, MS. It's probably a $55,000 house and I rent it on a discounted lease program ($50 discount) for $550 net per month.
Anyway… this house always seemed to attract the strangest tenants. I even had one who installed hydroponic marijuana gardens under grow lights in the closets of the master bedroom. I guess he was just searching for his groove?
After evicting the pot farmer, I met Karla. To tell you the truth, I was fed up and ready to rent to just about anybody who had the necessary funds. That's when Karla called. I met her and her friend girl over at the property. At first I thought she was a baker because she had this white flour all over her nose. She was polite about wiping it off after she realized it's presence.
Come to find out, Karla wasn't a baker after all. She worked in a local topless bar where her husband was the manager. She assured me she wasn't a dancer (yet) but made several hundred dollars a night as a waitress. The rent wouldn't be any problem. In fact, she could pay the first months rent and deposit in cash on the spot. I rented her and her husband (whom I never met) the house that day. Plus, she threw in a few FREE passes so I could “come on down to the club sometime“.
What Could I Have Been Thinking?
You would think that someone who makes $300 a night wouldn't have any trouble paying $550 a month for rent, wouldn't you? And she didn't for a while. But after about 6 months, I had to start sending out three day notices every month. She always paid, but it was later and later each month. I was starting to get that feeling in my stomach.
Then the inevitable happened. No rent. No phone call. No nuthin'. I went over to the house and couldn't raise anyone. I tried the door. They had changed the locks. After snooping around the outside I noticed the power meter had been removed. I wasn't feeling too good.
Finally I found an open window and gained entry into the house. What I found sent me into a spiraling depression. The inside of the house had been completely trashed. It wasn't habitable for man or animal. The carpets were completely ruined. Apparently they had a dog. A big dog. There were flies everywhere. The had even jammed the doors from the inside before they left.
As it turned out, they had been using the 2nd bathroom for the dog's kennel while they were away. I've never seen anything quite like it. The vinyl on the floor had been completely clawed away, as well as, the wood work and sheet rock about 3 feet up. Plus it was a bathroom, so you can just imagine the rest.
Long story short, it cost me about $3,500 to clean up and fix up the house. I had made a very poor business decision and it cost me a bunch of money. My attitude had soured.
“I'm Mad And I'm Not Going To Take It Anymore!”
So, I made the decision to sell the house. It just wasn't working out. But I wasn't willing to put it on the market and play the waiting game. I'd already sunk quite a little cash in the house and didn't want to compound the problem with the potential of making the payments out of my pocket (lifestyle) for 6 months or so while I waited for a buyer… then waited on the financing… and so on. There had to be a better way.
Let's Shift Gears For A Minute!
There are three opportunities for profit in just about any business venture. Real Estate is no different. You have the potential to make an up front profit… a profit as you go… and a profit on exit. Here's how this relates to Real Estate.
- Up Front Profit: In Real Estate, this could be a down payment, pre-paid rent, option consideration, commissions, assignment fees, etc. As the name implies… you receive this money on the front end of a Real Estate transaction. It's money in your pocket today. As you are already aware, I do not consider borrowed money to be profit… so it shouldn't be considered here. This is real profit today… on the front end of a deal.
- Profit As You Go: In Real Estate, this is known as a positive cash flow. It's income over expenses. This could also be financing you have extended on the sale of property such as a Deed of Trust, Mortgage, Contract For Deed, etc. Rental income in excess of expenses and debt service. That type of thing. I generally think of this as any type of monthly positive flow (although it could be annual, semi-annual or any other time frame). This is profit received over time.
- Profit On Exit: In Real Estate, this is when you cash in your chips. It's when you sell. It's when you convert your equity to it's cash equivalent. Generally, this profit is extended out into the future. It's the pot of gold at the end of the rainbow every Real Estate Investor dreams about. You might even consider this as future value. Most of the time this profit comes years down the road after your equity has matured. This is generally a larger lump sum profit realized upon the sale of your investment property.
Those are our three choices for making money in Real Estate. Sounds fairly simple doesn't it?
So… What's The Point?
Good question. Glad you asked.
You see… most Real Estate investment strategies only offer you 1 or 2 out of the 3 possible profit centers. Let's look at a typical rental property as an example…
You purchase a property… clean it up and fix it up… then find a qualified tenant to pay the rent on time. Hopefully, the rent covers your taxes, insurance, debt service, maintenance and management… plus provides you with a profit on a monthly basis. If everything goes as planned, your equity in the property grows with each mortgage payment you make. One day you wake up and realize you have quite a sizable profit in the property and decide to harvest your equity by selling… thus capturing a substantial profit upon exit from your investment.
That's what we all dream about, isn't it? The tenants pay for our house and provide us with some pocket change along the way. We've tapped into two of the three profits centers and everything is rosy. So… what's wrong with that?
Well… first and foremost is…
It's the rogue Landlord indeed that deep down inside doesn't have a burning distaste for tenants. I've had some great Tenants and I'm sure you have too… but all it takes is one bad apple to sour the way you view Tenants. Karla was a prime example of what I'm talking about.
The truth of the matter is this: If you own rental property you'll have to deal with a bad Tenant sooner or later. And hey, let's face it… some times the good Tenants can even be a pain in your butt. After all, they expect you to keep the roof from leaking… the air conditioning blowing cold… the walls painted… the carpets clean… the plumbing in good working order… the neighbors quite… the windows from breaking… the property secure… and on and on.
They can be a bit demanding, can't they. They expect you to take money out of your pocket (lifestyle)… and pay for improvements to a piece of property you'll never live in… and be responsible for damages you didn't cause. Makes me wonder why in the world we don't all become Tenants.Forget this ownership stuff. But, I'll save that for another time.
New and Improved!
Compare that to a home owner. They do all of those things for themselves. They are responsible, aren't they? Sure, they have to be. It's in their own best interest. They can make improvements to their property because they get a direct benefit… the use and enjoyment… and the pride of ownership. They'll work around the house and yard for the personal satisfaction. I've just recently heard that gardening, which includes working in the yard, flower beds and with potted plants… is the number one leisure activity in the United States today.
Speaking of the United States, did you know that the “American Dream” has always… and will always… be centered around home ownership. Home ownership is good for the individual… the local community… and our country. Home ownership encourages people to be responsible… to get involved… to take pride. Home owners have chips in the game. They have a stake.
But guess what? It has become more and more difficult to buy a home. The whole process has become complicated. Most of this complication revolves around the financing. While there are a hundred different loan programs available to potential buyers… they can be confusing. And if that isn't bad enough, rejection is the order of the day. Everybody has something wrong with them. Nobody's perfect. The financing process can be rigorous and frustrating. Sometimes it appears as if the lenders just chew people up and spit them out. Loan denied… next please!
Rent To Own Your Own Home (601-977-0277)
People want to own their own home. Don't believe me? Try running the simple three line ad above in your local paper. Run it and they will call. They'll call so much, in fact, you'll soon get tired of your phone ringing. Might be a good idea to test with a 3 day ad.
What do you think about this ad? Pretty non-threatening, isn't it? Does it sound high pressure? No! Does it sound as if you are in a position to help someone own their own home? Yes! Is it a soft sell? Yes! Does it offer more than a rental ad? Yes! Do you think this ad would attract someone with a home owner's mentality or a tenant's mentality? Who would you rather rent to anyway? Who would you rather sell to? Enough with the questions already!
Here's How I'm Beating The Tenant Game…
I decided I wanted to deal with people who want to become home owners. People with the home owner mindset. People who would be responsible. People who would take care of my property. People who had an incentive and desire to pay the rent on time.
So I developed my own “Rent to Own” program. Here's how it works:
Instead of a rental deposit, I charge a non-refundable Option Consideration. The size and method of payment of this money is determined by the market. On low end properties, this may not be any different from the size or method I would use to collect a rental deposit. On better properties, the amount can increase substantially. But, it all depends on your market. I'm finding quite a few people who have between $1,000 and $5,000 saved up for a down payment. These are the people who have demonstrated that they want to own a home. They have sacrificed over time to save for a down payment. They just need a little help.
This non-refundable Option Consideration will be applied towards the purchase price… so their money is working for them. In addition to the up front money, they must also pay a monthly rental fee for the property. This is where I can be extremely flexible. If they want to keep their monthly rental payments below comparable market rents, I can do that with an offsetting increase in the non-refundable Option Consideration. If they want to pay more on a monthly basis, but are a little short on the non-refundable Option Consideration, I can do that too! Anything over market rents will apply to their non-refundable Option Consideration… thus helping them save for a down payment over time. Did I mention the Option Consideration is non-refundable? Just checking.
In addition… because I generally buy property below the market, I can afford to give my Tenant/Buyer a healthy rental credit for each month they pay the rent “on time“. This could be as high as 100%. Sometimes it's only 50%… still not bad. And sometimes it doesn't even come into play. My generosity with rent credits is a function of my profit potential and my option strike price… coupled with time. Under my “Rent to Own” program, I can generally set the purchase price on the “high” side of retail and allow a large portion of the rental payment to reduce this price.
The Tenant/Buyer is responsible for the maintenance and up keep of the property. I will be responsible for the major components such as the roof, heating and cooling, plumbing systems, etc. They are still responsible for maintaining these items… but… I'll bear the larger expenses such as replacement. I tell my Tenant/Buyer to make a list of those things that do not work within the first 30 days of occupancy and I'll fix them. After that, it's their responsibility.
Currently… I'm setting these up on a 1 year term. I like one year because it passes rather quickly and meets with the expectations of the Tenant/Buyer. At the end of the year, one of three things will happen (none of which I dread). #1) The Tenant buys the house and I receive my profit. #2) The Tenant/Buyer needs more time and we can renegotiate on some basis for another year. #3) The Tenant/Buyer… for whatever reason… moves on down the road allowing me to do it all over again. The absolute worst thing that could happen is I have to evict the Tenant/Buyer and they trash my house on the way out. Less likely to happen here than if I did a straight rental, isn't it? Plus, I have more of their money to fix up the house if that does happen.
Does Everybody Win Under This Arrangement?
Sure they do. The Tenant/Buyer wins because they can have their money working for them from day one. I'll do whatever I can to help them become home owners. While I can't guarantee them financing (unless of course I'm in a position to finance it myself), I can help them navigate the available options, including credit counseling if necessary.
I win because I've secured an up front profit with the non-refundable Option Consideration… enjoyed an increased positive cash flow over the term of the agreement by eliminating the maintenance and management expenses… and if the sale closes, I will have a rather healthy pay day. Not too shabby!
Just remember this: There is a higher degree of responsibility on the part of the Tenant/Buyer. In addition to the non-refundable Option Consideration and the added maintenance they're assuming, they must also do what's necessary to qualify for a new mortgage loan. That's their responsibility. I can help them with this process, and so can you, but they're the ones who must actually do what's necessary. They have to pay their rent on time… pay their other bills on time… clean up their credit… get their debt ratios in line… etc. I encourage the Tenant/Buyer to be diligent and begin this process immediately upon occupancy. I'll help, but I can't do it for them. They have to do their part.
What About You Retail Freaks?
As you know, I like retailing houses. It's a tremendous source of “lump sum cash“. The biggest problem with retailing is the time frame. You put a house on the market and it might be 180 days or more before you realize your profit. All this time, your profit margin is shrinking because the property is not producing an income to cover your holding expenses. Add the risks accociated with a vacant house, vandalism and increased insurance costs… and it can be a bit unsettling at times.
Why not consider adding a “Rent to Own” program to your retailing efforts? You could cut down on your holding cost… your resale costs… as well as… make a small profit upfront.
She's out of my life now (she completely disappeared). I replaced her with a young couple who wants to own the house. They have been paying their rent on time for almost a year now. I received one phone call from them needing help with the air conditioning system. We got it fixed and they reimbursed me for the expense. I even recouped a sizable portion of my fix up costs back from them in the form of their non-refundable Option Consideration.
I don't know for sure if they are going to be able to obtain financing or not, but my gut feeling right now is that they won't. You want to know something? Even if they can't qualify for a loan, I'll continue to work with them. They are the kind of people I want to do business with. They are the kind of people who deserve to be helped. So, that's what I plan to do.
PS. Even if I haven't convinced you this market exists… try asking potential and existing tenants if they would like to “own their own home”. You may even want to add “Ask about Rent to Own” to your yard signs and other advertising. Once you find people who want to buy, further qualify them by asking how much money they have saved up for a down payment. I think you'll be surprised at the results.