To build wealth as a real estate investor you must buy and hold property. Unfortunately, holding property means having tenants since you need rental income to support each property investment.
I manage over 50 rental properties. That could be a nightmare without good systems and step-by-step plans to avoid frustration. Now with 7 years under my belt, I am happy to share with you the most important keys to managing a large portfolio of houses.
For you to benefit from my experiences, you may have to look at managing properties in a new light. My approach is unconventional but it has been adapted by highly successful investors nationwide for many years.
Let's talk about how to avoid the biggest problems of being a landlord. Most of my properties are single family homes. I am not an expert at dealing with your “typical” tenant or filling up “rental units.” However, you will discover tips that will apply to your multi-unit properties as well.
My overall “answer” to avoiding property management challenges is offering homes through a “rent-to-own” or “lease option” program. I will use the term “rent-to-own” but the strategies work the same as offering a lease with option to buy.
The BENEFITS of offering your houses on a “rent to own” basis include:
- You'll collect a sizable “non-refundable purchase deposit” instead of a refundable security deposit you'll have to manage. Without the need to keep it on account, you can spend the deposit now if needed. And you avoid legal entanglements regarding mismanaging security deposits.
- You get an “owner” mentality instead of a “tenant” mentality from your occupants. Since they plan on buying, they treat the property better.
- You will occasionally sell off a property at a premium price when a tenant actually closes… or get another sizable chuck of cash down from a new tenant if they don't.
- You can have built-in incentives in the form of rent credit and rent discounts when tenants pay on time. You no longer have to chase down payments as often.
- You can have built-in incentives in the form of rent credit and rent discounts when tenants never call you for repairs or maintenance. This will allow you to avoid phone calls about all the small stuff that can drive you nuts and chip away at your cash flow.
- You can manage many properties yourself or with the help of someone you hire in-house. You have more control than using a property management company.
- All purchase deposits, rent credit and improvements made to the property are non-refundable unless you cannot deliver clear title when they're ready to buy. Allow your tenant/buyer to build a deck (or other quality improvement) at their expense but it's yours if they don't close later, but theirs when they do.
- Only 1 out of 3 tenants (depending on your approach and how well you screen) will ever buy the home during the term you specify. Something usually changes in their life. That means you get to keep most of your homes, enjoying appreciation and tax benefits. If they move, their purchase deposits become extra income and any improvements become yours.
- You can be less picky regarding your tenant's credit history and stability as long as you have enough money in hand to be protected. You can offer challenged buyers a second chance and time to get re-established.
- You make a rental house more attractive to the marketplace by offering the purchase option, thereby filling vacant properties faster.
- You do not need to pull credit. Get your tenant/buyer in touch with a good mortgage broker and let them do it (in relationship to their plans to buy in the future).
- With enough money in hand to protect yourself, you can be very flexible with smoking and pets. Many tenants have trouble because of poor credit plus they have a pet. They just can't qualify to rent or buy. If you can work with them, they will agree to your purchase terms and work very hard to raise the cash down you require.
- You can have the purchase price and monthly rent increase on a predetermined basis so you can create a multi-year plan. The longer they stay, the more chances something will happen in their life where they'd decide to move.
- You can get above average income buy charging top market rent and collect additional purchase deposit money each month, quarter or year. Tenant will agree to your terms when they need to work with a more flexible landlord.
- You can occupy a house quickly that needs work by allowing the tenant to trade repairs and improvements for equity. You avoid the time and expense getting a house in top shape, plus you avoid the risk of an occupant messing up your new paint job, etc.
Please understand that the rent-to-own program is ideal for many tenant/buyers. If they move within a few years because of a job transfer, divorce, changing needs, etc., they avoid losing the normal money they would have had to spend first buying with a new loan and then reselling through an agent.
What are the DRAWBACKS to an investor who wants to hold long term for wealth building?
- You need to replace each house sold by continually buying new homes. To maintain a portfolio of 12 houses, you'll need to buy 3 or 4 more each year.
- might have to use all the purchase deposit money received from your last tenant buyer to fix up, remarket and reoccupy the home once vacated.
- You will be dealing with more people who have less at stake. A good qualified tenant may own assets, have a good stable job and good credit they'll want to protect. If they default on their rental agreement or a promissory note, you can get a payment agreement or judgment which you can collect on. A less qualified tenant buyer can only protect you with the amount they have pledged as a non-refundable purchase deposit.
- Without clear written agreements and a “meeting of the minds,” a tenant buyer may pursue partial or full reimbursement of money they paid toward buying the house if they change their mind. A liberal judge could unfairly rule in their favor. But when you handle it right and make concessions when it's smart business, this is rarely an issue. In fact most people apologize for not buying when it happens.
Notes on the Rent-To-Own Addendum:
I attach a “Rent to Own” Addendum to my Purchase & Sale Agreement (P&SA). You can use any contract you like and may have to modify the addendum to your agreement. The example I am providing is my latest version geared to the agreements in my “How to Collect 5 Figure Paychecks Buying & Selling Houses” home study course described at www.richardroop.com.
I say “So, if I have to evict you for not paying rent then you no longer get to buy the houses” with a smile.
My rental agreement has a $50 discount for paying on time and taking care of the house. If we advertise $995 rent, then I put $995 here in the first blank and $1045 as the normal rent on rental agreement. Next blank is today's date. Annual rent increase may be 5% to 10%. I use 10% at the end of a 1 or 2 year plan.
You can set up a plan to collect additional deposits above their rent to build up a down payment. Many times I will have them sign a Promissory Note instead and then credit the face value of note on their P&SA. In that case I cross out Provision C.
If you offered any rent credit, spell it out here. Typical for me is $1200 total rent credit at $100 per month for 12 months. If half of your tenant buyers actually closed then you'd only be giving away a $600 credit on average. Can you raise the asking price at least that to cover it? Of course.
Typically 12 months, sometimes 24. Extension is typically 12 months. The amount extra you get down depends whether you want them to close or not. Example: $10,000 if you want them to close or maybe $500 if you don't, or $3500 if you just don't care.
The increase % amount is normally % beginning on a date 12 months out. Or I may lock in the price for 24 months. If you market is appreciating faster then you may say 1% after 6 months. It is all up to you.
A clear disclosure.
In Paragraph 1B of my P&SA we have the total amount of additional binder deposits to be paid prior to close but not on day of contract. If they agreed to another deposit of $2000 in a week and then an extra $300 per month for 12 months, the total is $5,600 in my Paragraph 1B. We'd then spell out the details of the $5,600 in Provision C for $3,600 and H for the $2,000.