Investing in a house to rent calls for some careful homework
There was a time when people bought rental property for income. The monthly income plus tax benefits exceeded both the monthly expenses and the mortgage payments on the property. Result: positive cash flow. The inflation-charged real estate prices that started in the 1970s and lingered into the 1980s put a crimp on that practice. The reason most people buy rental property these days is holding power. The rent is important, but not as much for income as for maintaining an appreciating property for a profitable -- and quick -- future sale.
The process can become painful, though, if not handled correctly. A pronounced slowdown in real estate prices brings the ``quick'' part into question, and ill-planned management can turn the investment into a regular problem.
The first step comes before buying or renovating a house for rental. Do some homework. Figure out if buying and renting the house make economic sense. Calculate the monthly expenses, including the mortgage payments and maintenance costs. Don't include utility costs in that figure, because the tenants should pay them. Otherwise they have no incentive to ``close the windows on a cold day,'' as one property manager put it.
Once you've arrived at the needed rent (see box), see if you can get it. ``Get a good feel for what the competition is charging for rents,'' advises Dom Nessi, vice-president of property management for Robert Fuller Associates, a large Denver real estate company. ``Look at single-family homes and apartments. . . . You've got to shop the rents. If you buy something that costs $1,200 a month but the neighborhood will only allow $350 a month in rent, you're in trouble.''
Finding the right tenants is the most important part of the rental business and usually the least predictable. A ``For Rent'' sign out front and newspaper ads are common, but Nessi also recommends registering the house with local corporations to house visiting executives.
In a city such as Denver, where large companies constantly recruit new executives, personnel departments prefer houses to hotels for lodging families on a house-hunting trip.
Once prospective tenants start calling, selecting the right one will accomplish more for management of the property than anything else. Require references from at least two previous landlords and call them. Visit the prospects at their current home.
``I can't emphasize that enough,'' says Nessi. ``You may get someone answering an ad who is neatly dressed and very polite, but when you visit them they have really torn the place up. . . . You should also write into the lease how many people are allowed to live in the house. You may think you're renting to one person only to find the local chapter of the Hell's Angels living in your house.'' Insist, he says, on the right to an inspection on 24 hours notice.
By the same token, a rental house on the market should be as presentable as a freshly starched shirt. A thorough cleaning and a fresh coat of paint don't cost that much but often decide whether a house sits unrented for month or gets snapped up.
Generally, says Nessi, a rental house should be unfurnished. ``Some people will leave a dining table or a sofa, but I don't agree. Your furniture generally just gets in the way of the tenants.''
A landlord also needs to know the local customs on security deposits. In Denver, the going rate is half a month's rent, but in some other cities a full month's rent is normal. There are also local laws governing where the deposit is kept. Some states or cities require the landlord to put the deposit in an interest bearing account, payable to the tenant. That's not required in Colorado, for example, but if the landlord does put the deposit in such an account, he must turn the interest over to the tenant.
Many municipalities print a standard lease form that covers most of the ground. ``For a house,'' says Nessi, ``it's a good idea to have a one-year lease and then go month-to-month when it's up. That gives you the security of knowing the house will be rented for a year plus the flexibility to raise the rent after the first year. It's also good for the tenants for the same reason.''
Pets are a sore spot for experienced landlords. ``A pet will invariably damage the unit,'' says Nessi, ``no matter what the people tell you.'' Cats, he says, are usually more destructive than dogs. Renting a house, as opposed to an apartment, however, frequently brings a family with some beloved animal in tow.
If pets are unavoidable, require a nonrefundable pet deposit, usually the equivalent of a month's rent.
Nessi offers a few other tips that can simplify basic maintenance:
1. Wood floors, if the house already has them, are a good idea. Refinishing them so they last costs from 50 to 75 cents a square foot, quite a bit cheaper than carpet, which runs about $2 a square foot. They're also fashionable.
2. Carpets should be strong enough to accommodate wear. Earth tones don't show dirt and are more accommodating to various tenants' tastes.
3. Keep the landscaping simple, preferably little more than grass and shrubs. In dry areas, an automatic sprinkler system can save the landlord the cost of resodding every time a tenant moves out.
4. Mini blinds are easier to keep repaired and clean than drapes.
Last, but not least, if all this sounds like too much hassle, hire a management company. They generally charge about 10 percent of the monthly rent and in return will find tenants, check them out, ensure prompt payment of the rent, evict tenants who violate the lease, and keep an eye on maintenance. Chart: How returns on real estate funds compare with Standard & Poor's 500 and inflation
Pooled real estate funds S&P 500 stocks*
Unrealized Income Total Unrealized Income Total Year appreciation return return appreciation return return CPI 1975 1.3% 8.6% 9.9% 4.0% 4.3% 8.3% 9.1% 1976 2.4 8.8 11.2 18.4 3.8 22.2 5.8 1977 3.1 8.9 12.0 -3.7 4.6 0.9 6.5 1978 7.7 9.6 17.3 -2.2 5.3 3.1 7.7 1979 10.9 9.7 20.6 7.3 5.5 12.8 11.3 1980 8.8 9.3 18.1 15.3 5.3 20.6 13.5 1981 7.7 9.0 16.7 7.8 5.2 13.0 10.4 1982 0.0 8.5 8.5 -6.5 5.8 -0.7 6.1 1983 5.3 8.4 13.7 34.0 4.4 38.4 3.2 Arith- metic mean 5.2 9.0 14.2 8.3 4.9 13.2 8.2 *Returns compiled from average for the year Source: Real Estate Research Corporation