Five ways to protect a rental property investment
Mynd Editorial Staff
Investors face a maze of hurdles to find, finance, buy, insure, lease, maintain, repair, renovate and, ultimately, earn a profit when they buy a rental property. All that goes into the process can feel overwhelming; breaking it down into manageable steps can make the project feasible for even beginning investors.
Since the goal of every investor is to maximize profit while building equity in a property, the most important things to consider are what to do to protect that investment. That starts with the structure of the buying entity and includes a host of other important steps. Does it make sense to set up a Limited Liability Company? What sort of insurance, an umbrella policy or a special landlord policy? What’s the best method for screening tenants? What does a landlord need to do to comply with all state and local laws? And finally, what should an owner do to keep their tenants safe, inside and out?
Screening tenants to head off a nightmare scenario
Every landlord fears the tenant that pays late or not at all, is constantly asking for fixes around the property and causes disturbances in the neighborhood. Finding the right tenant is not rocket science, but a thorough vetting and a consistent process can help property owners avoid the nightmare tenant.
Almost every property owner has at least one nightmare tenant story.
Mynd Management offers tenant screening as part of its services and according to Jessica Sills, leasing manager, it rejects some 30 percent of applicants for its properties.
After two decades in the property management business, Sills has learned this lesson: “You can’t judge a book by its cover at all.”
There are a number of steps Mynd takes, and any property owner should have in place, to vet a potential tenant. For starters, the applicant has to earn enough income to afford the rent, has a clear rental history, and can pass background checks.
“Where it gets tricky is that we do see a fair amount of fraud,” Sills said. “Fake pay stubs are easy to create, as well as doctored bank statements.”
“We do have a way of sniffing them out,” she added.
When does It make sense to set up an LLC?
While LLCs offer many benefits to landlords, they are not necessarily the best approach in every case.
The primary benefit of forming an LLC (a limited liability company) for real estate investors is that if something goes wrong at a rental property — such as a tenant or a visitor getting hurt or injured — members of an LLC are not liable. The members’ personal assets, including their homes, cars, bank accounts and investments, are protected from an injured party that intends to sue. Nor are the members personally liable for the LLC’s debts.
If an investor owns one or two properties, an umbrella insurance policy, or extra liability coverage, will protect an owner’s assets in most cases. But once a property owner’s assets exceed the amount of liability insurance she is carrying, an LLC will offer an additional layer of protection. For instance, if an owner has $5 million worth of properties in multiple homes and only $2 million in liability insurance, she should consider setting up an LLC.
“When you get to a certain level, that’s when an LLC starts to make sense,” said Thomas Stepp, director of investor services at Mynd.
Forming an LLC in most states is an inexpensive and straightforward process that a real estate attorney can handle. Filing fees range from a low of $40 (Kentucky) and $45 (Arkansas) to a high of $425 (Nevada) and $500 (Massachusetts). Seven states charge no annual fee, and the others start at $10 a year and go up to $500. (Again, Massachusetts). Some states require an out-of-state LLC to register as a “foreign LLC,” which can require additional paperwork.
“Not all LLCs are created equally,” Stepp notes.
Asking a professional for advice is a wise step to take.
With insurance, price should not be determining factor
Once an investor locks up a deal to buy a property and has secured financing, she finds out that she needs insurance. And in too many cases insurance is an afterthought, and many people insist on seeking the best deal.
This can be a costly mistake.
“It’s not about getting the cheapest policy,” said Karla Rivas, director of business operations for Mynd “It’s about getting the best coverage for your asset.”
Michelle Afflalo, a principal at Ives Insurance Services, an independent brokerage in San Diego, said almost every agent has a horror story where a client had insufficient insurance and lost their investment in a fire or an accident. Afflalo said the average amount of a liability lawsuit starts at $1.5 million, so many property owners are carrying insufficient liability insurance.
Problems arise mostly because customers shop on price for insurance, unaware that saving a couple hundred dollars a year can lead to huge losses if the fine print does them in.
And many who invest in real estate are not aware that they need a different type of insurance.
“Most consumers don’t understand that there is a landlord policy and a policy you get for your personal residence,” Rivas said.
Also, if a property is unoccupied for more than 30 days, a policy needs to be converted so that it is covered as a vacant property, which is more expensive since insurors view vacant properties as riskier.
Afflalo said some learn painful lessons about insurance when it’s too late.
“Most people don’t know they lack proper coverage or have insufficient coverage until a claim occurs,” she said.
Landlords need to learn to navigate legal minefields
The contract between property owners and tenants begins with basic phrases: Lease term. Monthly rent. Security deposit. Cleaning fee. Pet policy.
But break down the lease and legal compliance — and toss in myriad federal, state and local regulations and old-fashioned paperwork and human interaction — and some of the policies successful property owners follow can often lead to their biggest battles.
Topping the list is an issue that can turn into a tug of war in the final chapter of a lease: Security deposit disputes.
“A lot of owners make the mistake of charging too much for wear and tear,” said Travis Bohling, vice president of the West for Mynd. “At the end of the lease, owners sometimes feel like all charges should be put back on the tenant.”
Other obvious yet sometimes overlooked obligations toward clear and concise legal compliance involve a tenant’s right to privacy and enjoyment of the property; a landlord’s promise to provide a habitable and safe home; and avoiding discrimination and adhering ot the standards of the Fair Housing Act.
“All these topics can look the same from a global vantage point,” said Giles Imrie, vice president, corporate counsel for Mynd. “But variations can be onerous from state to state and present legal landmines for landlords.”
Home safety: preventing burglaries, and accidents around the house
Landlords must take steps to provide their tenants a secure and safe home, protected from dangerous conditions inside, and from intruders outside. While codes and regulations vary from state to state, property owners are required to take measures to protect tenants from mishaps like fire, falls and carbon monoxide poisoning.
Employing simple electronic devices, proper landscaping, sufficient lighting, and modern lock systems, real estate investors have many ways to protect their properties — and their tenants’ possessions — against prying eyes and sticky fingers.
Motion detector lights can cover parking areas, driveways, backyards, or other approaches to a home intruders can try. Properly maintained landscaping — cutting back overgrown trees and shrubs, keeping outside windows clear of plant cover — not only improves curb appeal, but also deprives would-be thieves of hiding places.
Keyless combination door locks can be a better solution than combination lock boxes. These systems can integrate with smart home technology and can accommodate custom and permanent passcodes, voice control and other features. Video doorbells from companies like Nest, Ring, and Arlo range in price anywhere from $60 to $250, and offer various features depending on price.
According to the National Fire Protection Association, U.S. fire departments responded to an average of just over 350,000 home structure fires a year between 2014 and 2018.
“Every bedroom in a property must be equipped with a smoke detector,” said Billy Wardlaw, Mynd’s construction manager. “New homes built today are required to have them, and they must be hardwired to the house’s electrical system. The battery inside the unit is only a backup.”
Likewise, carbon monoxide testers must be installed near where gas cooking ranges are installed, like kitchen areas.
Injuries due to falls are among the most common in American homes, and they can be serious: twenty percent of older adults who fall suffer a broken bone or head injury. Outdoor stairs can be hazardous under snowy or rainy conditions, but can be less so when treated with affordable products like safety tape. Adhesive safety treads in tubs go a long way to avoiding falls.
“One of the top features requested by tenants is grab bars” in places like bathtubs, said Wardlaw.