How do you prevent putting in bad tenants?

Every landlords fear is that they fix a property up so well that it looks great and then they put bad tenants in who don't pay and destroy the unit on the way out. This is a real concern for real estate investors and there are no guarantees, but there are things to do to help shift away from bad tenants as much as possible.

Before I go any further, I need to add one condition. Different places have different anti discrimination laws. Find out what they are and base your tenant approval process around those laws. Please do not use anything that I write to justify breaking a local law or discriminating against good people for any reason. For the purpose of this article, I'll be focusing on residential tenants. I'll try to write something else for commercial tenants.

Once you understand the laws in your area, write a tenant approval policy. This should dictate the criteria where tenants will be approved or denied occupancy in your property. You should address credit history, previous rental history, income versus expenses & length of employment.

You may want to put something like:

1. Excellent overall credit
2. No rental lateness’s over 15 days in the past 2 years
3. Total monthly payments on debts are not greater than 36% of the potential tenant’s gross monthly income
4. Rental payment is not greater than 28% of the potential tenant’s gross monthly income
5. Minimum job history 2 years

You can adjust these categories according to your own discretion, but be careful not to make them too loose. You're better off making an exception to your policy to someone who doesn't qualify in a certain area then to reject someone for a reason other than that stated in your policy. That type of rejection is an invitation to a discrimination action.

You may be thinking... What do I do if I can't find someone who fits in every category??? Where do I make an exception? The first place I would make the exception is credit history... and the place I would never make the exception on is debit to income ratio. Someone might have been sick in the past or they might have taken out bills that they couldn’t afford in the first place. There are a lot of reasons that someone might have bad credit and they still can be good tenants. If someone doesn't make enough money to afford the rent, you're asking for problems. What if they have excellent credit and they say they can afford the rent even if it doesn’t look that way? Forget it. Do both of you a favor and recommend an apartment that they can afford.

As far as job history and income goes, use your judgment. If someone has always worked, even if at different jobs, and made similar amounts, chances are that will continue, even if they lose this job.

It's better to wait an extra month to find a good tenant, then to put someone bad in. What if it takes more then a month? Wait and don’t get discouraged. There are plenty of good, honest people out there.

How to deal with contractors...

Contractors (carpenters, electricians, plumbers, etc.) are some of the toughest groups of people to work with. Most are very hard working and honest.  However, there are some others who are crooked and will think nothing of trying to pass off shoddy work, trying to jack up the price half way through the job, not doing all of the required work, walking off of the job completely or all of the above.   If you’ve ever done a rehab or even owned your own home, you know what I’m talking about.  If you’ve been taken advantage of, don’t feel bad.  You’re not alone.  I’m right there with you.  The only reason I know any of this is because it’s all happened to me…  more than once.

Here is a list that I compiled of some keys to dealing with the 2nd group of contractors  (that also helps a lot with the first group)

1.      Get absolutely everything in writing.  This includes the following:

1.      Total Cost (usually broken down into 2, 3 or 4 installments as the work progresses, depending ion the size of the job.)  This means that you know and the contractor know exactly what work needs to be done for you to give them their next check.

2.      The installments section should break down what work has to be done to get each installment.  MAKE SURE THE BULK OF THE MONEY IS GIVEN TO THEM WHEN THE JOB IS FINISHED.... Not at the beginning. That's probably the most important thing I could tell you. You have to look at installments as “just in case the contractor stops returning your phone calls, you can pay someone else the rest of the money you have set aside to finish the job.”  If you can't, you're paying the contractor too much up front for each installment

3.      The quality of materials used.  You don’t want to verbally talk about marble countertops and have them show up with formica. 

4.      Breakdown between labor & materials.  Any contractor is entitled to make a fair wage.  I also believe that I’m entitled to know what that fair wage is.

5.      Timeframe with financial consequences if they don't finish in the allotted time.   This is very important.  Every day that your property goes unfinished is a day that you have to pay interest, taxes, insurance, utilities, etc.  Plus the risk that the market will turn for the worse, seasons change, pipes freeze, etc.

6.      Once you get more comfortable with what work needs to be done, I highly recommend that you come up with your own list and have them bid on your list.  That way they don’t leave something off their list and charge you more for it later…. Or the famous “That’s not my responsibility.”

2.      Make sure they are licensed & properly insured - if a problem happens because of their faulty work, you want to have recourse.

3.      Ask for recent references & call them. I know that you're busy, but it only takes a few minutes. If the most recent satisfied customer they give you is 3 years ago, there may be a problem.  If the contractor burns you half way through the job, you’ll wish you had done more due diligence in the beginning.

4.      Inspect, inspect, and inspect.  Be prepared to inspect the property a lot to make sure that the work is progressing.  The other day a friend of mind was complaining that the contractors were moving at a snails pace.  I asked him how often he inspects the property.  He told me ever couple weeks.  Big shock that they’re not pushing forward quick enough.  I recommend daily or every other day depending on the job.  If the property is too far for you to inspect that much, shame on you for buying a property too far to manage.  If you’re too busy with other stuff, make time.  This is your money we’re talking about.

5.      Last, but certainly not the least.  There will come a point with almost every contractor when they will ask for the next payment (or part of it) before they finish the task.  I’ve had this happen a million times.  Often with contractors I used before.  They always have a story.  Everyone does.  Sometimes I cave in and give it to them.  Sometimes, I remain strong.  Here’s what I can tell you.  Almost every time I caved in and gave them an advance before the work was done, I regretted it.  All of sudden when they had my cash, I became last priority on their list.  Stick to your guns and say, No.

This is a tough business for smart and touch people.  Know your rules and stick to them and you'll be way ahead of the pack.

It's all in "The Buy"

If you ask the average investor “When do you make money with real estate?”  He’ll probably answer “When you sell it.”  It seems logical, but it couldn’t be more wrong.

Here’s an example of a call that I got last week.  A newbie investor and called with a scenario that he wanted me to finance.  He told me that he had a property under contract for $50,000 and wanted to put $30,000 worth of work into it.  I asked what he thought he could sell it for once completed and he told me that he could sell it for $100,000.  Before I could say a word, he told me how great the deal was and that he would make $20,000 profit.  I asked him if he had figured out closing and carrying costs.  The answer was no.  I explained to him that after the realtors costs, transfer tax, title, appraisal, carrying costs, etc. He probably wasn’t going to make anything and the deal wasn’t so good after all.  Then he said something to me that really threw be for a loop.  He said “Well, I’ll just sell it for $120,000 then!”  After my shock slowly wore off, I realized that he has missed Real Estate Investing 101.  He was very sincere and believed what he was telling me, but he just didn’t get it… so I started from the beginning.

There are three major elements to making money flipping properties:

1.      The buy

2.      The work

3.      The sale 

That’s basically it.  There is always financing costs and turn around time, but they’re minor compared to the big three.

Let’s spend a little more time going over the “big 3” and what we can control.  Let’s start backwards:

3. The sale – Chances are the property is going to sell for what other comparable properties have sold for in the neighborhood.  The quality of work has an impact on the sales price, but only to a certain point.  If the nicest houses in neighborhood sell for 200,000, then no matter how nice we make out property it’s not going to sell for too much more.  We can install platinum toilets, but they’re probably not going to yield that much higher of a sales price.  Anything that far above and beyond is called “over improving” and will get you very little in terms of extra dollars at closing.  The sale pretty much is what it is and we can’t have that much of a positive effect on it no matter how good of a job we do. (Yes, we can have a negative affect on it, if we do a shoddy job)  Back to our example, a property isn’t going to sell for $120,000 when other comparables are selling for $100,000 just because we could use the extra money.

2. The work - Just like the sale, the work is going to cost what it costs.  Yes we can do a job better or worse or put in those extras that make the house a little nicer (granite counter tops, hardwood floors, etc).  There is also a decent variation if we use a general contractor or sub-contractors.  The cost of contractors will improve as you grow and get more experience.  For the average investor who does not have their own construction crew, you generally get what you pay for.  Cutting corners on the work is only going to hurt yourself when you go to sell the property.

1. The buy – This is the only major element that we can have a huge impact on.  We have little effect on the sale (aside from the quality of construction).  Unless you’re a major investor or can do the work yourself, we have little effect on the work. (The more we cut corners, will catch up with us when we close).  The purchase price is something and the only thing that we have complete control of.

Just like this article…. When looking at properties, work backwards. 

1.      First figure out median values in the neighborhood.

2.      Then figure out the cost of work it would take to bring this property up to par.

3.      Then after subtracting out the work, your closing and carrying costs, and your desired property, you’ll reach the maximum price that you’re willing to pay for that property.

 
(Or you can use the simple formula of being into a property for no more than 65% of the After Repaired Value)  When you’re out there looking, just remember to work backwards and that your profit is made when you buy the house.

10 Common Real Estate Investor Mistakes

10. Know your area - You need to have an excellent knowledge of the area you're buying in.  What blocks are good?  What blocks are bad?  Is there noisy street traffic?  Does the pizza place on the corner stay open until 3 am?  Are there kids hanging out on the corner late at night making noise?  You need to know all of this to determine what you're eventually going to sell or rent the property for.  This leads right in to number nine.

9. Be realistic about the sales price.  If every 3 bedroom in the neighborhood sells for 200,000, nobody's going to pay you 220,000 just because you're a wonderful person.  Know what sells for what & rents for what in the neighborhood and be realistic about the end price.  Yes... Rehabbed properties sell & rent for a premium, but that should factor into you price.  Actually, this is a perfect intro to number eight.

8.  Do quality repairs.  Hopefully, you're in this for the long hall.  Most investors concentrate on a particular neighborhood.  Neighbors talk to & trust their neighbors.  If you do quality work, they'll probably tell their friends, family & neighbors to buy or rent from you.  If the work stinks, they'll definitely tell their friends, family & neighbors to stay away from you.  While we're on the subject of work, this is a good way to start number seven.

7.  Know what work to do I what areas.  There are certain areas where luxuries like Jacuzzis, marble counter tops & hardwood floors are almost a prerequisite for selling a property at a top price.  There are other areas where it will barely get you a few dollars more and it certainly won't cover its cost to put in.  Know the difference.  This actually has nothing to do with number six.

6. Do your math.  2 plus 2 always equals 4.  I can't tell you how many times investors call me with a deal and they just never took the time to calculate all the costs, including realtor, transfer tax & carrying costs.  After doing the math, the deal stinks and they're actually wasting everyone’s time including their own.  Speaking of wasting time, here comes number five.

5. Be as good as your word.  This one should probably be number 1 or 2, but the list flows better this way.  Don't ever waste people’s time and don't ever lie.  It’s not worth it.  When you’re honest and you never waste people’s time, you'll soon get the reputation as a serious person who gets things done.  People will flock to do business with you, because of it.  I can't stress how important this is.   Here comes number four.

4. Most contractors stink.  Ok... Maybe I shouldn’t make a generalization like that, but most contractors still stink.  If you’re a good contractor, maybe you're the exception.  You have to be very careful.  Some contractors will do shoddy work, not complete the job when promised, try to pass of worse materials, stop returning your phone calls or never show up again once they cash your check.  You should inspect the job site a lot and never give them too much money before the job is done.  After that, number three will sound a little more positive.

3. Do your homework.  Educate yourself on investing.  You wouldn't attempt surgery after reading one medical book or attending one seminar.  Would you?  Read books listen to tapes & attend seminars.  Here comes number two.

2. Network with other investors.  The best way to meet other investors is to join the local investor club.  Different people specialize in different things.  Some people are great at finding good deals.  Others are great at rehabbing.  Some are great with managing rentals.  Find your niche and then find partners to fill in on what you're not great at.  Everyone has to bring something to the table.  Figure out what you can bring and the deals & money will come pouring in.   Now for the number 1 reason...

1.  I'm not really supposed to put plugs or advertisements in these articles, but the number 1 mistake most investors make is they don't use me for their financing.  Let's see if they publish this.

 

Ari Miller is Vice President of Gelt Financial Corporation, a private portfolio lender in Pennsylvania that specializes in investor real estate and development loans.  Gelt lends in PA, NJ & Southeastern FL.  You can contact Ari at (215) 947-2974 ext. 275 or AriMiller@GeltFinancial.com.  To learn more about Gelt Financial, go to their website www.GeltFinancial.com.