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Rookie landlords face big challenges

These scenarios play out daily in Anytown, U.S.A:

  • You're transferred to another market or lose your job.
  • You need to take care of a chronically ill out-of-town relative.
  • You can't pass up the opportunity of a lifetime on the opposite coast.
  • You'll soon be working a succession of contract jobs in different towns for at least year.

Whatever the motivation, you've got to move on. But you own a house and aren't sure you want to sell. You may return in a few years, or may want one of your grown kids to nest there again someday.

So rather than sell, you decide to hang out a for-lease sign. Just ask enough rent to exceed your house payment and you're on your way. You can't lose, can you?

You can, and resoundingly. To the unsuspecting freshman landlord -- especially an absentee one -- the renting pitfalls can be deep.

Check your tenants
Consider the case of Scott Fagerstom, who left his Seattle home in good hands when he took a dream job in San Diego. A trustworthy friend and colleague leased the place, but quickly left and subleased it to others, who also departed. Soon, the tenant mix was almost unrecognizable to Fagerstom, who was hundreds of miles away. And things got ugly.

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"I guess they were frustrated that there wasn't a fireplace, because they started a fire on my hardwood floor," says Fagerstom, who is vice president of an Orange County public-relations firm. "And one night, I got a hysterical call from a neighbor saying they were shooting guns on my lawn ... they also pushed a couch out the window."

Fagerstrom spent considerable time and money flying back and forth to the small-claims court in Seattle. He has since sold the house.

"The one big mistake mom-and-pop type landlords make is not running a credit report or checking references of all tenants," says Champaign, Ill., investor and Realtor Randy Hughes. "If you get what we call a professional tenant in there, they can spend two to six months in your house without making a payment."

Such deadbeats usually plead a plausible case to landlords, who will often let them move in sans a deposit. Or they may proffer a first-month rent check that bounces, usually after taking occupancy. "Then it's pure hell to get them out once they're in," Hughes says.

Be tough with the tenants upfront, screen them thoroughly, make it clear what's expected of them in their rental contracts, and clear their checks first, say seasoned landlords.

Today's drip, tomorrow's flood
Even before that, get a thorough home inspection, Hughes says. Small roof leaks or a faltering central air-conditioning unit or furnace may not be obvious to you, but they can also become monster problems, especially if you're a thousand miles away. A full appraisal is also helpful to establish value and rent.

Emotional attachment to a home aside, rental data suggests that owners of most higher-dollar houses should just buck up and sell them, says Ron Starr, a Bay Area landlord, investor and real estate educator.

Know the rent you can get
The lower the house appraisal value, the higher percentage of rent-to-value the landlord can expect to get, and vice versa, he says.

For example, owners can usually get about $550 a month rent for a $50,000 house, or 1.1 percent of the home's value based on the average mortgage, say landlords. But research shows a $200,000 home will get an average of $1,600 a month, or 0.8 percent of its value, while a $400,000 home gets about $3,000 a month, or just 0.75 percent, says Starr. The reason? It's tougher to find quality tenants for high-priced rentals, especially in a down economy, and it's harder to get a workable sum when you do.

Landlords getting less than 0.8 percent of a home's value per month aren't left with enough to provide for even a small cushion after fixed costs, especially as interest rates rise, Starr says. A monthly return of 1.25 percent or higher is optimal.

Finding a good renter can be tough, with so many first-time buyers entering homes in recent years due to relaxed lending standards, say landlords. "There are simply fewer quality tenants in the market," says Hughes, who has been a landlord for 30 years. "Everybody with a heartbeat and decent credit has already bought a home."

The good news is that new-home demand will drive up the price of your home investment, he added.

Finding help from afar
Without adequate preparation, becoming a remote landlord "can be a recipe for disaster," Hughes says.

Try to find a friend or relative to look after the place. Or better yet, enlist a handy neighbor who has a vested interest in the neighborhood, he says.

Property managers usually get from 7 percent to 10 percent of the month's rent, and may not be too motivated to do their jobs well by the small sum associated with a less-expensive home. "Of course, no property manager is going to do as good a job as you," says Hughes.

Also realize that renters "tend to not keep a house in very nice condition," Starr says. "A lot of times, an owner will get disgusted with what the renter has done to their home. Emotionally, the owner would have been better off selling in the first place."

Do your homework and double-check it, Starr says. "It doesn't take much for new landlords to find themselves in a negative cash flow."

Steve McLinden is a freelance writer based in Texas.

-- Posted: Oct. 30, 2003
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See Also
7 questions for would-be landlords
Sale of a rental property is a taxable event
Tax advantages of rental properties
Getting rich with rental property
Track prime rate/other leading rate indexes
More real estate stories

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