There’s a chance you may become a landlord at one time or other during your life, if you haven’t already. Perhaps you need to move but don’t want to sell your home in a down market. Or maybe you’ve heard about all the benefits of investing in real estate and want to give it a try.
Done wisely, residential real estate investing can help build wealth like few other assets can due to its tax benefits, inflation hedge, and leverage and cash flow potential.
However, becoming a landlord is also a lot of work, has its challenges and is peppered with land mines for the unwary.
How to Be a Landlord & Make Money
Below are a few suggestions for how to be a landlord, avoid pitfalls, and create wealth using residential real estate.
1. Choose Properties Carefully
If you are interested in becoming a landlord and are looking to purchase a rental property, this choice of property will likely be one of the most important financial decisions you will make. Ideally, your property will be capable of generating a positive cash flow and will have good appreciation potential.
By positive cash flow, I mean that ideally the rental income will exceed all of your expenses of ownership, which may include some or all of the following:
- Mortgage Payment
- Property Taxes
- Periods of Vacancy
This net cash inflow is extra money that goes into your pocket each month.
Before purchasing a property, create a simple pro forma budget to estimate what your rental income and rental expenses will likely be. If your rental income doesn’t come close to covering all of your expenses of ownership, then you may want to keep looking.
Choosing an investment property is not a decision that should be rushed. Do your homework and make sure you find a property that makes economic sense and is appropriate for you.
You might consider the following factors when looking at properties:
- Quality of the neighbourhood
- Repairs and improvements required
- Distance from where you live (especially if you will be managing the property)
Using a good real estate agent can help immensely with finding a good rental property.
Before purchasing, I also highly recommend getting a property inspection done. The last thing you want is to purchase a property with unknown defects. You might also consider purchasing a home warranty if appropriate for you.
2. Title Properties Appropriately
Make sure your property is titled appropriately as part of your overall estate planning. Not titling a property properly could have unintended consequences, such as accidentally subjecting it to probate or having it pass to an unintended beneficiary.
An estate planning attorney can help you determine how the property should be titled and help you create any appropriate documents, such as a will or a trust. Alternatively, estate planning software such as Quicken WillMaker or an online service provider such as Nolo can also help you create such documents at a discount.
3. Find the Best Mortgage
Make sure that you don’t overpay on your mortgage. Shop around and find the absolute best deal for you. Lowering the interest rate on your mortgage will decrease your overall costs of ownership and hopefully increase your positive cash flow (or at least decrease your negative cash flow).
4. Find Good Tenants
If I could only give out one tip for how to be a landlord without wanting to pull your hair out, it would be to find and retain good tenants. I can’t emphasize enough the importance of this. Tenants can make or break any landlord. Good tenants can make becoming a landlord highly profitable and enjoyable.
Bad tenants can make you curse the day you even considered becoming a landlord. They can waste your time, cost you thousands of dollars, destroy your property, and be a nightmare. So find good tenants!
So how do you find good tenants? Spending a little bit of time and money to find good tenants is 956,786,456,799 times better than spending a LOT of time and a LOT of money later on dealing with, evicting, and cleaning up after bad tenants. Trust me!
Here is the process for how I find good tenants:
a. Do any necessary repairs, improvements, cleaning, and maintenance necessary to make the property look attractive and at its best.
b. Take nice pictures of the property. You don’t need a $10,000 camera to take nice pictures but it helps to have a camera that takes quality pictures. The better the pictures, the more interest your property will likely create. If you don’t own a decent camera, borrow one or purchase an affordable one on Amazon. You will also use this camera to document the condition the property is in before your tenants move in, so it’s really important you have a decent one.
c. List the property, pictures, and rental terms on Craigslist and other appropriate sites. Also list your contact info, details of any open houses, and when you are available to show the property. Additionally, let your friends, family, and neighbours know about the vacancy using Facebook or word of mouth. My best tenants tend to come referred from people I know and trust.
d. Host the open house or show the property to prospective tenants. I generally have applications available on site and allow people to submit them right there on the spot. As I discuss below, I generally charge a nominal application fee to help cover the cost of screening applicants.
e. Learn everything you can about applicants to help you choose your tenant. I pull credit and do a background check on all potential applicants. I want to see their credit, proof of income, what their prior landlords say about them, and other important information about them.
This costs some money to do, but I generally charge an application fee to cover it. Even if you have to pay for this yourself, do it. I’d much rather spend $20 now than thousands of dollars later when I have to evict someone.
A property management company can screen tenants for you, potentially saving you the time of doing it yourself, but at a cost. You can generally save yourself a lot of money by doing this yourself, as long as you put in the needed effort and do it properly. If you want additional help, here is a book that can walk you through the process:
5. Understand the Law
Make sure you understand the laws about being a landlord and selecting tenants. Most states have laws forbidding certain types of discrimination. For example, it’s generally illegal to choose tenants based on religion or race. You may legally decide not to rent to someone because they have poor credit or no job, but you might get sued if they can prove that you overlooked them because they are Catholic and you are a Methodist.
Additionally, there are generally many other laws that stipulate when you may enter the property, when you are legally required to make repairs, the condition the property must be kept in, when you can evict someone, etc. Failure to follow these laws could lead to lawsuits and problems. Here is a resource that can teach you much of what you need to know and help keep you on the right side of the law:
6. Take Good Pictures
Before your new tenant moves in, take good pictures of the property to document the condition it’s in and how clean it is. That way, if your tenant damages your property, you will likely have proof that the damage was not pre-existing. You may then be able to keep some or all of their security deposit in order to cover the damage. If you don’t own a nice camera, you can purchase an affordable one on Amazon.
7. Charge a Security Deposit and 1st Month’s Rent
Before your new tenants move in, make sure they have paid you the first month’s rent and a security deposit.
I normally charge a security deposit equal to a month’s rent. If you make the deposit too high, people may lose interest or be unable to afford the payment. I normally keep this money in a separate savings account or money market account so that I’m not tempted to spend it. Make sure the account earns you interest, is liquid, and is FDIC insured.
If they damage your property beyond normal wear and tear, you may be legally entitled to some or all of their deposit in order to repair the damage done.
8. Keep Good Tenants
When you find good tenants, try and keep them as tenants! Try and convince them to sign a longer contract. Respond quickly to their questions and requests. Make your property a place where they are comfortable and want to stay.
When I find good tenants, I try and have them sign a 2 year contract rather than a 1 year contract, even if I have to lower the rent slightly as an incentive. For me, this is generally worth it since I know they will take care of the property, there will be less periods of vacancy (which can be very costly!), and it saves me a lot of time finding and screening potential tenants (which can be stressful and time consuming).
9. Use an Appropriate Lease or Rental Agreement
Don’t just write something up on the back of a used napkin, have your tenant sign it, and expect it to be legally valid and enforceable. Use an appropriate contract that is legally valid and protects your rights as a landlord. Even if the tenant comes highly referred or you are best friends, make sure you get everything in writing. You can generally obtain an appropriate rental contract from an attorney. Alternatively, you might use the following book:
10. Protect your Assets
As a landlord you have certain obligations to your tenants. If you run afoul of the law or someone gets injured on your property, you could potentially be sued for a lot of money. The last thing you want is to spend years creating wealth as a landlord only to have it disappear overnight due to some freak accident or incident. In certain cases, you could lose not only your investment property but your other assets may be at risk as well.
You can reduce your risk and personal liability by doing the following:
- Obtain homeowners insurance
- Obtain umbrella/personal liability insurance
- If appropriate, create an appropriate legal entity for your property that may help protect your assets, such as an LLC. An attorney can help you create this.
You can save a lot of money by shopping around for your homeowners and umbrella insurance.
11. Do Basic Repairs Yourself
You can save yourself a lot of money by doing basic repairs and maintenance yourself. I’m not kidding. Repairmen and contractors charge a ton of money for their time. I know some handymen who never went to college yet charge an hourly rate a neurosurgeon would be jealous of. I’m exaggerating slightly but you get the point.
Paying a handyman to do repairs every few months can really add up quickly. If you don’t know how to do basic repairs, here are a couple of books that show you how:
- Home Maintenance For Dummies
- Black & Decker The Complete Photo Guide to Home Repair: With 350 Projects and Over 2,000 Photos (Black & Decker Complete Photo Guide)
When I bought my first property, I was about the least handy person on the planet. I might be deadly with a calculator but give me a hammer and I’m like a fish out of water. Little by little though, I am slowly learning how to do repairs on my own. I still use a handyman for the big things, but I can take care of many of the minor repairs myself. You may find that much of learning how to be a landlord is learning how to care for a property.
12. Refinance (if appropriate)
If interest rates have dropped and/or your credit has improved since you took out your mortgage, it may make sense to refinance your mortgage. Some people are able to save tens of thousands of dollars over the life of their mortgage by refinancing.
13. Manage the Property Yourself or Find a Good Manager
You’ll generally save yourself a lot of money by managing your own property. If you are able to manage your own property and are comfortable doing so, do it.
If you need or prefer to use a manager, find a property management company that is honest, that does quality work, and that will take good care of your property. A good property management company can be a great help. Many of them will help you find and screen tenants, coordinate repairs, collect rent, manage the recordkeeping for tax and many other necessary tasks. A property manager brings professional experience and expertise and can make your life much easier, but at a cost.
For additional information about managing your own property or finding someone to manage it for you, you might take a look at the below book:
14. Keep Good Records
Good financial recordkeeping can help you stay organized, reduce your taxes, and will likely be a crucial factor in whether you are successful or not as a landlord. Set up an appropriate system and stick to it.
Creating separate bank accounts for each property, such as savings accounts, money market accounts, and checking accounts can help you easily track your income and expenses for each property. Make sure such accounts are liquid, FDIC insured, and pay you a decent return on your money.
Come tax time, it will be extremely helpful to have all of your property’s cash transactions in one or two accounts, rather than mixed in with all of your other banking transactions.
Keep records of the purchase, improvements made to the property, and important receipts.
15. Budget & Emergency Fund
It is important to create a budget and estimate your future income and expenses. Since your expenses will likely fluctuate month to month (i.e. you won’t have the same vacancies or repairs each month, etc), set aside money each month to cover future expenses that will likely be incurred later.
With real estate, there are some expenses that are very predictable, yet there are also other expenses that are impossible to predict. Set up an emergency fund to cover future unexpected expenses so that they don’t break the bank.
I generally suggest setting up a separate savings account or money market account for this purpose so that these funds don’t get spent on other expenses. Choose an account that is FDIC insured, liquid, and will pay you a decent return for the use of your money.
Once you’ve built some equity in your property, you may have the ability to take out a home equity loan, which could be used as a further backstop for unexpected expenses.
16. Income Tax Planning
Make sure you understand the income tax rules of owning a rental property, including what expenses are deductible, what records and receipts to keep, how long to keep receipts for, like kind exchanges, and other important tax rules. A little bit of tax planning can save you a lot of money in taxes. Tax law can be quite complex, but here is a book that can teach you what you need to know:
17. Challenge Your Property Tax Assessment
I also lower my overall taxes by challenging my property tax assessment each year (if I think it is too high, which it normally is). It usually takes me about 30 minutes or so to do this but I usually save several hundred dollars a year. Every county may be a little different though.
18. Avoid or Eliminate Private Mortgage Insurance
Private Mortgage Insurance, or PMI, will likely be charged if you don’t make at least a 20% down payment. Ideally, you would make at least a 20% down payment so you can avoid paying PMI. However, if you don’t have that kind of cash, you can later have it removed once you have paid down enough of your mortgage. Contact your mortgage lender for additional information.
19. Work Hard & Manage Stress
Becoming a landlord can be stressful whether you decide to use a property management company or manage the property yourself. All of the following will likely stress you out at one time or another:
- Periods of vacancy
- Repair & maintenance costs
- Bad tenants
Additionally, plan on working hard if you decide to manage your own property. It takes a lot of work to find and screen tenants, deal with tenant complains and requests, make or coordinate needed repairs, etc. Hiring a property management company can decrease significantly the time and work needed from you, but at a cost.
20. Hold Onto the Property
Rental real estate is not liquid and can be quite expensive to buy and sell. Unless you are extremely talented at flipping property, it probably doesn’t make sense to purchase a property if you don’t plan on holding it at least 5-7 years. Selling costs can quickly eat into your overall profitability.
Over long periods of time, many rental properties appreciate in value. The rent a property commands may also increase over time, while some of your rental expenses (i.e. a fixed rate mortgage) may remain constant.
Additionally, there can be tax benefits for buying and holding property until you die. Although you generally receive a depreciation deduction for a rental property, this lowers your tax basis and you may have to pay back some or all of this tax savings when you sell the property. By holding onto the property until your death, you (and your estate/heirs) never have to pay this back due to the step up in tax basis at death.
Final Thoughts about How to Be a Landlord
Becoming a landlord will not make you wealthy overnight. However, done properly, being a landlord can be quite lucrative over the long run. It is a lot of work and there are plenty of pitfalls for the unwary, but it can be an incredible investment.
Although I do contribute to a 401(k) and IRAs, I hope to fully fund my future retirement with the income from my rental properties.
Additional Information about Becoming a Landlord
For additional information about how to be a landlord and make money at it, consider the following books:
- First-Time Landlord: Your Guide to Renting out a Single-Family Home
- Landlording: A Handymanual for Scrupulous Landlords and Landladies Who Do It Themselves
What are your thoughts about becoming a landlord? What tips do you have for how to be a landlord and make money at it? Leave a comment below!