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Updated on Wednesday, January 10, 2018
The single-family rental industry is booming. So many homeowners are choosing to rent out their homes these days that annual home sales dipped 5 percent in 2017, translating to about 270,000 fewer homes sold that year, according to a study by Zillow.
Contrary to popular belief, big-time real estate investors aren’t driving that growth. On the contrary, a recent report by the Urban Institute found nearly half — 45 percent — of single-family rentals are owned by investors who own just one unit.
Cindy Kluger, 50, of Rancho Santa Margarita, Calif., became an unexpected landlord in 2017.
In January, Kluger, a single mother of two — a 16-year-old son and 13-year-old daughter — inherited her aunt’s home in the popular Larchmont district of Los Angeles.
“I was sort of excited about it from the beginning simply because it’s the house where I spent all of my holidays growing up,” Kluger told MagnifyMoney. “I get the honor of caring for this house that meant so much to all of us growing up.”
The home was built in the 1920s and had been in the family for nearly half a century, mostly serving as a destination for family holiday gatherings. Because her extended family was emotionally attached to the home, Kluger knew she didn’t want to live in it or sell the property, but there were taxes and maintenance fees to cover. As an alternative, she decided to rent the entire house out.
For any first-time landlord, navigating the ins and outs of renting out a property can be challenging.
“Being an effective single-family home landlord requires discipline first and foremost,” said Brian Davis, co-founder of SparkRental.com. “Being a landlord is not an emotional business, it’s a business of operating systematically.”
Here are some practical tips for anyone planning to rent out their single-family home for the first time.
Any home improvements needed at the property
Before you put your home on the rental market, you should make sure it has been properly inspected and that any underlying structural issues are repaired first.
“I think all homes should have an inspection, even new construction,” said Greenville, S.C.- based real estate consultant Sunny Lake. “To protect you and your investment, it’s always a good idea to have experts working for you to give you an opinion of value and condition.”.
Specifically, look for what needs to be fixed to make sure the property is both legally habitable and aesthetically marketable for prospective tenants.
Because Kluger had inherited a home that had been in her family for decades, she soon realized how many issues had been fixed with DIY repairs.
“For the past 20 years [my aunt] had put bandaids on what was broken,” she said. “I realized that everything had to be examined.”
To bring the home into the modern era, Kluger had to completely redo the home’s foundation, electricity, and plumbing, in addition to ripping out the wall-to-wall carpeting in favor of hardwood and repainting the walls.
“I think it’s super important to think about these things that you may not be aware of because you are not living in the house,” she said. “You don’t want to bring renters into that environment.”
Your property management style
One of the most important things you will need to figure out is who will be responsible for managing the property. Most crucial, you’ll need to decide who handles any general maintenance and whom the tenants will contact if something breaks.
If you take on that responsibility yourself, you may be on call 24/7 to fix a broken pipe (or call someone who can go to the property to fix it). This is the approach Kluger plans to take.
“The fact that I sort of enjoyed all of the maintenance things came as sort of a surprise,” said Kluger. As she set about renovating her home, Kluger says made several contacts with vendors in the area whom she can call if tenants report anything broken and trust they will promptly handle the request.
Lake says you can do it yourself if you are a hands-on person with a network of service providers. But, not all landlords want to take the hands-on approach.
“Landlords should hire a property manager if [they don’t live near the property], or if they don’t have the discipline to manage their properties effectively,” added Davis.
If you plan to hire a property management firm, be prepared to pay between 8 to 10 percent of the monthly rent as a fee, says Lake, although that fee will vary by location.
With that fee comes some valuable bonuses, including peace of mind knowing that the major snafus will be handled by someone else.
Having a property management company might also attract higher-quality tenants, assuming the company provides a higher level of service than you would be able to offer as a single property manager.
Property management companies may also have more experience dealing with tenant issues. If the tenants don’t pay rent, for example, the management company may have a process and a legal team already in place to help resolve the issue.
“It all depends on your accessibility, and how much contact you want to have with the tenants,” said Lake. “Lots of investors feel like the fee is worth it to not have to deal with the potential hassles of late rent, walk-throughs, property maintenance, etc.”
What you expect your tenants to maintain
Some property managers handle all of the property maintenance, while others only manage a portion and expect the tenant to do some of the work involved in keeping the property clean and looking nice.
In the case of a single-family property, tenants might be asked to keep up with lawn maintenance, pay for a garbage collection service, or even homeowners’ association fees, if applicable. And that information should be included in the lease that the tenant signs.
If you won’t allow the tenant to do any landscaping or lawn maintenance because you plan to hire a company to come handle that kind of stuff on a periodic basis, for example, that needs to be stated in writing in the lease. If the tenant is expected to cover HOA fees, the details about how you’ll collect the fee needs to be in the lease, too.
In addition, the lease would need to outline what kinds of modifications the renter is allowed to make to the property. Are they allowed to paint the outside of the home? What about the walls on the inside?
Can they install a fence to keep their dogs in the backyard? If you don’t want your tenants to make any drastic changes to the property, that needs to be clearly stated in writing.
How you’ll find reliable tenants
It’s your property, so you’ll need to decide how you’ll choose a tenant for your property. It’s easy enough to post an ad on Craigslist or Facebook, but that’s just the first step. Once you receive applications, you want to make sure you have a way to choose a tenant you can trust to pay rent in full and on time. That may involve some level of underwriting — like like pulling a credit report and running criminal background check — to check a tenant’s creditworthiness.
“Tenant screening is an art and science in itself” said Davis. He offers the following tips to simplify the process:
- Always run full credit, criminal, and eviction reports.
- Always verify income and employment.
- Verify housing history as best you can with not just the current landlord but a prior landlord.
- Consider inspecting the applicant’s current home to see if they maintain it well.
Davis recommends making the inspection of the applicant’s current home a condition of lease acceptance.
“Applicants don’t have to agree, and the landlord doesn’t have to lease to them,” he says. “But, because it’s the most labor-intensive part of screening, it should be left for last, and only done for applicants who otherwise will be accepted.”
In Kluger’s case, she decided to get the help of a real estate agent to find her first tenant. The agent will find and screen tenants on behalf of Kluger and her father, this time.
“Once she helps us with that process my intention is to educate myself and learn what needs to be done to properly screen renters,” said Kluger.
Regardless of the agent’s opinion, the landlord gets the last word.
“One of the things my dad had me ask the real estate agent is that after she screens the person and thinks she has found a good candidate that we get last say. That we get to meet them and sign off,” said Kluger.
Even if you have a real estate agent taking applications, as in Kluger’s case, Lake recommends hiring an agency to run background checks on any applicants, as they have more access to financial, criminal, and other personal history.
If you don’t have the budget to hire an agent and agency, you may be able to handle the process on your own.
There are several websites that offer tenant screening services, for a fee. A couple of examples include Spark Rental, Cozy, and MyRental. Cozy, for example, charges $39.99 for both a background check and credit report, but the fee is assessed to the applicant, not the landlord. MyRental reports even include a ‘tenant score’ — a three-digit number that predicts the likelihood of lease default and lets you see if other landlords in your area accepted or declined applicants with that score for around $35.
How much you’ll charge for rent
To set your number, Lake says you’ll need to know the current market value of your property, which will vary based on the location and vacancy rates. She recommends calling up experts in your market for help in determining the rent amount if you’re not a seasoned agent or investor.
“You don’t want to overprice the property and have it sit empty,” she said. “But you don’t want to underprice it and leave money on the table.”
Beware: There may be restrictions on how much you are allowed to raise rent each year. Rent control laws are passed by cities, so you should check the municipal code to see if any rent control laws apply to the area you live in.
You can find your home’s estimated value on mortgage websites like Zillow or Trulia. You can also pay to have an appraiser come and check out your property in person for a more accurate estimate.
“Appraisals are required for financing, but landlords should learn to assess market rents for themselves,” advised Davis.
You should also decide how much of a security deposit, if any, you will request. The deposit acts as security for you in case the tenant is unable to pay rent for a period of time, or to fix any damages left by the tenant when he or she eventually moves out.
The rules surrounding security deposits vary from state to state. For example, New York has no law limiting the amount a landlord can charge for a security deposit, but, if the apartment is in the rent-controlled jurisdiction of New York City, the landlord is limited to collecting up to one month’s rent for a security deposit. Meanwhile, Alabama state law limits landlords to taking only one month’s rent.
State laws may also regulate where you are allowed to keep security deposit funds, if you must first do a walk-through of the residence to collect a deposit, when you are allowed to keep the deposit, and within what amount of time you are required to return the deposit. Check landlord tenant laws in your state to figure out what rules apply to you. Here are a few resources on Nolo, American Apartment Owners Association and Landlord.com to get started.
Outside of the law, the amount you require is up to you to decide, but will likely depend on how confident you are about the applicant’s creditworthiness. For example, if the applicant is self-employed and that causes you to be less confident in their ability to make the rent payments, you may require a larger security deposit, or ask them to pay upfront a few months worth of rent before they are permitted to move in.
How the cash flows work
If you’re looking to rent a single-family home as an investment property, you should understand the money going in and out of your investment, and how much it will cost you to make money on your rental. In other words, you should understand your cash flows.
For example, you may run yourself into the red if the rent you charge is only enough to cover your monthly mortgage payment and doesn’t take into consideration all of the other costs you’ll incur renting the property like your property tax, utilities, or what you pay to a property manager or other facility managers.
To get an idea of your cash flows, consider your maintenance costs on the property. In addition to property taxes, community fees, and general maintenance costs, you want to factor in cushion for the unexpected, like any potential lapses in tenancy during which you may not be able to receive rent, too.
“You need to have some risk tolerance to be an investor,” says Lake. “If the rental market is soft in your area, you need to have enough other cash flow to maintain your property even if it’s vacant.”
Lay out the cash flow — what you’ll be paid versus the amount of money you plan to put into the investment — and see if the number you estimate you’ll have after all is said and done makes good financial sense for you to rent the property.
What your insurance policy covers
If you’re renting out a home that’s still under a mortgage, you will likely need to purchase a landlord insurance policy to have the proper protections in place, according to Davis. The protection is similar to a homeowner’s insurance policy, but it doesn’t cover belongings.
Some homeowners insurance policies will cover short-term rentals, but most don’t cover long-term rentals like you would need to rent a home. Landlord policies generally cost about 25 percent more than a standard homeowners policy, according to the III, but you’ll get more protections in exchange for the increase.
Landlord insurance typically provides:
- Property insurance coverage — This covers any physical damages to the structure of the home caused by nature.
- Coverage for your personal items — If a lawnmower you keep on-site for lawn maintenance burns in a wildfire, for example, landlord insurance would pay for the loss.
- Liability coverage — Legal and medical expenses may be covered if a tenant or one of their guests gets hurt while on the property.
- Coverage for loss of rental income — If for some reason you are not able to rent the property — maybe it’s being repaired or rebuilt after damage from a covered loss — the insurance company should pay you the lost rental income for a specific period of time.
Since landlord insurance won’t cover your tenant’s stuff, you may also want to state in your lease whether or not you will require a tenant to keep renters insurance. When your tenant has renters insurance, that saves you, the landlord, from liability if something happens (think: fire, flood) and the tenant’s items are damaged.
How you’ll cover a bad tenant or an emergency
As a landlord, you’ll want to have an emergency fund or other fast borrowing option in place in case you need to make an unexpected major repair, or cover your mortgage for a few months in case your tenant can no longer afford to pay rent.
“Landlords absolutely, positively need a cash cushion,” said Davis.“As a rule of thumb, I like to keep around two months’ worth of rent on hand for each property, plus a source of available funds if needed.”
The fund exists to cover the occasional bad tenant or extended vacancy, and to keep up with the general maintenance of the home — in case, for example, a water heater breaks and you suddenly need $1,800 to replace it.
Lake, on the other hand, recommends landlords keep six months worth of rent in an emergency fund, but says that amount also depends on what other cash flow options you have at your disposal.
“It can be challenging for people to have that kind of cash along with a personal emergency fund,” said Lake. She recommends working with a financial advisor or property manager as a starting point.
Consider setting up an emergency fund, and contributing to it monthly. At the very least, you should have access to emergency money via quick borrowing options such as a credit card, home equity line of credit or home equity loan.
How much money you’ll need to cover a bad tenant or emergency may fluctuate depending on your property and the average amount of time it takes to evict someone, as it may vary depending on your state’s laws. You also want to consider the average time it may take to get another tenant in who will pay the rent. Check online or with a real estate lawyer in your area to calculate what the worst-case scenario may be for your situation.