8 pitfalls for new landlords
When struggling home sellers opt to rent out their homes until the market improves, they can be in for one rude awakening after another. Here's how to avoid the worst newbie mistakes.
Can't sell your house? Try this: Just rent it out. You know, at least until a good buyer comes along.
If only it were as easy as it sounds.
With a glut of homes for sale and prices still dropping in many areas, would-be sellers who've already moved or downsized are now facing this question: Since the house is empty, should I fill it with renters until the market picks up?
The answers from experts range from the risk-averse ("No! Don't do it!") to the optimistic ("Absolutely! Beats nothing!"). While that might seem like little help, there is one point on which they all agree: Do not, under any circumstances, enter into a landlord-tenant relationship without learning the basics first.
"To be honest with you, it's really not a good solution for many, many people," says Del Walmsley, with the National Apartment Association. "If you don't know what you're doing as a landlord, there are just a tremendous number of pitfalls you can fall into with tenants."
Walmsley, a landlord of 20 years, could fill a radio show with bad-tenant stories. Wait, he does fill a radio show. For an hour every weekday, callers to the Del Walmsley Show, broadcast in Dallas and Houston, talk about real-estate investments and share tenant tales.
There are the tenants who leave early, breaking leases without notice, and the tenants who stay too long, neglecting to pay rent with excuse after excuse. (Read some of these in the Landlord Protection Agency's Excuse of the Day.) There are the destructive tenants, who play "throw a brick into the wall until it sticks," and the retaliatory tenants, who, irritated by rent requests, clog the toilets with cement upon their eventual departure.
"Real estate is easy; people are difficult," Walmsley says. (You can read MSN Real Estate readers' tales of nightmare tenants here.)
8 pitfalls to avoid
Still, every bad outcome can be avoided, he says. The trick is to go in prepared.
"All landlord-tenant problems are created by the landlord's greed or laziness," Walmsley says. "Or lack of information, but that really falls under laziness, because you can get educated."
So, learn from the mistakes of others and avoid these common pitfalls:
1. Treating a rental casually
Renting out your home is a business. Fail to treat it as such and you could be hit with fines or legal judgments that far exceed a few mortgage payments. Collect any rent and you are a business in the eyes of:
- The tax man: Rent is business income and must be reported to the Internal Revenue Service. On the flip side, certain repairs and upkeep, in addition to mortgage interest, can be deducted as business expenses. Don't skip the extra paperwork; if the IRS finds unreported income, you can be ordered to pay penalties, back taxes and interest. Also, at some point your house could be reclassified as an investment property, which has different tax implications than a primary residence.
- Insurance companies: Turning your home into a business isn't necessarily covered under your homeowner's insurance. "If there's a fire and you're not living there, the homeowner’s policy won't cover the loss," says Mark Adams, a real-estate lawyer with Hall, Render, Killian, Heath & Lyman, in Troy, Mich. Get liability insurance to protect your house and its occupants.
- Authorities: A host of federal, state and local regulations exist to protect renters from hazardous living conditions and discriminatory housing practices. Think of it this way: You are free to be as stupid as you like in your own home, by failing to install a smoke detector, for example. But as a business you are responsible for protecting your tenants. Even an occupant without a lease can be considered a "tenant at will" and has legal protections.
2. Going it alone
Thick books are devoted to the many ways in which landlords can be successfully sued. The experts recommend talking to — and preferably hiring — a property manager (if not a lawyer) familiar with the regulations in your city and state.
Some of the large companies might not take single-property clients, says Liz Berg, owner of Landlord’s Best Friend Property Services, in Portland, Maine, and one of many who don’t advertise. "They do exist, but they're not always easy to find."
Try linking to the local affiliates of the National Association of Residential Property Managers to find a property manager. The National Apartment Association has local groups that publish "red books" with regional regulations. Or start by reviewing the statutes for your state.
Property managers can tell you if your property is up to code and what to charge, and do the advertising, screening and lease management for a fee, typically around 10% of the rent.
3. Confusing 'rent' with 'mortgage'
It's natural to assume the rent should cover the mortgage. After all, it's what you paid to live there, right? But this is not how it works. It is the most common misperception new landlords have, say property managers.
The mortgage is an agreement you made with the bank based on the sum of the loan, the percentage you put down, your credit history and the market valuation of the property at the time of sale.
Not one of these factors goes into determining rent.
"There's no relationship whatsoever between what they pay for mortgage and what they rent it for and pay us," says Bob Alldredge, a property manager and owner of Jericho Properties Realty, near Denver.
Remember that the two also buy different things. A mortgage pays for an investment. Rent pays for a temporary roof with none of the financial or tax benefits of ownership.
See what similar rentals are fetching in your area or get a property manager's estimate.