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.
4. Failing to do background, credit checks
You know that internal sensor that lets you size up a person's character in one meeting? Well, says Walmsley, "It doesn't work at all."
A nicely dressed, well-spoken person could be living beyond his means, he says, or be a great salesman (aka con man).
No, when entrusting what's likely your biggest financial asset to a stranger, the rule is this: screen, screen, screen.
Managers say you want to know whether an applicant has been evicted in the past; whether he has a history of criminal behavior that could jeopardize you, your neighbors or your property; and whether he earns enough. An industry standard is a monthly income at least three times the rent.
Here's where property managers are particularly helpful. They have relationships with background-investigation firms and know the laws surrounding data searches. For instance, you may know that collecting background information on someone requires her signed consent, but did you know that federal law mandates that you shred the data afterward to prevent identity theft?
You needn't chuck the gut check altogether. Just use it to supplement a criminal and financial screening. And credit scores alone are not all-telling, say managers, as it’s possible for people’s credit to be damaged (after a hospitalization or divorce, for example) without their ever having missing a rent payment.
"I rented to this couple and I was convinced that although their credit stunk they were going to legitimately pay their rent on time," Berg says. "And they did pay their rent on time, and they still do pay their rent on time."
5. Going with a handshake
People who pay to live in your home are typically still legal tenants, with or without a lease. In other words, don't think forgoing a lease will let you forgo a legal eviction process, as well.
"I would never recommend not having a lease," says Adams, the real-estate lawyer. Often the tenant gets the benefit of the doubt anyway, he says. "I can't think of a situation where you'd be better off without a written document."
In many states, a lease is required. And the state might mandate certain inclusions. Among other things, a lease also allows you to spell out which, if any, payments or damage tenants are responsible for, Walmsley says. That and getting a security deposit large enough to cover possible missed rent are the two most crucial ways to protect yourself, he says.
6. Not upgrading your home
"A lot of people will think, 'Well, I'm going to rent it out so I don't really need to paint, or fix the fourth burner on the stove,'" says Sylvia Hill, co-owner of H.M.S. Development Inc., in San Jose, Calif. "Wrong."
It may seem counterintuitive to upgrade for others, but the payoff is big: Nice homes attract nice renters. "If you don't have a well-maintained home, you're going to get the tenants who don't maintain a home," Hill says. "A majority of tenants want a nice place to stay, and they're going to keep it up. There are a lot of excellent people who rent for years and years and they take excellent care of the property."
In addition, broken items not only pose a potential liability, but tenants can claim uninhabitable conditions as a reason to not pay the rent.
7. Believing ignorance is a legal defense
Taking on renters is a little like adopting children; you become legally responsible for their safety, at least as it relates to the property. That includes structural damage, environmental hazards (radon, carbon monoxide, lead paint, mold) and security. It's up to you to ensure the property meets code when it is rented and up to you to take reasonable measures to respond to renters' concerns about unsafe conditions, even neighbors' suspicions of potential criminal activity on your property, say experts.
"If you're going to do it, don't enter into the landlord-tenant situation thinking either, 1) it's easy money or 2) that you don't have to know anything about it," says Debra Carlton, of the California Apartment Association, a trade association that represents managers and owners. "There are huge penalties" if you get it wrong.
In addition, a number of federal fair housing laws, as well as state laws, protect tenants from discriminatory selection. You might know, for example, that it's a violation of the Fair Housing Act to reject an applicant based on race. But did you know you can't reject someone with a past drug conviction, which could be considered a mental disability? (You can reject someone with a conviction for selling drugs, however.)
You also can't suggest that, due to a person's limp, he might be happier with a first-floor apartment. Nor can you tell prospective tenants that the third floor with the low windows is unsafe for children. You have to fix the windows.
Depending on state and local laws, renters also have a right to have a home business, as long as it's not a nuisance. In California that permits a day care with up to a dozen children. "There can't be discrimination based on some arbitrary opinion you have about someone's ability to be a good renter," Carlton says. “You only really have two reasons you can discriminate: their ability to pay rent and whether they've been a nuisance tenant somewhere else. Anything else is irrelevant."
8. Getting desperate
Robert Howells, an owner of Sundance Property Management in Portland, Ore., says he's received a spike in calls since 2006 from homeowners who have moved, can't sell and choose to rent out their property. Property managers in other areas of the country report the same. (The numbers of renters outside large complexes is not immediately tracked, according to RealFacts, an apartment data specialist.)
"It's a good idea, but they have to be realistic about it," Howells says. "Just because they decide they want to lease their house out doesn't mean there's a renter sitting there waiting."
Pam Widman, a broker with Carefree Property Management, also in Portland, has a client who moved to Florida and left a house that's now been on the market nine months and has been difficult to rent as well, due to some structural oddities.
Try to prepare yourself — financially and emotionally — for the possibility that you'll be footing the bills for the foreseeable future. Otherwise, fear and anxiety could drive you to rashly trust the wrong tenant. "Don't be so desperate that you rent to the first person that comes along," Berg says. "You need to have an application and you need to check every reference that's provided."
Otherwise, you could end up in worse shape than when you started.
