So, You Want to Be A Landlord...

Investors may underestimate the complications associated with owning a rental property.
By: JAMES R. HAGERTY: The Wall Street Journal Online
Determined to profit from the housing boom, many Americans are acquiring rental properties. But some of them may be underestimating the risks and complications that come with being a landlord.

"We get a lot of inquiries from naive people," says Mike Phillips, who owns Century 21 All-Pro, a real-estate brokerage firm in Kansas City, Mo. He gets calls from people in California, Florida and New York who figure property in Kansas City must be a steal.

Mr. Phillips tells inexperienced investors they need to examine such factors as the health of the local economy and the supply and demand for rental housing. In much of the country, the fundamentals look bleak for landlords. Low interest rates have allowed many former renters to buy their own homes in recent years, removing some of the most reliable tenants from the mix. According to the Census Bureau, the vacancy rate for rental housing in this year's first quarter was 10.1%; that rate has been gradually rising since the late 1970s, when it was around 5%.

Investors also need to ask whether they can cope with the hassles of dealing with tenants. "What if the renter's kid shoves G.I. Joe in the toilet?" Mr. Phillips asks. "You have to have a game plan, because they're going to call you."

Yet Americans' faith in real estate is remarkably strong. During this year's first four months, investors accounted for nearly 10% of new mortgage loans used to buy homes in the U.S., up from 6% in 2001, according to LoanPerformance, a unit of First American Corp.

For those willing to put up with the ordeals of owning rental property, here are some tips from seasoned landlords.

FIGURE OUT YOUR TOTAL COSTS. Unless you take into account all of your costs, you won't know whether you're making money.

"Most people underestimate their expenses dramatically," says Jonas Lee, a managing partner at Redbrick Partners LP, a New York firm that invests in single-family rental housing in Baltimore, Philadelphia and other Northeastern cities. The costs include obvious things like insurance, maintenance and property taxes. But they also include items that some landlords overlook, such as periods of vacancy, bad debts, the occasional need to replace expensive items like roofs or furnaces, and time spent managing the properties, Mr. Lee says.

All of these costs can easily eat up half of expected rental income, Mr. Lee figures. And that's before you consider financing costs, which may absorb the rest of your rental income, or more.

SCREEN POTENTIAL TENANTS. Many landlords use a variety of Internet services to check on applicants' credit histories as well as any past evictions or criminal troubles. "My theory is that if they don't pay Citibank, they're not going to pay me," says Jean Yevick, a veteran rental-housing owner in Pittsburgh who is president of the Western Pennsylvania Real Estate Investors Association.

Some landlords also consider such things as whether the applicant shows up on time for an appointment and can communicate clearly. Neatness helps. "If they have a car that's full of junk and is disgusting-looking, the likelihood is that they're going to keep a dirty house," says Ms. Yevick.

Don Werner, a Denver landlord who is chairman of a committee of independent rental owners who belong to the National Apartment Association in Alexandria, Va., requires his tenants to have monthly income of at least three times the rent.

UNDERSTAND THE FAIR HOUSING ACT. Among other things, this 1968 law prohibits discrimination in the renting of housing based on race, color, national origin, religion, gender, family status or disability.

That doesn't mean you have to rent to anyone who comes along. But you should strictly follow written policies about your criteria for selecting tenants so you can't be accused of bias. It is lawful, for instance, to refuse to rent to convicted criminals. But you could be vulnerable to complaints of discrimination if you applied that rule only to certain applicants. If you want to run criminal checks on some applicants, run them on all.

"Where people get in trouble is when they eyeball a situation and just go with their gut," says Bryan Greene, a senior official at the U.S. Department of Housing and Urban Development who helps enforce the fair-housing law. HUD and local housing agencies last year investigated more than 9,000 complaints about possible violations of the law. The penalties can include fines of as much as $11,000 per discriminatory action as well as damages to victims.

REACT QUICKLY WHEN TENANTS CAUSE TROUBLE OR DON'T PAY. "There are a lot of people who have convincing stories" about why they haven't paid the rent, says Chris Ballard, who owns rental houses in the Atlanta area as well as Century 21 Gold Medal Realty in Atlanta. But "you have to stick to your standards," he adds. "You learn over time to be polite but firm and direct." After 30 days, he starts the eviction process. Some landlords start even sooner.

Many rely on the courts to evict deadbeat renters. But Rich Sommer, a landlord in Stevens Point, Wis., says he can usually work out problems informally by visiting tenants. "Most often a five-day notice will encourage them to leave," he says.

If tenants violate Mr. Sommer's rules, which include a ban on kegs of beer, he urges them to find another home more suitable for their lifestyle choices. To show his good faith, he sometimes shows up with a check refunding part of the deposit and promises to pay the rest if the tenant leaves within a few days without causing damages.

INSPECT THE PROPERTY REGULARLY. Mr. Ballard, in Atlanta, makes sure to inspect each unit once every six months. In the past, he was less disciplined about inspecting. He then discovered that one tenant had let more people move into the house without Mr. Ballard's knowledge. That eventually caused a septic tank to overflow and leak into the backyard. During his inspections, he carries a camera so he can record any evidence that a tenant isn't fulfilling responsibilities.

BE READY FOR PROBLEMS. Landlords need strong stomachs. Mr. Sommer has had a suicide in one of his apartments and a drug raid in another.

Expenses can come in big lumps. Mike Weston, a financial planner in Highlands Ranch, Colo., says sewer lines broke in two of his rental units within a month. "I'm assuming it was a total coincidence," he says. The cost totaled more than $10,000. Other tenants called him in to unclog toilets or shoo away bees from the backyard. Eventually, he decided the headaches were too frequent and sold his properties. "Every time I went out of town, I had nightmares about what would happen to the property," he says.

MAKE SURE YOU ARE PROPERLY INSURED. Ted Webersinn, a commercial-property appraiser in Surry, Maine, and his wife, Susan Sokol, owned rental rowhouses in Baltimore in the 1980s. They initially expected the neighborhood where they invested to improve, but the crime and blight only grew worse. The property manager they hired carried a gun while collecting rents. Eventually, the couple sold four of the houses and gave one to the city.

More than a decade later, a former tenant sued them, alleging that the tenant's children had suffered from exposure to lead paint. The case rumbled on for years before being settled out of court. The couple's insurer paid for the settlement and legal fees. As soon as that suit was settled, a second tenant filed a similar one. Altogether, Mr. Webersinn and his wife endured about a decade of litigation. Without insurance, Mr. Webersinn says, they probably would have had to file for bankruptcy.

DON'T COUNT ON RAPID APPRECIATION. "People are real high on appreciation right now," says Mr. Sommer, the Wisconsin landlord. "They think they're just going to make gajillions." But house prices are unlikely to keep rising indefinitely at the rapid clip of the past few years. That means some investors may find themselves remaining in the landlord phase longer than they expected while waiting for a good opportunity to sell. A landlord for the past 35 years, Mr. Sommer describes real estate as a way to "get rich slowly."

BE GOOD TO GOOD TENANTS. Mr. Sommer's wife, Carolyn, bakes Christmas treats for them every year.

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