Being an investor requires that you wear a lot of hats. If you deal with investment properties or manage a rental property, you know that bad tenants can ruin your cash flow, so the banker's hat needs to be put on before any of the others. This lets you know when you should walk away from a bad deal or when you should offer up a contract. Determining an acceptable cash flow for a property means doing the math. You have the potential for a profitable investment if you adhere to this simple formula:
(Monthly rent charged) is greater than (total cost of mortgage + taxes + maintenance costs + any other expenses such as HOA fees, capital expenditures, lawn care fees, property management fees, etc.)
Ideally, you want at least a 5-10% profit after the above expenses are calculated. If you have nothing left after covering the basic costs of a property, then it is NOT a good investment and you need to avoid that investment or adjust the amount of rent you need to charge, and be sure that the property and location will justify that increase.
Real estate investing only works if the numbers work and you can turn a profit, but once you have the property don't destroy the numbers by renting to bad tenants. This is where the calculator has to give way to sensible and diligent management practices.
When you put bad tenants in a property without doing the appropriate legwork first, you are asking for trouble. Real estate that is sitting empty does represent a negative cash flow, but doing your homework and screening applicants appropriately will be worth it when you avoid the following bad events:
- Your renter doesn't pay rent on time.
- Your renter doesn't pay rent at all. This could lead to an eviction process, which is also costly to undertake.
- Your renter doesn't have the appropriate income to afford your property.
- Your renter doesn't take care of the property, leaving you with thousands of dollars' worth of damage that is now your responsibility.
- Your renter decides to sublet the property without permission and without telling you who is moving in.
If you don't want to do the background checks yourself, then you should hire a professional tenant screening service to do it for you. These services pay for themselves by looking into a potential applicant's credit records, rental history, and a criminal background check. Some services will even check an applicant's references for you, a step that you should NEVER omit.
Using a tenant screening service can also guarantee that your process is legal and fair according to the U.S. Fair Housing Act, which states, “The Fair Housing Act prohibits discrimination in housing because of: race, color, national origin, religion, sex, familial status, or disability.” (You should also be familiar with your particular state laws as well because they can also prohibit discrimination based on marital status, sexual orientation, and gender identity.) Professional tenant screening services can ask the right questions, the right way.
The cost of a tenant screening service can range from $25-100 depending on the level of detail you need regarding an applicant's background. Often this cost can be passed along to the applicant if you charge a rental application fee (this is also a great way to weed out the people who are “just looking” from those who are serious about renting a place). The reports generated will allow you to legally review an applicant's credit report, criminal background, and eviction history. In doing so, you improve cash flow by weeding out applicants that don't offer security of revenue.
Another way that bad tenants can squeeze your cash-flow margins is if they don't follow the rules that you have specified in your lease agreement. If your agreement states clearly that no pets are allowed, then the renter who is walking two big dogs on a daily basis is clearly in violation of the lease agreement, and there may be untold damage to the property. Situations like these can also be a good reason to personally contact former landlords to see if the applicant can follow the rules or not. You want to rent to people who have a track record of following the rules, not breaking them.
Other red flags to watch for include applicants who want to pay only in cash, applicants who want to haggle over the price of rent or deposits, applicants who refuse to undergo a background or credit/criminal check, applicants who don't fill out the entire application, applicants who want to pay in installments, and applicants who are vague in any of their responses to your questions. If any of these occur, increase your scrutiny and be prepared to reject that applicant.
As an investor it is worth it to do your due diligence and follow these simple guidelines to find the best applicants to place in your investment property. Don't let a bad tenant ruin your cash flow!