Some of you have messaged to let me know you’ve taken the plunge and bought a rental property as a first-time real estate investor. I can’t tell you how excited that makes me feel. The idea that more physicians are finding ways to create passive income on their way to financial freedom is awesome. Some of you have even bought an investment property out of state like I did. I’ve said it again and again that I believe owning real estate is one of the best ways to gain wealth – in terms of money and time.
However, one of the biggest deterrents to owning real estate is the notion that being a landlord is extremely difficult. People fear the dreaded weekly 10:00 pm phone call on a Saturday night for a clogged toilet. In my five years of owning rental property, I’ve never gotten that call. (Well, I did one time on a Sunday afternoon and got it taken care of with a 5-minute call.)
But why have I never really gotten that call? Mainly because I’ve delegated the management of my properties to experienced property managers. Sure, having property management is an expense and eats into your profits, however, I feel it’s absolutely worth it to not have to deal with many of the issues they deal with. My time is ultimately more important and more valuable. In fact, I’d rather spend that time figuring out how to acquire more passive income.
I do self-manage one small property though. It’s a condo that my wife and I lived in during residency and for a short time after we both started our attending jobs. We bought our current home and decided to rent out that condo. I’ve thought about letting someone else manage it, but it’s in good condition and we've had a long-term tenant that is just fantastic. Since I know the property so well and know all the vendors to call if there's an issue, it's been easy to manage.
I’ve learned so many lessons over the past five years about being a landlord and made my share of mistakes. My goal is to keep you from making the same ones. So especially for all you newbie landlords, here are 5 landlord mistakes that you do not want to make.
Not Hiring Professional Property Management
Okay, I know I don’t have a property management company for my condo, but that’s one small unit. For all of my other properties, especially the ones out of state, there’s no question in my mind that I need to have competent property management in place. It’s a no-brainer. Time is precious and it’s worth it to have someone manage it for you.
When I'm referring to management, I would strongly suggest hiring professional management, not just some friend or tenant to help. The reason I'm saying this is that good, professional management companies absolutely run the property differently. They know how to maximize the profitability of the property, partly because they're incentivized to. The other thing is that professional property managers understand state and local laws.
We initially hired a friend of the real estate broker to manage our apartment building. It was poorly run, tenants were unhappy, and we received a good number of complaints directly from them. When we changed management over to a professional company for only a fraction more, we saw how differently good management runs things. All our leases were organized and properly filled out. All the necessary disclosures were done correctly. All the proper signage around the building were put up to make sure we were in compliance with landlord-tenant laws. It was the difference between night and day.
Overestimating Your Rental Rates
There’s a certain pride that comes with ownership and in many ways, we tend to overestimate what we can command in rent. Maybe you’ve re-done the floors or the bathrooms and expect that people should be willing to pay more it.
However, it’s important to think as a consumer or renter. Do a direct, honest comparison with properties in that area. Hopefully, your property management has a great understanding of the local market and can price your unit properly. And you have to be willing to drop rents if the market doesn't support it or show interest in that price.
What I’ve learned is that it’s better to have your place occupied for less than keep it unrented for a long period of time. For example, having a place rented for $600 x 12 months ($7200) is way better than having it rented for $650 x 10 months ($6500).
I've definitely made this mistake in the past. I remember being stubborn about the rental price for my condo at first and I lost a few potential great tenants. This was all over a small amount each month. However, after it sat vacant a while and I was paying the mortgage on it, I realized it made more sense to drop the price to meet demand and have it rented. Since that point almost 5 years ago, yes, I've had tenant turnover but because I've been smarter with the price point, the longest I've had it unrented between tenants is 2 weeks.
Being Lenient with the Eviction Process
Okay, this one may sound cold and harsh, like the stereotypical tough landlord. However, if a tenant is not paying you, they’re not keeping up their end of the bargain. If a tenant is breaking the terms of the lease, they're not holding to what they agreed to. Delaying the eviction process will set yourself up for future pain.
Depending on where you live, the process may take a while so it makes sense to get started sooner rather than later especially for repeat offenses.
We had a situation recently in one of our rental properties where someone was starting to show a pattern of late rental payments. They had been living there for a year without any issues. Property management suggested we start the eviction process immediately.
We felt bad doing that to a tenant who had been with us a while, so we suggested we give them some time. Well, it took over two months to receive their rent and now that tenant is habitually late on their rent. We wonder if their rent will make it on a monthly basis. We wonder if leniency now helped encourage this habit of late payments.
Underestimate the Cost of Repairs and Maintenance Expenses
This can be the toughest one to learn and is still something that I'm continually working on. As owners, we definitely don’t expect as many things to go wrong as they actually do. Just ask any homeowner, things break and need to get repaired/fixed. It’s extremely important to make sure to estimate these costs correctly especially as you’re trying to figure out what your cash flow situation will be and how well your investment is doing.
Also, let’s be honest, most tenants do not have the pride of ownership like you do. They just don’t take care of the place as well and that leads to more wear and tear on the property and all that it contains.
Landlords might be good at estimating monthly expenses like gardening or the occasional plumbing issue. However, they sometimes forget about a concept called capital expenditures or CapEx. These are larger scale maintenance issues or replacement costs. They may not occur every year but need to eventually be addressed. Examples of this include roofs, HVAC systems, water heaters, etc. They can be big costs to replace and the smartest way to account for this is to put aside money in your budget to account for the lifespan of these items and how much it'll cost when you do have to repair it.
I try to take this into account by setting aside around $600-700 per unit a year just to cover some of these expenses. I calculated that by trying to figure out what those large costs are and how much I'd have to pay when they come to the end of their lifespan. Again, I haven't had the properties for that long, but that number has worked for me thus far.
Not Treating It Like a Business
My wife and I became “accidental landlords” when we began to rent out our condo. We didn't initially treat it like a business. So honestly, in the beginning, we didn't have an accurate idea how much money we were going to make from it.
Only when I began to take being a real estate investor seriously did I think about owning rental property as a business. As such, I began to consider issues such as billing, bookkeeping, tax issues, proper paperwork, liability and asset protection.
We're lucky we had great tenants and the property is in a great area. However, I can see how people can lose money by not understanding the numbers and how to efficiently run the property to make sure you have a good return.
Are Mistakes Inevitable?
Owning real estate is one great pathway to acquiring wealth. However, there is a learning curve, especially as an owner and landlord. The key is to learn from your mistakes and keep moving on, but what I've learned is that it's also very important to learn from other people’s mistakes (like mine). Spend time reading and asking others with experience and expertise. You'll be surprised to find out how willing people are to share their successes and failures.
Acquiring passive income isn’t always easy, especially at first. It will take some effort up front to make sure you've set it up for long-term success and benefits. There will be bumps along the road, but making mistakes and learning from them is part of the process. But now that you know, just try to not make these landlord mistakes.